As fundraising slows, LPs push back on misaligned fund terms

Nothing sparks my nerd spirit like a meaty discussion about the intricacies of the LPA.

I’ve been having numerous conversations about terms and conditions lately, a subject near and dear to my heart. Nothing sparks my nerd spirit like a meaty discussion about the intricacies of the LPA.

One thing folks are observing out there is a proliferation of fundraising incentives – early bird specials, fee breaks for first-closers, etc. Incentives have come back in a big way, apparently, as fundraising slows and LPs triage their forward commitment calendars, saving their capital for only a select few shops.

Another interesting consequence of the tighter fundraising environment is around term negotiations. LPs are taking a harder line in the negotiations than they have in the past, being afforded more leverage in these talks, as many GPs are desperate for pledges to their new funds.

We’ve heard about push back on various terms, but one in particular seems to be riling up the limited partner community. This is GPs’ effort to codify in the LPA so-called “pre-clearance” of conflicts in GP-led deals. Read the full story here on Buyouts.

Pre-clearance would allow, under certain circumstances, GPs to waive the limited partner advisory committee review and consent process for GP-led deals. Instead, the transaction would go straight to the election period when LPs decide whether to sell their interest in the asset or assets, or roll their stakes into the continuation fund.

For many LPs, this is an affront to their ability to properly vet a deal. Many institutions believe the LPAC review process is vital to ensuring the fairness of GP-led transactions. Even though technically the LPAC review is confined to assessing how the GP arrived at pricing and whether it represents fair market value, the process gives both the LPAC and the GP time to consider other aspects of the deal, like the rationale.

For example, one LP told me, a continuation fund process on an asset a GP has only held for two years would be problematic. In that case, the price for the asset might be rich, but still the LP would object to the process simply because of the short hold period. What exactly is the rationale for running such a process on an asset after only two years? This goes beyond a simple decision of selling or rolling – it gets to the heart of questions such as what exactly is the GP doing with LPs’ capital? What is the strategy and what is the GP getting out of the transaction that the LP is not?

We’ve also heard that, considering fees and other economics, not just price, a deal might leave existing LPs worse off. Without the time to consider the impact of all economic factors, existing LPs could be losing out compared with the GP simply selling the asset in an M&A sale.

Not every LP I spoke to had a problem with pre-clearance: a few said they were OK with it as long as the GP-led deal had a market price or a fairness opinion. More concerning to these LPs was the time and burden the influx of GP-led deals represented – for some institutions, it’s got to the point where they have so many of these deals to consider, along with their routine job of vetting and monitoring fund commitments, that they usually just choose to sell.

It seems GPs will continue pushing this term and many LPs will keep pushing back. I’m not sure if “pre-clearance” will become a routine part of private equity operations. But it is an example of LPs exercising their power in term negotiations and the ongoing struggle between GPs pushing as far as they can, and LPs figuring out where they have the leverage to push back.