A tighter fundraising environment has provided limited partners greater say in designing management fees, clawback provisions and fee offsets, according to a study by New-York based law firm Debevoise & Plimpton.
In investigating the matter, Debevoise tracked over 200 buyout funds and then compared the key financial and legal terms of funds that had final closing from 2005 through 2008, prior to the crisis, compared against the terms of funds raised since 2008, post-crisis.
The study discovered “no substantial shift” in the key economic terms of buyout funds, but that three key areas did however begin to reflect certain proposals in the Institutional Limited Partners Association' “Private Equity Principles”, a set of best practices guidlines on terms and conditions that was released this time last year.
Firstly, the study found post-crisis funds showed a notable decrease in management fees after an investment period had concluded. This reduction in fees was long-demanded by LPs and included in ILPA’s guidelines, which argue reduced management fees following a wind-down of a fund’s investment period was a reflection of lower operating costs.
The study noted funds with capital commitments of $2 billion or more raised prior to the crisis had average post-investment period management fees of 1.24 percent, and funds of the same size raised after the crisis showed a lower 1.10 percent fee.
Likewise, funds with capital commitments of less than $2 billion had post-investment management fees averaging 1.81 percent, with funds of the same size raised after the crisis offering a lower 1.73 percent average fee.
Secondly, the study discovered a change in the handling of fee offsets, which occur when a GP reduces or cancels management fees as a result of receiving income from break-up fees, transaction and/or monitoring fees charged to portfolio companies.
More fund sponsors are now increasing their fee offset percentages or even agreeing to a 100 percent fee offset when raising a new fund, according to the study.
While the study stated it was too early to tell whether a 100 percent fee offset will become a market standard as ILPA guidelines recommend, 86 percent of funds raised post-crisis provided a fee offset percentage of 80 percent or higher compared to just 64 percent during the boom years.
Likewise, only a marginal 9 percent of funds raised post-crisis failed to offer fee offset percentages of at least 50 percent, while that number prior to the economic downturn was 24 percent of funds raised.
Lastly, the study unearthed LPs gaining favour in clawback provisions – which allow fund investors to recover money in the event GPs receive too much carried interest, such as when managers receive carry on successful exits early in the fund’s life, but then fail to match such performance in subsequent disposals.
In noting ILPA’s recommendation that GPs should make any necessary clawback payments within two years, as opposed to waiting until the fund completes its last exit, the study revealed 16 percent of the sample funds now provide for the provision compared to the lesser 10 percent of funds offering the provision raised during the boom years.
The study measured nine key economic terms of buyout funds: the timing of carried interest distributions, carried interest percentages, preferred return rates, management fees both during and after the investment period, sharing of transaction and other fees, joint and several guarantees on GP clawback provisions, interim clawback provisions, and after-tax calculations on clawbacks.