Limited partnership agreements may be starting to put LPs at a disadvantage when it comes to co-investing, according to research by MJ Hudson.
Although 94 percent of funds contemplate co-investments in their LPAs, just 45 percent require co-investments to be on “substantially similar terms” to the investment made by the main fund, according to the alternative asset management consultancy’s latest Private Equity Fund Terms Research report.
Just 13 percent of LPAs that mention co-investments stipulate that the GP cannot charge a management fee or carried interest in respect of co-invested amounts – up from 5 percent the year before, according to the report.
Of the funds that contemplate co-investments, only 38 percent require co-investments to be acquired or disposed of at the same time as the fund’s investment. This is an increase from 27 percent the previous year.
Just 11 percent of the funds allow some LPs to have priority rights of first refusal in respect of co-investment opportunities.
“The methods by which managers allocate co-investment opportunities are often opaque, to say the least,” MJ Hudson noted in the report. “As a result, co-investments can create misalignment, as not all LPs are treated equally.”
Who gets a seat?
On a bright note for LPs, 100 percent of funds surveyed had an LPAC – the body that primarily advocates for LP interests. Ninety-one percent of funds specify that GP affiliates cannot be members, and nearly three-quarters permit LPACs to exclude the GP’s representatives from sensitive discussions.
Still, GP influence finds a way: 52 percent of funds require disclosure and approval of all actual and potential conflicts or transactions with affiliates to the LPAC (or the investors). This compares with 42 for disclosure and 39 percent for approval in 2019’s survey.
A managing director at a global asset manager that runs a co-investment programme told Private Equity International that co-investments will continue to grow as GPs still prefer to partner with LPs over being a member of a consortium deal.
“The buck is moving to the GPs,” the MD said. “I can go with a like-minded PE firm in a deal, but I’d rather have three or four of my LPs who are aligned with me, and I can have an easier time making critical decisions because the LPs are aligned with me anyhow.
“You will see fewer consortium deals, but you will see more co-underwriters partner with GPs to fill that capital structure need that used to be filled by other PE firms.”
MJ Hudson’s report analyses the terms and conditions of a sample of private equity and venture capital funds that came to market or raised capital in 2019, representing $158 billion in capital commitments.
Placement agent and advisory firm Triago estimates that co-investments’ share of all shadow capital last year was 32 percent, or around $57 billion – the same proportion as in 2019.
Adam Le contributed to this report