Full GP forfeiture in for-cause removal terms increasingly rare

MJ Hudson’s 2022 report details the strengths and weaknesses of terms offered by funds.

The number of funds that provide for full forfeiture in the event of ‘for cause’ removal halved between 2020 and 2021, according to the seventh edition of MJ Hudson’s Private Equity Fund Terms Research – Economics, Alignment and Governance report.

The report – which offers LPs and GPs insights into the effects of current fundamental economic, alignment and governance terms offered by buyout, growth and venture funds – noted several ways in which fund terms have changed since 2018.

For-cause removal is when a GP commits serious wrongdoing, and investors vote to hand assets to a third party. GP removal is rare – and when it does occur, it can make headlines.

Fifteen percent of funds that either closed or came to market in 2021 provided full forfeiture in the event of for-cause removal, as opposed to 33.3 percent in 2020, according to the report. While the number that provided between 26 and 99 percent forfeiture grew from 9.5 percent in 2020 to 20 percent in 2021, the year still saw an overall increase of funds providing 25 percent or less forfeiture, going from 57.1 percent to 65 percent.

The report also revealed an increase in the amount of carry that funds are able to distribute to third parties. Those with some limit to the allocations they can make rose from 51.1 percent in 2020 to 61.9 percent in 2021, while those with no limit increased from 22.2 percent to 23.8 percent. There was a decline in the number of funds with an absolute prohibition on transfers of carry, going from 26.7 percent to 14.2 percent.

“Our data show large movement in some of the more detailed terms that speak to alignment, such as carry forfeiture on GP removal, in favour of GPs,” said Whitney Lutgen, a partner in MJ Hudson’s private funds law team and one of the authors of the report.

“Our research also shows that the core economic terms – management fees and carried interest – continue in line with common assumptions around the two and 20 formula. These two observations suggest that the market, in this mature phase, still has movement in some terms, but certain core concepts are well-entrenched.”