The terms they are a-changing

Investment guidelines developed by the Institutional Limited Partners Association could have less impact than they might have done simply because there are so many provisions, according to Switzerland-based investment consultant Strategic Capital Management.

“It’s a little bit over-ambitious. There are 80 bullet points stipulating various things: almost 50 dealing with reporting,” said Stefan Hepp, a partner with SCM. “It’s very valuable, but LPs run the risk of being too detailed, and by doing so, they’re watering down the impact.”

[The ILPA guidelines are] a little bit over-ambitious. There are 80 bullet points stipulating various things: almost 50 dealing with reporting

Stefan Hepp

SCM recently published its 2009 review of private equity terms and conditions. In the report, the firm said the ILPA guidelines “go a bit too far in the limited partners’ direction” and that in recent due diligence projects, ILPA members were not strictly sticking to the guidelines, but focusing more on the points they considered to be key.

“This being said, a few ILPA members seem to take the guidelines very serious[ly] even if it means that they miss a top-in-class fund,” according to the report.

SCM found certain terms and conditions will receive more pressure from LPs this year. A preferred return – or hurdle rate – of around 9 percent or 10 percent, rather than the more common 8 percent, will be pushed by LPs, as will waterfall distributions for carry, where it is paid only after capital is fully returned.

Also, LPs will push for GPs to use 100 percent of any transaction fees to offset the management fee and to use cash for partners’ commitments to funds, rather than rolling in excess management fees.

“Should limited partners be successful in negotiating a netting of the fees, managers of larger funds will lose a truly important source of income,” the report said.

From 2007 to 2009, GPs’ contribution to their funds ranged from 1 percent to 5 percent, with most GPs contributing around 2.5 percent, the study said. The funding of such commitments was made easier in the time period because of the amount of carried interest GPs collected during the bull market, and the amount of fees managers collected in the past few years, SCM said.

SCM also noted that during one recent due diligence project, pressure on fee income had led to the GP having to reduce its commitment: “This may perhaps become a wider phenomenon in the industry going forward.”

Half the funds that started fundraising in 2009, and that SCM clients committed to, either reduced their management fees and/or changed the split of the deal fees in favour of LPs, the firm said.

The use of placement agents also dropped last year to about 52 percent, compared to 57 percent in 2008, according to the report. This was due to decisions on the placement agents’ part to turn down mandates they did not feel would be successful, SCM said.

“For this purpose, some placement agents changed their model from a pure success fee to a mix of retainer and success fee,” the report said. “While such models improve the placement agents’ position, managers will probably be more reluctant to award mandates to placement agents where the fundraising success and duration seems questionable.”