Metrick & Yasuda (2010)

Citation: Metrick, A., & Yasuda, A. (2010). “The Economics of Private Equity Funds.” Review of Financial Studies.

Metrick and Yasuda’s 2010 paper provides the definitive analysis of how private equity fund economics actually work. Using a novel dataset of 238 funds (94 VC, 144 buyout) with detailed contract terms, they build a model to estimate expected GP revenue and examine how it varies across fund types and characteristics.

The central finding is striking: about two-thirds of expected GP revenue comes from fixed components (management fees) that are not sensitive to performance. This challenges the narrative that PE compensation is primarily performance-driven.

flowchart LR
  subgraph GP Revenue Sources
    MF[Management fees ~2% annually]
    CI[Carried interest ~20% of profits]
    TF[Transaction fees BO only]
    MON[Monitoring fees BO only]
  end
  MF --> FR[Fixed revenue ~2/3]
  TF --> FR
  MON --> FR
  CI --> VR[Variable revenue ~1/3]

Key findings on fund economics:

1) Management fees dominate. The “2 and 20” label is misleading. The 2% management fee, compounded over fund life, generates the majority of GP revenue. Carried interest only pays off if returns exceed the hurdle rate significantly.

2) BO and VC are fundamentally different businesses. Buyout funds are more scalable—experienced BO managers grow fund sizes faster, leading to higher revenue per partner in later funds. VC funds show no such scaling; experience doesn’t increase fund size or revenue per partner.

3) Fee structures have meaningful variation. While 2% initial fees are common, most funds give LP concessions after the investment period (switching to invested capital basis, lowering rates, or both). Median lifetime fees are ~12% of committed capital for BO funds, ~18% for VC funds.

4) Fund size drives economics more than fee rates. Successful GPs don’t primarily negotiate higher fee percentages—they raise larger funds. A 3x larger fund at slightly lower fees generates far more GP revenue than a small fund with premium terms.

flowchart TD
  subgraph BO Scaling
    EXP1[Prior fund success] --> SIZE1[Larger next fund]
    SIZE1 --> REV1[Higher revenue per partner]
  end
  
  subgraph VC Non-Scaling
    EXP2[Prior fund success] --> SIZE2[Similar fund size]
    SIZE2 --> REV2[Flat revenue per partner]
  end

Why the BO/VC difference matters:

VC is labor-intensive. Each portfolio company requires intensive partner involvement. The median VC fund makes 20 investments with 4-5 partners → ~5 deals per partner. This ratio can’t increase much without degrading quality.
BO is more scalable. Buyout deals are larger but fewer (median: 12 investments per fund). More importantly, BO firms can add professionals and leverage operational resources. Revenue per partner grows with experience.
Implications for LP negotiations. VC LPs have less leverage—fund size is constrained by the nature of the business. BO LPs face GPs who can credibly threaten to scale up and dilute returns.

The carried interest option:

The paper models carried interest as a call option on fund performance. Key parameters:

Strike price = hurdle rate (typically 8%)
Underlying = fund returns
Volatility driven by number of investments and their correlation

This option-pricing framework shows that carried interest is worth less than naive calculations suggest, because it only pays off in good states. The fixed fee component provides downside protection for GPs regardless of performance.

Implications for the GP fee debate:

The paper provides ammunition for both sides:

Critics: Two-thirds of GP revenue is guaranteed regardless of performance. GPs are paid even when LPs lose money.
Defenders: The structure reflects the reality that GP human capital has outside options. Fixed fees are the price of securing commitment for 10+ years.

PE fund economics are more complex than “2 and 20” suggests. Fixed revenue dominates, buyout and VC have fundamentally different scaling properties, and fund size is the primary lever for GP wealth creation. This is why fee structures persist and LP bargaining power remains limited.