LPs get aggressive on fund terms

While limited partners have had success negotiating fund terms and conditions, changing distribution structures remains a hard sell.

In today’s difficult fundraising environment, limited partners are bringing a variety of fund terms to the negotiation table with their general partners.

That’s according to a panel of LPs who spoke at the Dow Jones Private Equity Analyst conference in New York last week. One issue on the forefront of LPs’ minds is the worry that carried interest paid early in the fund’s life may ultimately prove to have been too much, in other words more than the standard 20 percent of profits above a specified hurdle rate, often 8 percent.

“A partnership term that we’re spending a lot of time on these days has to do with interim clawbacks,” said Charles Froland, chief executive officer and chief investment officer of Performance Equity Management. “The idea that, through the carry distribution, a GP can get ahead of the LPs and then the LPs might end up paying for the taxes on those distributions and have to wait out the fund’s life to get back the carry – which could be 10, 12, or 14 years down the road –  just seems unfair.”

Rather than wait until the end of the funds’ lives to settle up, LPs are asking GPs to allow for an interim clawback or even a series of clawbacks before the fund’s term has expired.

“I think there’s movement on that and I think it’s gotten a lot better,” Froland said.

The waterfall distribution plan is another LP-GP partnership issue that has seen a significant amount of discussion recently, according to Kenneth Rosh, head of the Private Equity Funds Group at Fried, Frank, Harris, Shriver & Jacobson.

“For the American waterfall, there’s more pushback to try and push the sponsors a little bit more toward the backend of the waterfall,” he said.

One fundraising benefit coming from the GP side of the table that has come under scrutiny is the so-called “early-bird special”, when GP’s offer a small rebate on management fees to LPs who commit before a first close.

“We’ve seen GPs do this [and ] we’ve discouraged them from doing it generally,” said Hussein Khalifa, a partner at Mvision Private Equity Advisers. “I think it sends a wrong message. It risks alienating existing investors who we know who may not be able to come in early.”

A different kind of incentive that MVision has come up with pertains to co-investment opportunities.

“We came up with a preferred co-investment programme,” Hussein said. “We just weighted the dollars of early closers more heavily than the dollars of late closers in terms of the priority in which they get co-investment opportunities.”

While clawback issues and the sharing of transaction and monitoring fees have evolved in recent years, much to the delight of LPs, whether GPs will embrace co-investment incentives and changes to waterfalls remains to be seen.