On a list of the most heavily-negotiated points significant to LPs raised in a limited partnership agreement (LPA), management fees took first place, according to London-based law firm MJ Hudson.
“Often addressed at the outset of negotiations on terms, LPs will expect, at a minimum, to see detailed budgets to justify fees being charged to ensure that GPs are not unduly enriched from charging excessive management fees,” it said in its first LP Intel publication released in early February and prepared by the law firm’s LP Unit.
“If investing a reasonable percentage at first closing, LPs may also expect to receive an ‘early-bird’ fee discount or a fee ‘holiday’,” the report said.
Ranked number two was fee offset/disclosure, with LPs expecting all transaction and monitoring fees to be offset against management fees, in accordance with Institutional Limited Partners Association principles, and disclosed at least annually if not more frequently, the report said.
Only the most successful GPs, or those in particular sectors such as infrastructure, are still able to argue to retain fees from portfolio companies and “even then they will need a compelling reason”, the report said.
The third most negotiated issue was the GP commitment, “which has seen an increased trend in LPs’ favour”. For firms raising their third or more fund, LPs expect the total GP commitment to be higher and range from 2-5 percent.
No fault removal right, in which an LP can replace a manager, came fourth. “The period during which the GP cannot be removed without cause and the level of compensation and carried interest to which the GP is entitled on a no fault removal are also key negotiating points for LPs,” the report said.
This protection remains common among some European funds, but does not typically exist in the US, where some funds provide a no fault termination right that discontinues the fund, MJ Hudson said.
A key person event ranked fifth. In addition to individuals, LPs are now paying attention to the “triggers for and the consequences of” such an event. The report noted that managers are increasingly trying to “carve-out other activities, including work on side projects and charitable work from the devotion of time requirements, which is far from satisfactory from an LP’s perspective.”
Further down the list were distribution waterfall/hurdle at number six, that noted managers “attempting to raise an EU fund with a deal-by-deal distribution waterfall will likely receive push back from LPs”, and LPs were focused on carry escrow and clawback guarantee provisions.
“In terms of the hurdle rate, an 8 percent preferred return is still very common but is coming under pressure given the low inflationary environment, with a few GPs now even going to market with no hurdle whatsoever, such as Advent’s latest fund,” the report noted in reference to Advent GPE VIII, currently in market targeting $12 billion.
Indemnification, including LPs’ requests for more information on the extent GPs have insured against such claims, ranked seventh.
Most Favoured Nation closed the list as the eighth most negotiated point. “Savvy LPs” make sure one is included, while smaller LPs resist tiered MFN clauses, the report noted.
The application of a tiered MFN clause to disclosure “has the effect of curtailing the transparency of side letter terms, not to mention the non-disclosure of inconsistent investor terms, potentially causing issues for EU funds under AIFMD [Alternative Investment Fund Managers Directive]”, MJ Hudson said.