Fee and expense allocation
ILPA's reporting and transparency standards, including the ILPA Principles 3.0 and the ILPA Reporting Template 2.0 released in January 2025; the FCA's treatment of fee and expense allocation as a conflict of interest; SYSC 10; and the limited partnership agreement.
Look at what a limited partner pays for in a year. The management fee comes off first. Then the offsets that are meant to reduce that fee, the deal costs charged to the fund, the broken-deal expenses when a transaction dies, the placement fees, the interest running on the subscription line, the operating-partner charges, and behind all of that a long tail of partnership expenses. Every one of those is a figure an LP can pull off the report and trace to a cash movement, and the limited partnership agreement gives them the audit rights to do it. ILPA has now standardised how each of those figures gets reported, and the FCA treats fee and expense allocation as a conflict of interest it will pursue.
So the practical question for a board is what an allocation has to look like on the page when an LP’s auditor asks why a particular cost fell on the fund and not the manager, or on this fund rather than that one, or on the LPs rather than the co-investors. Not the policy in the abstract. The disclosure and the contemporaneous evidence that answer the question from records. The firms that come off badly here are rarely the ones that overcharged on purpose. They made a reasonable call in the moment, kept nothing that showed the reasoning, and two years on can’t demonstrate the call was reasonable.
Expenses are traceable cash movements, so start there. Unlike a valuation, an expense allocation is a cash movement an LP can trace. Over a fund’s life the offset practice, the deal-cost allocation and the expense apportionment add up to basis points of net return, and institutional investors judge their managers in those terms.
Then there’s the standard, which has been written down and then tightened. ILPA’s Principles 3.0, published in 2019, set clear expectations on offsets, broken-deal costs, pre-investment expenses and the governance of unforeseen costs. In January 2025 ILPA released version 2.0 of its Reporting Template, the product of its Quarterly Reporting Standards Initiative. It takes the required partnership-expense categories from nine to twenty-two, requires disclosure of fee rebates, waivers and offsets, demands granularity on amounts paid to related persons, and removes the manager’s ability to modify, reorder or supplement the line items. Reporting “partnership expenses” as one summarised number is on its way out. What replaces it is line-item and comparable across managers, so an LP can benchmark your expense practice against your peers in a way it couldn’t before.
The FCA now examines fee and expense allocation directly. The FCA’s March 2025 valuation review named investor fees as one of seven conflict situations firms must identify and manage, and the follow-on conflicts review covers fee and expense allocation directly. The relevant limb of SYSC 10.1.4R is the first.: a conflict exists wherever the firm is likely to make a financial gain at the client’s expense, which is what every decision to charge a cost to the fund rather than the manager amounts to. There’s a disclosure hook as well. FUND 3.2.2R, carrying the AIFMD Article 23 investor-information requirements, makes the manager disclose the fund’s fees, charges and expenses and how they are calculated, before investment and on any material change, so an opaque or shifting expense practice fails twice over, as a conflict and as a disclosure. This is now a regulated conflict the firm must be able to show it managed, not just a commercial matter between GP and LPs.
An LP audit, and the operational due diligence an LP runs before a re-up, works through a predictable set of flashpoints. Each has a recognised standard and a piece of evidence that meets it.
| Flashpoint | The standard | The evidence |
|---|---|---|
| Management fee offsets | ILPA Principles 3.0 expect portfolio-company fees, transaction, monitoring, director and advisory, to be 100% offset against the management fee, with any exemption rare and clearly defined in the LPA | A reconciliation showing every fee received from portfolio companies, the offset applied, and its basis in the LPA, including how accelerated monitoring fees are treated on exit |
| Broken-deal and dead-deal costs | ILPA expects these allocated between the fund and any co-investment and parallel vehicles on a pro rata basis | A deal-by-deal record of broken-deal costs and how they were split, showing co-investors bore their share rather than the fund carrying costs for deals co-investors would have shared |
| Co-investment expense allocation | Co-investment vehicles should bear their share of deal and broken-deal costs, and the basis on which co-invest is offered and charged should be disclosed | The allocation of costs to co-invest, and whether it lines up with how co-invest opportunities were distributed |
| Placement agent fees | Placement costs shouldn’t pass to the fund without disclosure; where the fund bears them the treatment should be transparent and, where applicable, offset | Disclosure of the placement arrangements and their accounting treatment, reconciled to the LPA |
| Organisational and fund formation costs | Typically capped in the LPA, with the manager bearing the excess | The formation-cost total against the LPA cap, and confirmation the manager absorbed any overrun |
| Pre-investment and travel costs | ILPA Principles 3.0 expect sourcing, networking and preliminary due-diligence travel to be borne by the manager, becoming a fund transaction cost only once an investment passes the initial term sheet | A policy that draws that line and an expense trail that respects it |
| Operating partners and senior advisers | Where in-house value-creation teams, operating partners or senior advisers are charged to the fund or to portfolio companies rather than absorbed by the management fee, that must be disclosed, and amounts paid to such related persons are now a specific ILPA reporting category | Disclosure of the arrangement and the related-person amounts, with benchmarking where the charge falls on the fund |
| Subscription and NAV facility costs | The interest and fees on fund-level borrowing are borne by the fund, and their effect on reported IRR should be transparent | Disclosure of facility costs and, increasingly, returns shown with and without the leverage effect |
| Compliance, regulatory and insurance costs | Whether the fund or the manager bears regulatory, examination, compliance and insurance costs is a recognised allocation question, and amounts to related persons must be broken out | A clear, disclosed allocation basis consistent with the LPA |
| Shared expenses across funds | Where costs are shared across multiple funds or vehicles, the allocation methodology must be consistent, rational and defensible | A documented methodology and its consistent application across the platform |
| Unforeseen and novel expenses | ILPA expects GPs to build a decision framework with LPs for costs not contemplated at inception, and to engage LPs, including through the LPAC, in allocating them | The framework, and the record of LPAC engagement where it was used |
The pattern is the same across all eleven, and it’s the same one that runs through valuation and conflicts. Auditors test the contemporaneous record, not the policy.: the offset reconciliation done each period, the broken-deal allocation memo written when the deal died, the formation-cost reconciliation against the cap, the LPAC engagement minuted when a novel expense came up.
