The proposed terms for Bain Capital’s sixth buyout fund are raising eyebrows among US institutions. Offer documents for Bain Capital Fund VI, which is targeting $700-800 million (ecu 645-740 million) will feature an unprecedented 30% GP carry. Bain will market the main vehicle in conjunction with a $300 million “standby fund”, featuring a conventional 20% carry, which will invest alongside Fund VI in larger deals.
According to Geoffrey Rehnert, one of Bain’s managing directors, Fund VI’s higher carry reflects the number of senior staff on the Bain team. Following the recent promotion of five of its principals – Jonathan Lavine, Ed Brakeman, Dominic Ferrante, John Connaugton and Mike Krupka – Bain’s complement of managing directors has risen to 15.
“We have more managing directors on staff than other firms, and the only way to keep hard-working people is to compensate them”, said Geoffrey Rehnert, pointing to the returns of over 100% achieved on previous funds.
Bain expects to close Fund VI by early April and does not rule out the possibility of it being oversubscribed. However, some market sources have expressed doubts that investors will swallow the carry increase, even in a fund-raising market where GPs currently seem to have the upper hand.
Erica Bushner, a vice principal of Wilshire Associates and former head of alternative investment at Pennsylvania SERS, described the 30% carry as “extremely rich”. Attorney Thomas Bell of Simpson, Thacher & Bartlett, who has been involved on offer documents for several buyout funds, predicted that some investors would react negatively to the 30% carry, which he decribed as “in the nature of pushing the envelope”. That said, “there is a small universe of firms that can do this, and I think Bain might be one of them,” he conceded.
While a higher-than-standard carry for US buyout funds is not unprecedented, LPs have previously been allowed some choice in the matter. Ripplewood Holdings, for instance, accompanied a 30% carry with a 15% hurdle rate, but gave investors the option of choosing a standard 20% carry and hurdle rate instead.
Bain, whose GPs themselves are expected to commit up to $200 million to the fund, is offering a 15% preferred rate of return for fund VI. While this hurdle is remarkable in the context of a sixth fund from a group with Bain’s reputation and track record, it may not cut a great deal of ice with the market, as Erica Bushner pointed out: “The hurdle rate is pretty much a non-event if you expect to achieve the kind of returns that are promised”.
Although market observers believe that LPs are reluctant to accept GP-friendly terms, even for the highest calibre firms, for fear of setting a precedent, some sources believe that Bain is in a position to pull off the 30% carry. One New York placement agent was quoted as saying: “They’ll get it done because they are Bain and because they don’t have many state pension funds as investors – institutions tend to be more flexible and more dedicated”.
The “standby fund” is intended to top up the equity requirement for larger transactions; where a deal requires equity of over $50 million, the difference will be drawn down equally from Fund VI and the standby vehicle. The standby fund features a standard carry, and will charge a management fee of 2% on invested capital only, reflecting the fact that Bain is under no obligation to invest the top-up vehicle fully.
Some sources suggest that potential investors will perceive the standby fund as a second-tier vehicle since it will probably invest in fewer deals than the main fund. Others, though, are predicting that, thanks to Bain’s reputation, both vehicles will be oversubscribed, saying that many investors would prefer to have a slice of the standby fund rather than miss out altogether.
Time alone will tell. But it seems safe to predict that, if Bain does pull off a 30% carry and reach full subscription, other houses will soon look to follow suit. Such a development would provide the surest indication to date that there is more institutional capital currently seeking a home in the US buyout market than there are first-class funds to absorb it.