Fund T&Cs: Tailored fit

With too many funds chasing too little money, many observers argue that the pendulum has swung back in favour of LPs when it comes to fund terms and conditions (T&Cs). Fees are especially sensitive: more than two thirds (69%) of respondents to unquote's 2011 Nordic Survey believe there will be a change in the compensation structure for private equity professionals in the next 1-5 years. But corporate governance aspects such as key-man clauses and no-fault rights are also said to be under intense scrutiny.

An analysis of recent closings searching for clues as to what the new standard is would leave one puzzled, with T&Cs varying. "The LPAs vary greatly, and I would argue that they have never so strongly reflected the bargaining power of a GP in the way they do today," notes SJ Berwin, partner Sonya Pauls.

Management fees are following a downward trend, sitting closer to a 1.7% average now than to the once-industry standard 2%. But recent fundraising efforts tell a more nuanced story. EQT's latest €4.75bn vehicle seems pretty LP-friendly, with a 1.5% management fee - on the other hand Riverside will be enjoying a 2.5% fee on it fourth fund, which closed on €420m in late 2010. Models vary greatly in between, with an array of ramp-down mechanisms and early-bird discounts to attract investors.

The fee structure and corporate governance clauses of course depend on myriad factors, including fund size. But they also highlight the ‘flight to quality' syndrome currently at play in the market. "The terms GPs are able to negotiate reflect the bifurcation currently seen in the fundraising market - strong funds display very management-friendly terms," says Pauls. "The track record really rules here."

Not only are good GPs able to maintain a sometimes generous compensation model - Chequers Capital quickly raising €850m in July for a vehicle with a 6% hurdle rate comes to mind - but they can also tone down the LPs' cautious approach to corporate governance, according to Pauls: "A number of very successful GPs are now coming back into the market with T&Cs that have less corporate governance and less no-fault rights than they had in 2007."

When it comes to the much-discussed transaction fees, the downward trend towards a 100% offset will undoubtedly be welcomed by LPs. But then again, structures are still very much tailored for the time being: 80/20 seems to be the default position, with Pauls observing many variations from this norm depending on the fund.

Eye of the beholder

It would seem that LPs should be given credit for looking at T&Cs in a more pragmatic light than one might imagine. First of all, considering investors as a uniform and cohesive entity is ill-advised: "Demands vary greatly between LPs, a fact that is often overlooked," warns Pauls. "There are investors who are happy with certain terms that others might view as deal breakers."

One individual LP might not even look for the same T&Cs in all the funds it chooses to partner with. This can lead to the sort of thorough and lengthy negotiations that should make quick fundraises the exception rather than the norm going forward. "Despite ILPA being a useful framework, we are not seeing a ‘check the box' approach at all. Instead, we are finding that investors are adopting a more sophisticated approach than ever - especially when it comes to mid-market funds," notes Pauls.

As with so many aspects of the LP/GP relationship at the moment, transparency from the manager will be key. If certain terms in a fund deviate from the market standard, the GP better have a stellar track record to justify it, or be ready to argue its case thoroughly. Says Pauls: "Where GPs provide transparency and where it makes sense, LPs are willing to talk about aggressive fee arrangements because they understand that the manager may actually need the extra income. For instance, we have negotiated funds where the transaction fees split was still set at 50/50 because it made sense: the fund had a really large team to support and the GP was able to convince investors that maintaining a sizeable and talented team would be of ultimate benefit to them."

Rather than an overwhelming power shift in favour of LPs, the current trends in fund T&Cs paint a picture of flexibility and carefully tailored relationships - LPAs shouldn't turn into ‘limited partnership ultimatums' just yet.

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• Topics
• Fundraising
• SJ Berwin
• Chequers Capital
• EQT