As partnership terms arguably become more standardized, both general and limited partners would be well-served to pay attention to areas where industry practice remains all over the map—and fund expenses is a prime example.
The latest version of our bi-annual study of partnership terms and conditions—the Thomson Reuters PE/VC Partnership Agreements Study 2014-2015, based on a survey of some 168 private equity firms around the world—finds a number of terms where industry practice seems to be coalescing around a new, often LP-friendly standard.
Compared with the 2010-2011 edition, for example, transaction fee offsets of 80 percent and 100 percent are far more common among North American buyout and growth equity funds. The development suggests LPs are winning the argument that higher percentages are needed to keep their interests aligned with GPs. Years ago it wasn’t uncommon for GPs to keep all such fees.
Likewise, nearly all key-person provisions in North American buyout and growth equity fund agreements (82 percent) today feature automatic suspensions of investments when they are triggered; four years ago our survey found it true for just 59 percent of U.S. buyout fund agreements. This is far friendlier to LPs than a trigger that, say, requires a vote by LPs to suspend investments.
So where is there more fluidity and less standardization? Terms that determine who picks up the tab for a variety of expenses, whether it be the GP or management company, the fund, or both, seem to be ripe for negotiation, given the wide range of industry practices.
The question of who pays is an important one. If it’s the GP, the partners would have to pay out of fee income, leaving less money to allocate to salaries, bonuses and other expenses; if it’s the fund, the partners would have less money available for investments, and they would have to return more money to investors before taking their carried interest (assuming their carried interest is calculated net of expenses).
One relatively new expense for many North American buyout and growth equity funds has been the cost of registration and compliance as an investment adviser with the U.S. Securities and Exchange Commission. According to our study, more than one in three of those registered (36 percent) say the GP or management company picks up the tab for such expenses, as you might expect, but a fairly substantial one in five (21 percent) says the expense gets shared, and a surprisingly high four in 10 (43 percent) says the fund pays. (No doubt many LPs see registration and compliance as a cost of doing business for the GP.)
It is fairly common for the GP or management company to bear the expense of travel at North American buyout and growth equity funds, but more than a third of the time (34 percent) the fund pays, and in a small percentage of instances (6 percent) the expense is shared, according to our study. By contrast, the fund usually bears the expense for annual meetings, but a third of the time (33 percent) the GP or management company pays, and in a very few cases (4 percent) the expense is shared.
And who bears the cost of using outside consultants? In about four in 10 (41 percent) North American buyout and growth equity funds studied it is the fund, over a third of the time (37 percent) it is the GP or management company, and 20 percent of the time the cost gets shared.
Outside consultants can be expensive—and so can the cost of not paying attention to terms determining who pays for partnership expenses.
(Correction: The story has been corrected to note that 43 percent is roughly four in 10, not one in four)