CalPERS’ commitments show strength of GPs in negotiating terms

Popular GPs have the advantage in fee negotiations with potential investors in their funds because so many LPs want in, putting a premium on access.

The nation’s largest public pension, CalPERS, is moving in a big way to grow its private equity portfolio, targeting billions more for the asset class over the next few years.

Part of the expectation of big institutions putting large amounts of capital into private equity is a break on fees and other economics that come with the asset class. Large private equity limited partners like California Public Employees’ Retirement System try to use their ability to push down the cost of private equity or even win more access to no-fee coinvesting, in effect lowering the overall cost of the program.

Still, even CalPERS, with $481 billion in assets as of February, occasionally has to settle for paying above-market economics to access certain in-demand funds in today’s market. Popular GPs have the advantage in fee negotiations with potential investors in their funds because so many LPs want in, putting a premium on access.

Premium terms are broadly defined as carried interest rates above 20 percent, or management fees above 2 percent. Premium could also mean no performance hurdle that needs to be met before the GP begins collecting carried interest, or a preferred return under the market-norm of 8 percent.

There are other, governance-related terms that could be considered “premium” or “off-market” involving organization of the key executive group, recycling provisions and even GP-removal provisions.

Some LPs consider premium term GPs who link funds together across a platform, meaning LPs can only invest in the fund they want if they also commit capital to an ancillary product.

Premium terms are not the norm in the buyout fund world. They are more common in venture capital, where the best GPs have long been able to command above-market carry and management fee rates.

Still, certain buyout and growth GPs are able to push hard on terms that may not work for less known, or GPs with weaker performance.

“There’s always groups of highly sought-after, highly in-demand GPs that are able to command premium terms, that hasn’t changed,” said Scott Reed, co-head of private equity USA at Aberdeen.

“At the end of the day, it’s all about who has the relative leverage in the negotiations between the LPs and the GPs. If the GP believes they have substantial investor demand for their fund, they’re in position to at least propose, if not get, premium terms.”

Many LPs will accept premium terms as a reward for overperformance, rather than just straight up off-market economics, sources told Buyouts.

“Premium terms can be worth it if the returns are there,” said Chris Schelling, director of alternative investments with Venturi Private Wealth. “That’s where due diligence comes in, to understand how the manager is going to go about generating returns, consistent, repeatable and that they are worth the cost.”

CalPERS takes terms

A summary of CalPERS’ commitment activity last year reveals that several of the funds to which it committed capital included premium terms. A CalPERS spokesperson declined to comment.

For example, one relationship the system formed last year, with a firm called Goodwater Capital, includes commitments to two funds – an early stage venture pool and a late-stage growth fund – with premium terms. CalPERS made the commitments through parallel vehicles called Springblue A and Springblue B.

Both commitments, which flow into Goodwater Capital IV (Springblue A), the firm’s early-stage focused flagship fund, and Goodwater Infinity II (Springblue B), a later-stage focused fund, include the potential for premium performance fees. The funds have the ability to earn 30 percent carried interest if distributions are 3x greater than aggregate contributions, according to the informational summary. The carry rate for both parallel funds is 20 percent if distributions are 1.5x greater than aggregate contributions, the summary said. Neither fund has a preferred return.

Fund IV also includes a 2.5 percent management fee on aggregate commitments, with an annual 0.25 percent reduction after the five-year investment period, to a 1.5 percent floor, according to the summary. The management fee for Goodwater Infinity II is only 1 percent – 1 percent of the aggregate capital commitment during the investment period, 1 percent on invested capital post-investment period and 1.5 percent of cost-basis after the 10-year term.

No one from Goodwater returned a comment request. CalPERS committed $50 million to Goodwater Capital IV, a $450 million fund focused on early-stage investments, and up to $50 million to Fund II, a $450 million pool targeting later-stage companies.

HIG’s Europe Middle Market LBO Fund, to which CalPERS committed up to €100 million, charges a straight 25 percent carry rate, the summary showed. The fund closed on €2 billion last year.

The Europe LBO Fund also charges a 2 percent management fee on capital commitments during the six-year investment period, which stays at 2 percent of net contributed capital post-investment period, the summary said. Organizational expenses on the fund are capped at €2 million, the summary said.

Brian Schwartz, co-president with HIG, did not respond to a comment request.

Insight Partners is another GP charging premium terms, which sources said is not surprising considering the firm’s pedigree in venture and growth investing, not to mention its strong past performance.

The firm is charging 25 percent carry on its twelfth flagship fund if net IRR is greater than 25 percent and distributions are 2.4x greater than aggregate commitments, the CalPERS summary said. Insight had collected around $20 billion for Fund XII as of late last year, PEI reported. It’s not clear if the fund has closed. Organizational expenses are capped at $7.5 million on the pool, the summary said.

Insight has the same carry structure on an annex fund it’s raising alongside flagship Fund XII. CalPERS approved commitments of up to $600 million to the flagship fund, and $150 million to the annex fund, the summary said. No one from Insight Partners returned comment requests.