As fundraising slows and capital becomes scarcer, limited partner agreements are mirroring the challenged environment. Here, Private Equity International rounds up some key trends in fundraising terms from industry practitioners in 2023.
Top managers are keeping their funds open longer and engaging in “game theory” strategies, as the congested fundraising market makes raising capital tougher, according to research by law firm Paul, Weiss, Rifkind, Wharton & Garrison. GPs are using repeated and targeted communications, including e-subscription booklet platforms, to streamline subscription questions, the report notes.
The annual study of fund terms, with results derived from the analysis of 50 recently raised private equity funds, found that 83 percent of PE funds surveyed had an offering period of 12 months. This is in line with 85 percent last year, although extensions beyond the period are often requested by the GP.
“What you do see in a market like this is a baked-in ability for GPs to extend, as opposed to going to all investors and seeking amendments. So, you might have the GP do [a six-month extension] and thereafter, the LPAC needs to approve,” Marco Masotti, who leads the private funds group at Paul, Weiss, told PEI upon the publication of the study.
In fact, one-and-done closings are gone for the moment, industry practitioners note. In addition to fundraising taking longer, there’s also a focus on how to close deals with LPs as soon as possible.
There are different ways that GPs address fundraising extensions, Deborah Gruen, a partner at Simpson Thacher, tells PEI. “You don’t want an LP to become unhappy because it’s taking… too long. There’s a trend towards rolling closing, which means that you are just continuing to close as soon as LPs are done.”
Gruen adds that another way to extend the fundraising period – if GPs want to keep the same 12- or 18-month period – is to adjust the date from which that period starts. Instead of it starting from initial closing, GPs start it from the effective date when they actually turn on the fund.
Terms that will move in LPs’ favour include not allowing prewired provisions on conflicts that meant GPs, due to having more clout a few years ago, didn’t have to go to limited partner advisory committees, says Michael Wolitzer, head of Simpson Thacher’s investment funds practice. “LPs are pushing back more on those.”
“You’re also seeing some push and pull on initial closing discounts as GPs get creative on economics,” adds Gruen. “Sponsors will often give an initial closing discount, but you’re seeing an extension of what the initial closing period is, instead of it being that LPs come in at the first closing. They’re calling it an ‘anchor closing period’, or an ‘initial closing period’. These are rewards for loyalty if you’ve invested in multiple funds.”
Management fee discounts were usually given when LPs came in early, during a relatively short initial closing period – for example, 30 days. That has changed in recent months as GPs offer more loyalty discounts to existing LPs, or if an aggregate commitment amount is met, or if they come in early but over a longer period after the initial closing, Wolitzer points out.
Potential conflicts in GP-leds
Another fundraising term that is attracting a lot of attention is the pre-clearance of conflicts of interest in GP-led deals.
The issue has gained significance as the secondaries market has become an accepted portfolio management tool, and one that GPs are increasingly comfortable turning to during a more difficult exit environment. Data from Jefferies’ latest Global Secondary Market Review shows that GP-led volume in 2022 was the second highest on record, at $52 billion.
An important role for LPACs is to advise on any potential conflicts of interest. As the GP is both the buyer and seller in such deals, the “disclosure and resolution of the conflict falls under a GP’s duty of loyalty to its fund investors under the US Investment Advisers Act”, affiliate title Buyouts reports.
The inclusion of pre-clearance in a fund’s LPA would bypass the LPAC conflict waiver process. “In essence, pre-clearance removes responsibility from the LPAC for giving its blessing to the deal, and puts it on every LP in the fund. Each LP can then vote by either selling or rolling,” Buyouts reports.
“Pre-clearance comes through an expansion of the language to indicate that, in some cases, the GP doesn’t have to follow that process,” says Kari Harris, chair of the investment funds practice at law firm Mintz. “As long as the price has been validated, and as long as the LPs are offered practical options and the terms are no less favourable than would be obtainable from a third-party buyer, then we don’t even need to go to the LPAC; you will be deemed to have consented in advance.”
With the US Securities and Exchange Commission aggressively targeting private funds, especially around enhancing disclosure requirements and additional rules on GP-led secondaries, it can only be expected that the negotiations of terms between LPs and GPs will reflect the proposed changes.