PE will start adopting VC’s fund terms

More venture capital-like fund terms could be bad news for limited partners.

The Carlyle Group has introduced ratcheted carry on its fourth European tech fund, which closed on €1.35 billion at the end of January. CETP IV will charge a market-standard 20 percent carry until it returns 2.25x cost to limited partners, at which point it will jump to 25 percent, according to a source familiar with the vehicle.

Tinkering with carry is not unheard of at this point in the cycle. As one private investments head at a global wealth manager tells us: “We saw this happening three months before the global financial crisis.”

Ratcheted carry – performance fees that increase when a fund reaches a certain IRR or multiple – is typically more common in deal-by-deal strategies, possibly as a means of incentivising staff to stick around longer given that they’re not constrained by a 10-year fund term.

Tiered or stepped carry featured in 17 percent of funds reviewed for MJ Hudson’s Private Equity Fund Terms Report, which analysed terms in 2018 on funds raising capital across private equity, venture capital and other alternatives. Higher carried interest rates are more common in certain venture and tech funds, which have a greater spread of terms than buyouts, managing partner Eamon Devlin tells PEI.

North American VC heavyweight Kleiner Perkins, for instance, introduced ratcheted carry on its early-stage funds in 2016, charging 25 percent carry that jumps to 30 percent once it quadruples returns for investors, according to a CNBC report at the time. The firm collected $600 million for its 18th venture fund last month. It’s unclear whether the terms remained the same and Kleiner Perkins declined to comment for this article.

Carlyle’s head of investor relations Michael Arpey told PEI last week that the firm was pleased to have set terms “appropriate to a fund like this” that would ensure alignment with its LPs. Arpey declined to disclose Fund IV’s terms.

“We’re only as good as our people and it’s important for our firm to ensure that they are appropriately incentivised,” Arpey said. “Creating the right set of terms for particular strategies that tailor both to the needs of the LPs and to our needs is what we strive for and we have accomplished with this fund.”

Tech talent – how to hire and retain it – was a big talking point at the CFOs & COOs Forum in January and it’s reasonable to assume that Carlyle competes (for deals and staff) with big venture firms. Offering similar fund terms and incentivisation, therefore, is not beyond the pale.

Higher carry certainly didn’t dampen appetite: one LP that committed to the vehicle told PEI it was the “craziest fundraise we’ve participated in” due to its speed. Fund IV raised twice the capital of its predecessor, a €656.5 million 2015-vintage, in just three months. That fund sits at a 1.8x multiple of invested capital and 25 percent net IRR.

Buyout firms are becoming more entrenched in the traditional hunting grounds of VC and growth investors. If they can get away with it, they may well adopt more of the fee terms.

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