All signs point to a more challenging fundraising environment this year, with faster fundraising cycles and supersized mega-funds. Are there going to be shifts in fund terms as 2022 progresses?
Here’s a round up of factors that could shape fund terms, based on industry reports and views from market participants.
Higher GP commitment
The level of general partner financial commitment to the fund is the top issue for LPs as far as terms or structure of a fund are concerned, according to Probitas Partners’ Private Equity Investor Trends for 2022 survey. This has increased to 66 percent, from 40 percent last year. For European respondents, the level of GP commitment was tied as an issue at 67 percent with a cap on fund size. Meanwhile, for Asian investors, GPs’ skin in the game was tied with the structure or inclusion of a key-person provision, both at 63 percent. As such, LPs are expecting GPs – especially mega-funds – to make even chunkier commitments to their own funds.
“We’re seeing many LPs’ capital budgets already full for 2022 with re-ups, so LPs will have to decide between re-upping with an existing manager or committing to a new manager, or possibly scaling down their commitment sizes,” says Ashley DeLuce, a vice-president in Callan’s private equity group.
“While we haven’t seen this impact fees or terms yet, we may start to see power shift back to LPs further into 2022, depending on the fundraising environment,” she adds.
Callan’s Private Equity Fees and Terms Study found that fees charged by buyout funds kept to the 2 percent norm, despite an increase in fund size in the last year. The average management fee for large buyouts was 1.61 percent, 1.87 percent for medium buyouts and 2 percent for small buyouts.
The level of detail into how GPs engage with LPs and go to market may be the difference between mission accomplished and mission failed.
“A fundraise is a 12- to 18-month process, and it’s more important than ever in a crowded market to plan every aspect of it with military precision – when you send out docs, when you get comments back, which LPs to engage with first,” Marco Masotti, who leads the private funds group at law firm Paul Weiss, tells Private Equity International.
Masotti adds that the most important thing for GPs is to design a process that factors in every contingency.
“It’s about moving the private placement memorandum in a crowded market from the bottom of the pile to the top of the pile. You do that with the relationship, with helpful terms – such as fee discounts and co-investment rights – and you do it with military precision.”
LP protections in first-time funds
More safety measures are being added to the limited partner agreements to ensure that LPs in first-time funds are protected. These include clearly defining the GPs’ time commitment to the fund product, bad leaver clauses and step-in rights – in which the fund’s largest investor will have the ability to step in and manage, or appoint a replacement manager – if there is a serious breach of agreement, said Gabriel Boghossian, a partner at law firm Stephenson Harwood, at Unigestion’s European Emerging Manager Summit in November.
The trigger for raising a successor fund is also higher for first-time managers, he added. LPs want to see the first-time manager invest the majority of capital, while more established managers might decide to come back to market when they’ve reserved about 75 percent of total commitments for future investments.
“When we’re talking about Ts and Cs, it’s as open as a football field,” Boghossian said.