New fundraisings may prompt amendments

Limited partners may seek changes to existing partnership terms when GPs come calling about the next fund, say advisors to both LPs and GPs.

Current economic malaise notwithstanding, a number of private equity firms are planning to kick off fundraising efforts in 2010. Not much is certain about the market, but these GPs will almost certainly find the 2010 fundraising market to be exceptionally difficult.

Setting aside the chief worry, which is that LPs who backed the prior fund will fail to re-up, GPs may find that their investors will use these new fundraising efforts as an opportunity to talk about terms they now find to be unsatisfactory in the current partnership.

“The renegotiation of existing funds is a drama yet to unfold,” says Louis Singer, a partner in the New York office of law firm Morgan Lewis & Bockius. “I think that’s something that will be played out as GPs go back to market.”

The most dramatic request from LPs may come in the form of “interim clawbacks”. According to one placement agent source, some LPs are prepared to ask several of their existing GPs to place additional capital in escrow reserves as preemptive moves against possible clawbacks at the end of the funds’ lives. The requests will be presented as prerequisite for commitments to the next funds, the placement agent said.

An LP would want an interim clawback if there was any 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. In particular, some buyout funds may have paid the GPs carry based on early distributions in 2006 and 2007, but now the deteriorating performances of these funds call into question whether the GPs will ultimately clear their hurdles and qualify for any carry at all. Rather than wait until the end of the funds’ lives to find out, some LPs want GPs to set capital aside now as a precaution, says the placement agent.

Singer confirms that very few funds raised during the frothy 2006 and 2007 fundraising market included interim clawback provisions (the issue is mostly confined to the US – most European funds return all capital to LPs before GPs begin to receive carry).

Two prominent advisors to institutional investors said they had not yet seen any indications that LPs would seek to amend current partnership terms to include interim clawback provisions.

But LPs may well be in the mood to renegotiate other terms when their GPs come calling.

Singer says he expects discussions on a range of terms and conditions in existing partnerships. One partnership amendment that may be sought after concerns the management fee offset. “If an LP has only a 50 percent fee offset, that would be a red flag,” says Singer, who notes that the market for this term is moving toward 100-percent of transaction-related fees going toward the offset of management fees. Some GPs still keep for themselves as much as half of so-called deal fees.

Another area of amendment may be in the governance of the fund, including how limited partner advisory committees are structured, how regularly meetings are called, how “in camera” meetings (without the GPs) are called.

Since many GPs are now attempting to raise “annex” or “supplemental” funds, many LPs will want to amend terms concerning cross-fund investing and related issues.