Frans Verhaar: Validation, the invisible cost

November 11, 2025

By Frans Verhaar, Managing Director, Head of Continental Europe at bfinance

The costs of illiquid investments have been under scrutiny for years. And rightly so: the total fee burden on private equity, private debt, real estate and infrastructure is considerable and can significantly affect the net return over the term. Yet one crucial aspect of cost management often remains overlooked: validation. In other words, do investors check whether the agreed terms are actually being applied correctly?

In recent years, much progress has been made in the area of transparency. Investors are demanding greater insight into cost structures, industry groups such as ILPA have defined best practices, and most Limited Partner Agreements (LPAs) are more comprehensive than ever. But insight alone is not enough. After all, transparency says nothing about the accuracy of what is being invoiced.

A recent bfinance survey of private market investors shows that 90% of LPs are primarily focused on “hidden costs” and benchmarking fee levels. Only a fraction (about one in ten) mention checking compliance with the LPA or validating carried interest calculations as a priority. And nearly two-thirds of investors do not perform any validation of their General Partners' waterfall or carry calculations at all.

This is striking, because this is precisely where the biggest differences arise between what investors think they are paying and what is actually deducted from their returns.

The governance blind spot

In many organisations, the division of responsibilities is unclear. Comparing fee levels is the responsibility of the investment team: it directly affects returns, portfolio optimisation and manager selection. Validation, on the other hand, is often seen as something for the back office or compliance: a kind of administrative exercise. As a result, it falls between two stools: too operational for investors, too complex for administration.

But that attitude can prove costly. In the United States, regulators (SEC) have uncovered several cases in recent years where managers made mistakes in their cost allocation. Some of these led to millions of dollars in repayments. Not infrequently, these involved well-regarded, globally active funds.

Our experience shows that most errors are not the result of malicious intent, but of complexity and differences in interpretation. LPAs are often lengthy documents in which definitions and calculation methods leave room for different interpretations. Nevertheless, in practice, the differences often work to the detriment of the investor.

Where does it go wrong?

A number of practical examples show where things can go wrong:

• Incorrect application of the fee basis. Managers sometimes continue to calculate based on committed capital rather than invested capital for too long, or do not exclude certain investments from the fee basis.
• Incorrect accrual method. An LPA prescribes daily accrual, but the manager applies quarterly accrual because this is easier to align with invoicing.
• Incorrect waterfall calculation. In hybrid structures (partly deal-by-deal, partly whole-of-fund), incorrect application of the transition rules can lead to substantial differences in carried interest.
• Incorrect compounding of the hurdle. Some managers apply “simple compounding” where “strict compounding” has been agreed, resulting in the preferred return being too low.

These kinds of deviations may seem small, but in funds worth hundreds of millions or billions of dollars, they quickly add up. In diversified institutional portfolios, more of these kinds of errors can cost millions in value over time.

From transparency to validation

The lesson is clear: transparency is a good start, but no guarantee of accuracy. An LP may know exactly what is being charged, but not whether that calculation is correct.

A systematic validation process, either internal or with the help of an independent party, provides that certainty. It is not an audit in the traditional sense, but a targeted check on the application of agreed terms and conditions: have the management fees been calculated correctly, have the hurdle rates been applied correctly, is the distribution in the waterfall correct?

When irregularities are discovered, this rarely leads to conflict. On the contrary, it often forms the basis for a constructive discussion with the manager and better mutual coordination. Moreover, it strengthens the investor's governance position and creates confidence among internal and external stakeholders that the costs are indeed correct.

Conclusion

Private markets will always remain more expensive than liquid markets. That is the price for access to unique return opportunities and illiquidity premiums. But more expensive does not have to mean paying more than agreed.

Those who want to manage costs seriously cannot limit themselves to comparing fee levels or pursuing transparency. Validation is the missing link in professional cost management, the silent but crucial step that ensures that investors actually pay what they should pay, no more and no less.