GPs take charge on change of control provisions – report

GPs eyeing potential capital from the fund of firms market are building in legal requisites to ensure such transactions could happen without LP consent.

Private equity managers are future-proofing their businesses, potentially at the expense of LP-GP alignment of interest, according to Eamon Devlin, a fund lawyer at MJ Hudson.

Research from the alternative asset management consultancy found that most funds still retained some restrictions on their ability to transfer their own interests in funds. These said Devlin are being eroded in recent years with 94 percent of funds surveyed in the latest Private Equity Fund Terms Research saying their limited partner agreements included at least “some restrictions” on the ability of the GP to transfer its interest without investor or limited partner advisory committee approval.

Almost three-quarters of funds had some restriction on the ability of the principals to transfer their economic interests in the GP without investor or LPAC approval. Almost 70 percent had some restriction on the GP’s ability to transfer its entitlement to receive the carried interest without investor or LPAC approval.

Hudson told Private Equity International this was not the case five years ago, when most GPs were not allowed to sell any equity to a third-party investor

“With the number of funds being raised to buy GP stakes increasing quickly, GPs are therefore building in the requisite legal mechanism to allow them to sell a percentage of their firm in the future,” he said. “They are future-proofing their business to allow them to do this type of transaction without them needing investor consent.”

Neuberger Berman’s GP stakes unit, Dyal Capital Partners, is on track to raise around $8 billion by the year-end for its fourth fund dedicated to the strategy. Smaller GP stakes managers such as Goodhart Partners and Stonyrock Capital Partners have launched vehicles focused on the mid-market, as previously reported.

Devlin noted that while LPs previously had more clarity on who controlled the fund – the GP and the team behind it – entrants such as GP stakes managers and banks providing fund finance had made the concept of control more complicated.

“Control becomes more complicated with more people at the table,” he said. “If the fund is borrowing money, the GP has to answer to that bank. And if it’s got a minority shareholder then it’s got to answer to them as well.”

He added that the phrase “LP-GP alignment” was no longer sufficient in private equity because there were more people in the LP-GP relationship: “It’s more GP-LP-bank-minority fund owner alignment now.”

Another concern is how this dynamic might play out in a downturn. “Fund finance didn’t exist and people didn’t take minority stakes five years ago in any meaningful way,” said Devlin. “The speed of decision-making could be affected because GPs need to get other people financially on board.”

The report found that other mechanisms to ensure LPs and GPs have better alignment of interest were becoming more commonplace. These include high levels of GP commitments as well as management fee offsets.

There is increasing evidence that GPs are committing more capital to their funds. According to the report, more than one third of the funds surveyed had committed 3 percent or more, above the equivalent proportion in each of the prior years.

Almost all of the funds – 95 percent – offered full offset on transaction fees, such as director’s fees and monitoring fees.