Impotent Revolution

The year 2010 was meant to herald a new dawn for private equity. Mega-deals, pundits said, wouldn't return in earnest for years (five to ten, according to a survey conducted by unquote" last year). Banks would no longer bend over backwards to provide vast amounts of leverage for deals, as clubbing would take over as name of the game. And LPs would be firmly re-positioned at the top of the totem pole and GPs would again have to kow-tow to their demands.

But just weeks into 2010 and there are already reasons to doubt a true reversion to basics. Last year ended with Apax's Marken deal flirting dangerously close to mega-deal territory - and just one bank, Lloyds, underwrote the entire £300m debt tranche. While such deals are likely to remain exceptional and not represent the norm, they do show that the changes the market has witnessed have not been as profound as many had feared - or even hoped.

The fundraising market is unlikely to prove different. Despite liquidity issues plaguing many blue-chip investors in 2009 and threats of real changes to who rules the roost in 2010, in fact it may be that very little changes in the short-term. And for all the furore surrounding the Institutional Limited Partners Association (ILPA) guidelines, which have more than 90 supporting institutional investors, they in fact have only 18 GPs signed up.

“The LP community does not speak with one voice. They do not all have capital constraints and do not collectively paint one picture” Mark Mifsud, partner at Kirkland & Ellis

Jason Glover, partner at Clifford Chance, points out that the ILPA Guidelines represent more than a statement of standard terms; they are a wish list of what investors would like. "Investors are aiming to introduce a No-Fault suspension of investment period which would allow them to be able effectively to cancel their undrawn commitment at any point in time," Glover points out as a non-standard provision in a typical limited partnership agreement. "Another example would be the requirement that a fund manager introduces a time diversification test so that it can for example only invest a proportion of the fund within a 12 month period." Both examples, Glover argues, illustrate ILPA's attempt to introduce provisions which extend far beyond the market norm.

Diverging interests
Could it be that such great expectations have put most GPs off fully subscribing to the guidelines? GPs are proving more malleable than their signatory rate would suggest: Mounir Guen, CEO of MVision Private Equity Advisers, reckons all the GPs he advises - up to two dozen per year - will see adjustments to their terms. "It won't be as straightforward as reducing the percentage of a management fee, but there will be changes - perhaps in terms of step down. It will affect all GPs raising right now though."

So change is likely to be widespread but not earth-shattering. In addition to GPs employing different tactics, a factious LP community will also hinder any seismic LPA changes. "The LP community does not speak with one voice," Mark Mifsud, partner at Kirkland & Ellis argues. "They do not all have capital constraints and do not collectively paint one picture. There is actually a real pot pourri of requests from investors nowadays."

The diverse range of LPs means that some are actually siding with their GPs - not fellow LPs - and feel that enforcement of contractual obligations without forbearance is important. "Some LPs are informing GPs that they don't want someone being let off lightly'," Mifsud explains.

This was largely the result of seeing some GPs treat defaulters with kid gloves. Once a provision ignored in the legal process of fundraising as it was so infrequently used, its increasing usage has caused LPs to look at it more closely. Over a year ago, Permira announced a punitive way out for defaulting LP SVG. However the agreement that hit headlines was not the one originally put forward by the GP, who enjoys a long-standing relationship with SVG. The initial proposal was far less punitive for SVG, inadvertently penalising those LPs who were honouring their commitments.

And they said so - ultimately SVG was made to forfeit its profits in the fund, which were then diverted into the coffers of maintaining LPs. A fairer outcome than the one initially suggested - and in line with more traditional default provisions.
So while deemed draconian, they're not deemed so by liquid LPs, who are calling for existing measures to be called on and enforced.

Talking money
While default provisions have only proved a hot topic in the last 18 months, fees have proved a perennial point of debate, and remain so. As ever, the GP-jury is split. "Some houses are voluntarily saying that they will not charge fees until they start investing or otherwise giving some fee break. Others have been persuaded to reduce fund size," Mifsud says. Some larger funds have tried to lead by example - take for instance TA Associates, which reduced its fee from 2.5% to 2% for its ninth fund, while Fortress Investment Group is believed to be considering lowering fees.

But some feel that their small size combined with self-proclaimed stellar track record makes it ok to increase what they charge - so thought at least one mid-market UK buy-and-build specialist, which raised its fee by 50 basis points for its latest vehicle. Unfortunately it proved a telling lesson, with a handful of LPs refusing to re-up under such terms, and the fund target size reporting being sliced in half as a result.

The ILPA guidelines state: "Management fees should cover normal operating costs for the firm and its principals and should not be excessive. All transaction and monitoring fees charged by the general partner should accrue to the benefit of the fund, including off setting management fees and partnership expenses during the life of the fund." Some may construe this as indicating 2 and 20 may not be the best fit. The guidelines go on to state that "management fees should step down significantly upon the formation of a follow-on fund and at the end of the investment period", before outlining how expenses should be accounted for.

"The ILPA guidelines propose that budgeted fees will be the next step," Misfud infers. "However, I don't think this is necessarily realistic. There is too much inertia in the system. Many funds that will be raised are very well established and the flat percentage fee remains overwhelmingly the norm."

A lifetime
With liquidity concerns the concern du jour, a lot of funds have shortened their lives, or the life of their investment horizons. This is either because they see a niche in the market or the LPs didn't want to be invested for so long. In December Spanish GP Altamar cut its investment period for its latest secondaries vehicle to 18 months, shorter than the four-to-five years more typical for funds of funds.

But it doesn't always work. Some funds have long lives - 20 + years even - because of the nature of the investments, for example PPP and infrastructure funds. "For such vehicles, LPs prefer a longer fund life as it takes pressure off GPs to divest prematurely what may be providing stable cash flow yields."

One reason given for shortening fund lives is investor liquidity. However, this is already available via secondaries. The discounts of the past year have put some sellers off, according to some advisers and GPs, and so some LPs prefer to explore other methods of finding ways out.

Rather than shortening fund lives or decreasing fees, what many LPs agree is necessary is increased GP alignment. "LPs are asking for more skin in the game and they want to see the commitment being made in cash," Mifsud continues.
Unfortunately this pressure to put more money up front comes at a time when GPs have their own liquidity issues. "How do you put more in now? If you haven't had realisations, you don't have cash. I haven't seen LPs push for this as much as for other changes," Guen explains.

Only time will tell how LPAs will evolve. As most funds raised in the second half of the last decade will only be around 60-70% compliant with the ILPA Guidelines, according to Glover's estimates, there is reason to believe that change will occur. But don't expect it to be overwhelming in pace or scope.

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• Fundraising
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• Clifford Chance