LP fees up as GP commitments fall

The concept of alignment of interest – the bedrock of the LP/GP relationship – appears to be under threat according to the findings of a new survey.

A new study by Zurich-based alternative asset manager SCM Strategic Capital Management has revealed that private equity general partner groups are taking longer to deploy their capital: swallowing higher fees as a result. 

The report found that the four-year investment period that was market standard throughout the 1990s was found in only 10 percent of 235 new private equity fund offerings coming to market in 2005. About 60 percent of these funds stated an investment period of five years, and a further 22 percent more than five years.

In addition, 44 percent of the funds surveyed this year said their investment periods started with the final closing, compared with 35 percent when a similar study was undertaken last year. It has traditionally been the case that investment periods commence at the time of a fund’s first closing.

Ralph Aerni, head of private equity at SCM, said that the combined effect of longer and deferred investment periods on the funds in the survey produces an average increase in the total management fee payable by investors in those funds of between 10 and 15 percent. 

“GPs do indeed need those longer investment periods to deploy the capital of their increasingly larger funds,” says the report. “But it is the investor that has to pay the increase in cost that is a side-effect of this trend.”

The survey also found that commitments to new funds made by GP management teams have fallen over the last year. More than 50 percent of funds surveyed in 2005 incorporated a management stake above one percent of the total, a decline of around 10 percent compared with the previous year.

The trend towards declining GP commitments may lead some investors to conclude that the alignment of interest is weakening

SCM third Annual Review of Private Equity Terms and Conditions

The combination of higher contributions from limited partners and lower commitments from general partners could bring into question alignment of interest. The report concludes: “While success-based fees are largely unchanged the trend towards declining GP commitments may lead some investors to conclude that the alignment of interest is weakening in an industry that is both growing and maturing.”

The report did, however, conclude that corporate governance standards in private equity have increased, with 99 percent of funds providing advisory boards and 94 percent offering key man provisions.     

The third Annual Review of Private Equity Terms and Conditions was based on SCM’s deal flow of new private equity fund offerings for the period 1 January 2005 to 30 September 2005 and included 235 private equity partnerships and other investment vehicles.