Terms and conditions of private equity partnerships appear to be shifting in the direction of limited partners, although investors must fight both inertia and the ability of general partners to divide and conquer.
Inertia stems from the fact that it’s easier to keep a term the same than it is to change it, especially when dozens of limited partners all have to agree to the change, along with whatever concessions need to be made in return. Lawyers may also be reluctant to shift from their boilerplate terms; never far from their thoughts are the risks of something going wrong if they veer from the tried and true.
The divide-and-conquer strategy can come into play when, early in the game, investors sit down one-on-one with GPs to press for a particular term only to get told that they’re the only one asking for it. “How can we be the only one?” said Tim Kelly, a partner at funds-of-funds manager
This summer Thomson Reuters conducted its bi-annual survey of partnership terms and conditions, producing plenty of evidence that terms have become more LP-friendly—although not definitive evidence given that different funds participate in every version of the study. Eighty percent and 100 percent fee-sharing are rapidly becoming market standard, say fund attorneys, and our PE/VC Partnership Agreements Study 2012-2013 supports this view. The predecessor study, which included buyout and growth equity funds closed from 2005 to 2009, found that about one in four funds had 80 percent or 100 percent fee-sharing. This year’s study, which includes North American buyout and growth equity funds closed from 2007 to 2011, finds that more than a third do. Similar, the two-year-old study found that two in five U.S. buyout and growth equity funds had 50 percent fee-sharing; this year’s study finds that less than 7 percent do.
This year’s survey, which 30 North American buyout and growth equity firms completed, asked whether GPs had offered investors any special incentives to investors to come in on the first closing—see chart below. More than one in eight (13.3 percent) North American buyout and growth equity firms said that they did offer incentives, such as a break on a management fees. Along the same lines, one in 10 said that their management fee percentages vary by commitment size (presumably larger commitments garner lower fee percentages); that is up from 3.3 percent two years ago when we asked the same exact question.
Given that it’s been more than two years since the Institutional Limited Partners Association published its set of recommended terms, and nearly a year since it published a second version, we added a question to see how many firms are actually marketing their terms and conditions as ILPA-compliant. It’s hard to imagine that any GP is following all the ILPA recommendations, which include such LP-friendly items as 100 percent fee sharing, all-contributions-plus-preferred-return-back-first distribution waterfall, and no-fault divorce clauses that can result in removal of the GP or dissolution of the fund. Nevertheless, the study found that just over 8 percent of North American buyout and growth equity funds have promoted their terms and conditions as ILPA-compliant, as have just over 18 percent of the North American venture funds and more than one in four (27.8 percent) of the funds of funds.
Are your terms and conditions ILPA-compliant? With no sign of the fundraising market easing in the months ahead, it’s a question more and more investors will likely be asking.