That’s always the big question buyout professionals have for their fund attorneys as they head out to raise a new fund.
Partnership terms and conditions do change over time—slowly, but noticeably—so it’s worth taking the market’s temperature upon reaching a higher Roman numeral. Bear in mind than some law firms boast larger collections of terms than others. It’s best to tap those that represent a number of large institutional investors, since they’ll be privy to a larger cross-section of the market than those that primarily represent general partners. Market surveys are another useful source.
For the summary of market terms below I have two main sources. One is an April 17 seminar on buyout fund terms led by Partners Gary R. Silverman and Timothy Spangler of law firm Kaye Scholer LLP, whose client list includes both general and limited partners. The other is the fifth annual review of terms and conditions from Zurich-based advisory shop
• Management fees: A majority of buyout shops charge 2 percent of committed capital as a management fee during the investment period, according to Kaye Scholer. Bigger funds charge less: 1.5 percent, for example, is the average for funds in the $5 billion range. In addition, some firms offer a blended rate that rewards LPs for contributing more to the pot. One possibility: charging 2 percent on the first $750 million raised, 1.75 percent up to $1.25 billion, and 1.5 percent after that. Once the investment period ends, most buyout shops stick to the same percentage but apply it to capital drawn down into unrealized investments to reflect how much work remains to be done to manage and liquidate the portfolio, according to Kaye Scholer. Other firms stick to committed capital, but lower the fee charged, with the average reduction being 25 percent. One nuance many LPs battle hard for these days is making sure management fees are deducted from the equation so that they’re not, in effect, paying fees on fees.
• Carried Interest: 20 percent, and don’t even think about trying for something higher unless your firm is really something special.
• Investment Period: Just in time for the credit crunch that has many of them sidelined, buyout firms appear to be negotiating longer investment periods. The SCM study registered a noticeable shift from five-year investment periods (55 percent of the sample) to six or more years (24 percent, up from 20 percent the year before). According to Kaye Scholer, many buyout firms also negotiate the right to terminate the investment period at their discretion, in effect clearing the way to raise another fund.
• Management Fee Offsets: Limited partners typically get to keep 80 percent of transaction and related fee income, though in practice buyout firms agree to deduct them from their management fees for tax reasons, according to Kaye Scholer. Some LPs have managed to secure 100 percent of such fees, while some GPs (notably, The
• Fund Formation Costs: LPs bear the cost of fund formation, which Kaye Scholer provides useful estimates for. They are $300,000 on average for funds of less than $100 million; $450,000 to $750,000 for funds of $100 million to $500 million; $1.2 million to $1.5 million for funds of $500 million to $1 billion; and $1.8 million for funds of more than $1 billion.
• GP Commitment: One percent of the fund is still the most common ante for partners of a buyout shop. But the trend has been toward bigger commitments as partners grow wealthier and as LPs press for commitments that represent a meaningful percentage of net worths. Just over a third of SCM’s sample of firms proposed committing 1 percent to their own fund; three in five proposed committing more than 1 percent; and about one in 10 proposed committing 10 percent or more.
Reach Gary R. Silverman at 312-583-2330; Timothy Spangler at 212-836-8502; reach SCM Strategic Capital at 41-43-499-4949.