Ex-Summit exec’s shop, Equality, sets unusual term on debut fund

  • Why is this important: Fund comes with a 5 pct hard hurdle

Equality Asset Management, formed by ex-Summit Partners executives, is targeting $500 million for its debut fund, which will come with an interesting term: a 5 percent hard hurdle, two sources with knowledge of the firm told Buyouts.

Fund I, which is expected to hold investments longer than traditional PE funds, also will have a management fee slightly lower than the 2 percent most new firms set for their early funds, one of the sources said.

A preferred return is a hurdle the GP must reach before starting to collect carried interest.

For many years the PE-market norm for preferred-return hurdles has been 8 percent, a result of higher interest rates in the 1980s when such hurdles became common. At that time, PE firms had to earn more than bank certificates of deposit, according to a 2017 paper by Mary Abbott, partner at Osler.

Some private equity professionals have questioned why the hurdle has stayed at 8 percent when interest rates have been historically low.

LPs see preferred returns as insurance against the GP collecting profits before it has generated a decent rate of return for investors.

Equality’s preferred return is structured as a hard hurdle rate, meaning the GP collects carried interest only on returns that beat the hurdle rate.

In the case of Equality, this means LPs collected distributions from profits up to 5 percent, at which point the GP starts to collect its share of profits, generally split 80 percent to LPs and 20 percent to GPs.

With a hard hurdle, the LP will always take more than the 80/20 split because of the 5 percent hard hurdle, a fund formation lawyer said. “It means you will never get to 80/20 split on total profits. LPs will always get more than 80/20 split,” the lawyer said.

This is different from the type of hurdle many funds use: a preferred return, usually 8 percent, with a GP catchup provision. This means LPs receive distributions on profits up to the 8 percent hurdle, typically putting them over the contractual 80/20 profit split, after which the GP receives all or most distributions until it reaches its share of the preferred return. Once that occurs, LPs typically get 80 percent of profits and the GP gets 20 percent.

Around 86 percent of 35 North American buyout shop respondents use a preferred return with a GP catch-up provision, according to Buyouts Insider’s 2018-2019 PE/VC Partnership Agreements Study.

A hard hurdle is more typical in the energy and infrastructure space and is unusual in buyout funds, according to the fund formation lawyer and two PE-market sources.

Funds with hard hurdles usually have lower management fees and also are usually in funds with concentrated investor bases, one of the market sources said.

Sean Silva, a spokesman for Equality, declined to comment citing regulatory restrictions.

Long-term view

Fund I hit the market around the beginning of the year, one source said. Equality is working with UBS on the fundraising.

Thomas Roberts, former managing partner at Summit, last year launched Equality to focus on long-term investments in durable technology, healthcare and tech-enabled growth companies.

“Our thesis is that the path to outperformance, given all the competition to buy quality assets, is to make [fewer higher conviction bets], hold those companies longer so you can do more with them after you purchase the company, and charge lower fees along the way,” Roberts told Buyouts in an interview last June.

Along with Roberts, Equality is led by co-founders Jeff Del Papa and Gabriel Gomez, both managing directors.

Gomez formerly worked at Summit Partners and Advent International. Before business school, he spent nearly nine years in the U.S. Navy as an aircraft carrier pilot and Navy SEAL platoon commander.

Del Papa worked worked at TA Associates from 2011 to 2017 and Thoma Bravo from 2008 to 2011, according to his LinkedIn profile. He was an associate at Summit Partners from 2003 to 2006, his profile said.

Action Item: Check out Buyouts Insider’s PE/VC Partnership Agreements Study here: https://bit.ly/2L8ASb3