A workable framework has six components.
- An expense allocation policy that includes a decision framework. Beyond listing which costs fall where, it should set out, as ILPA recommends, how to allocate the costs the fund documents didn’t anticipate, so novel allocations come out consistent, rational and defensible rather than ad hoc. This is the document that turns a run of individual judgements into a system an auditor can test.
- A contemporaneous record for each material allocation judgement: what the cost was, why it fell where it did, and which LPA provision or which policy backed it. Most firms don’t have this, and auditors ask for contemporaneous reasoning first.
- Reconciliation to the LPA. The agreement is the contract, and the audit tests practice against it. A firm should be able to tie its offsets, its formation-cost cap, its expense categories and its fee calculations back to the specific LPA terms, side-letter variations included.
- ILPA-standard reporting. Adopting the ILPA Reporting Template, and version 2.0 for funds in scope from 2026, tells LPs the firm reports to the recognised standard, and it forces the firm’s own books into the line-item detail, the internal-versus-external split and the related-person granularity the audit will go looking for anyway.
- Related-person transparency. Where a cost is paid to the manager, its affiliates, its staff or connected parties, that has to be visible and, where the fund bears it, benchmarked. ILPA 2.0’s emphasis on related-person granularity turns opacity here into an obvious gap.
- LPAC engagement where it’s owed. For conflicted, novel or material allocation questions, evidence that the LPAC was engaged and, where appropriate, consented, minuted. Under SYSC 10 that’s part of how a firm shows it managed the conflict rather than only disclosed it.
The January 2025 template raises the bar in several concrete ways, set out below. The 2016 template let managers report partnership expenses across nine categories and, importantly, let them modify the template to fit their own books. Version 2.0 removes both. It requires twenty-two expense categories rather than nine. It prohibits modifying, reordering or supplementing the line items, so every manager reports on the same grid. It makes the firm separate costs incurred by internal staff from those charged by external service providers. It widens disclosure of offsets, rebates and waivers, of offering and syndication costs, of placement fees, of subscription-facility fees and interest, of insurance, and of fees charged to portfolio companies. And it pulls carried-interest roll-forward, realised, unrealised and paid, into the body of the capital account statement.
What that does in practice is let an LP take your report, set a peer’s beside it, and compare the two expense practices line by line, because both sit on the same standardised grid. A firm whose accounting can’t readily produce the twenty-two categories, or that’s been reporting a summarised expense figure, shows as behind the standard the moment an LP asks for the template. It applies on a go-forward basis to funds still in their investment period during the first quarter of 2026 and to funds commencing from the start of 2026. This is a live issue for any firm raising or deploying now.
In August 2023 the US Securities and Exchange Commission adopted private fund adviser rules that would have required detailed quarterly statements of fees, expenses and adviser compensation, and would have restricted certain charges without disclosure or consent. In June 2024 the US Court of Appeals for the Fifth Circuit vacated those rules in their entirety. As a matter of US law, the mandatory quarterly statement is gone.
The disclosure standard it aimed at isn’t. ILPA’s reporting template already demands comparable granularity. Sophisticated LPs already require it through side letters and audit rights. The FCA’s conflicts framework already makes a UK manager identify and manage the fee-allocation conflict and evidence it. Vacating the SEC rule removed one jurisdiction’s mandate and left the LP expectation, the ILPA standard and the SYSC 10 obligation where they were. UK obligations on fee and expense transparency are unchanged by the vacated US rule.
Before an LP or its auditor tests your allocation practice, test it yourself. For the last financial year, check whether you can pull a single file that answers each of these:
- every fee received from portfolio companies and the offset applied against the management fee, reconciled to the LPA
- each broken deal and how its costs were split between the fund and co-investors
- formation costs against the LPA cap, and confirmation the manager bore any excess
- which travel and pre-investment costs the manager carried versus the fund, with the dividing line clear
- all amounts the fund paid to the manager, its affiliates and connected persons, with benchmarking
- subscription-facility costs and their effect on reported returns
- novel expenses that arose, how they were allocated, and the LPAC engagement record
- this year’s report in the ILPA 2.0 format
Any item you cannot evidence from a file is where an LP audit starts.
This insight is provided for general informational purposes only and doesn’t constitute legal, investment, or regulatory advice.