Who pays management fees remains the biggest bone of contention for investors during due diligence with managers, according to PEI’s Perspectives Survey 2019, and are rising up the agenda as fund sizes grow.

In all, 45 percent of respondents pointed to management fees as the most contentious terms raised during negotiations on the limited partnership agreement, and advisors say this is not surprising.

“Fee negotiations tend to follow a well-trodden path,” says Jason Glover, investment funds partner with law firm Simpson Thacher & Bartlett. Management fees are typically expressed as a percentage annual levy on funds committed. “First-time funds are usually at 2 percent, and then thereafter tend to find an equilibrium at about 1.5 percent, especially for the mega-funds,” says Glover.

“The area of contention arises when you are looking at increasing the size of the fund, with some investors querying why doubling the size of the fund means the total amount of management fee should also double, when the manager is not necessarily doubling headcount.”

Nearly two-thirds of the investors surveyed (65 percent) have asked their GPs for greater fee transparency and disclosure in the last 12 months, with 63 percent agreeing that the fees charged by private equity funds are now difficult to justify.

Mounir Guen, chief executive of placement firm MVision, says: “For me, the debate isn’t so much on the quantums when it comes to fees, but on the visibility of the underlying cashflows, and how they are categorised relative to expenses, fees and other costs of investment.

“Where GPs spend a lot of time in discussions with investors is on fund size, and what the fund size means for the positioning of the strategy. There’s then a fairly interesting discussion to be had around resourcing relative to that positioning, and it is worth noting that US private equity teams are typically much smaller relative to the quantums they are investing than their European counterparts.”

Nick Benson, investment funds partner with Latham & Watkins, says there are also frequent bilateral conversations to be had around fees: “Often big investors will feel they should get a particular deal given their size and strategic importance.”

Second to fees, investors pointed to unsatisfactory or non-existent key-person clauses as a hot topic in LPA discussions, with 44 percent saying these were a recurring issue. Glover says: “Key person is always an issue, and it becomes an increasing focal point in the market as investors become more keen to back institutional brands, which tends to drive a much broader key-person test than might previously have been the case. Investors now often want to see a broader bunch of people named, and then there is negotiation around trigger events, remedy periods and so on.”

A third of the LPs pointed to the GP commitment as an issue, with investors focused on general partners having  ‘skin in the game’ by committing their own money to a fundraising. Again, this becomes more of an issue as fund sizes grow, with GPs typically asset rich but cash poor, and therefore constrained in their ability to commit.

Guen says: “The investors would typically like the GPs to be at 2 percent of total committed capital, but not all managers can meet that – some funds can do a lot more. That’s an area where there are sensitivities.”