Balance of power

Francinia Protti-Alvarez
01 January 2010

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Investors are putting a significant amount of pressure on buyout houses, pushing for better terms and in some cases scaling back commitments

There is talk that we are on our way out of the crisis. However optimistic the news, it has not eased the pressure on major buyout houses, many of which are being leaned on by LPs seeking to revise the terms of their relationships. US heavyweight CalPERS, the California pension fund, is the latest example of this, with widespread reports suggesting it is looking to modify its terms with private equity firm Apollo Global Management. The investor is apparently pushing for lower management fees, a reduction in commitments and a renegotiation of other costs for some of the dozen Apollo funds in which it has investments.

CalPERS is not alone: already the increased negotiating power of limited partners has become noticeable, something to which Carlyle Group can attest. In an attempt to appease its investors, the US buyout behemoth has had to make several concessions to LPs. Last December the firm announced that it had agreed to several changes to terms on its fifth fund, including a split on transaction fees, limits on the amount of debt investments and limits on the amount of capital to be invested in 2010 and 2011. The one blessing for Carlyle is that it has not been forced to downsize its fund from $13.7bn - and even this is positive only if the capital can be effectively deployed.

These problems are all the more salient for GPs that have hit troubled waters. In France, for example, PAI partners' chief Dominique Megret and his right-hand man Bertrand Meunier left the firm, triggering the key-man clause on its EUR5.4bn fifth fund. New chairman Lionel Zinsou penned a letter to investors in September offering a 50% reduction in the vehicle - until then the largest in continental Europe - and investments from the vehicle were frozen.

In December, following month-long negotiations, PAI received LP approval to halve the fund to just under EUR3bn and resume investing. Again, though, concessions had to be made in relation to fees and corporate governance in order to sway the necessary two-thirds of investors to support the restructuring. The percentage of investor votes required to terminate the vehicle had been lowered from 80% to 60%, a move partly designed to circumvent the veto right held until then by BNP Paribas, the fund's largest investor. PAI is said to have agreed to pass on 100% of fees to LPs, with the exception of its management fee.

Other GPs have not been so "lucky". UK-based buyout house Candover has been the latest to announce a "substantial" reduction of its latest fund, following nearly 12 months of negotiations that stemmed from its listed parent's liquidity issues. The fund was targeting EUR5bn and reached a first close of almost EUR3bn just weeks before Lehman's collapse, with EUR1bn coming from Candover Investments. The reduction will release all investors, including its listed parent, from a "significant proportion" of undrawn commitments.

As a result of the suspension, UK oilfield services business Expro will be the one and only investment made by the 2008 Fund. Commitments to the 2008 Fund will be scaled back "pro rata subject to an appropriate follow-on reserve of EUR100m", which, alongside additional funding from the 2005 Fund, should allow the investment to be viewed as a going concern. What is more, parent Candover Investments will not contribute to this follow-on.

However, while downsizing and returning undrawn commitments to LPs may breathe new life into stricken vehicles, the changes happening with some of the larger buyout funds indicate that there could be a significant transformation ahead in the sector. This raises an important question: what happens when GPs that developed their track record in one segment of the market are forced to operate at in a different area targeting different deals? Investors may now have some long sought after leverage to improve terms, but the downside of strategy shift also needs to be considered.