On your mark…

UK-based private equity firm BC Partners is officially marketing its ninth buyout fund, according to documents from The San Francisco Employees’ Retirement System.

The start of the process ends many months of speculation about the fundraising, which was being trailed by the media as early as January this year. It has been viewed as a bellwether for post-crisis fundraising: its success or failure will be monitored closely as it represents the first large-cap firm to kick off a fresh marketing process after the 2008 collapse of the financial markets.

As widely predicted, the fund is targeting €6 billion in commitments, which would make it marginally larger than the €5.8 billion raised for the firm’s BC European Capital VIII in 2005. This is noteworthy, given the expectation in some quarters that GPs will be competing for commitments from a more limited pool of capital than before and that the investment environment may favour smaller funds than those raised during the boom years.

BC Partners is among a group of firms which have spent the past 12 months pre-marketing: testing the water ahead of formally starting a fundraising process. London-headquartered Montagu Private Equity has begun marketing its fourth fund, which will target €2 billion with a hard-cap of €2.5 billion. This amount would be in line with the firm’s third fund, which collected about €2.3 billion in 2005.  In October, the firm received a €60 million commitment from Massachusetts’ state pension.

Meanwhile, Stockholm-headquartered private equity firm EQT is expected to enter the market again in the coming months. It has room in its €4.3 billion EQT V fund – which is approximately 65 percent invested – for “one or two” more investments, said a source with knowledge of the firm. Barclays Private Equity is also understood to be pre-marketing for its fourth fund, which will target around €1.5 billion. Its previous fund closed on €2.4 billion.

Barclays Private Equity, EQT, Montagu and BC Partners all declined to comment.

NEW DEAL

In order to build up momentum for the its fundraise, BC Partners is offering a 5 percent discount on all GP fees for limited partners who make commitments to the fund prior to the first close, according to market sources.

In explaining a firm’s motivation for reducing fees, Peter Flynn, director of Candela Capital, a private equity fund placement firm, says a successful first close is a key test of a fund’s strength.

“We’re not generally seeing these discounts to investors throughout the fundraising process; it’s testimony to a tight fundraising environment which has LPs waiting to see how well the fund is able to attract investors in the first round of marketing,” Flynn explains.

Flynn adds that the first group of investors to commit capital to a fund are invariably taking more risk than investors who sign up later on in the fund’s lifecycle. “They aren’t aware who the future LPs are going to be, have less information regarding the overall shape of the portfolio and whether or not the fund will ultimately hit its target size,” Flynn noted. 

SPOT THE DIFFERENCE

Much has been made of the shift in negotiating power to LPs in today’s fundraising environment. However, little has actually changed when it comes down to fund terms and conditions, according to a study on the matter from New York-based law firm Debevoise & Plimpton. The study, which examines the key economic terms of buyout funds throughout the past five years, discovered no “substantial shift” in the key economic terms during the period.

“LPs and their advisors are vigorously negotiating fund terms these days, in many cases citing the ILPA report to support their arguments,” the report notes. However, there is little evidence of an overall industry-wide shift of power towards LPs.

The study tracked over 200 buyout funds, comparing the key financial and legal terms of funds that had final closing from 2005 through 2008 with the terms of funds raised since 2008.

While there was little overall change in terms, the study did note, however, that there appears to have been some limited or partial movement to adopt proposals put forth by the Institutional Limited Partners Association – an organisation advocating on the behalf of institutional investors in the private equity industry.

Last year the group released best practice guidelines for LPs when negotiating terms and conditions with GPs, dubbed The Private Equity Principles. In November ILPA will add to the principles by introducing a new set of financial reporting standards.

DEMANDS MET

Funds raised in post-crisis years, the study notes, showed a notable decrease in management fees after the investment period had concluded. This reduction in fees was long-demanded by LPs and included in ILPA’s guidelines, which argue that reduced management fees after the wind-down of a fund’s investment period reflect lower operating costs.

Large funds raised after the crisis – those of $2 billion or more – had post-investment period management fees of on average 1.10 percent. Those raised before the crisis charged a fee of 1.24 percent. For smaller funds, the post-crisis funds charged 1.73 percent in management fees after the investment period. Pre-crisis funds charged 1.81 percent.

Secondly, the study discovered a change in the handling of fee offsets, which occur when a GP reduces or cancels management fees as a result of receiving income from break-up fees, transaction and/or monitoring fees charged to portfolio companies.

More fund sponsors are now increasing their fee offset percentages or even agreeing to a 100 percent fee offset when raising a new fund, the study said.

Clawback provisions, which allow fund investors to recover money in the event GPs receive too much carried interest – such as when managers receive carry on successful exits early in the fund’s life – have also shifted. In line with ILPA recommendations, more funds are agreeing to make clawback payments within two years, rather than waiting for the end of the fund life.

The fact that there has been as yet minimal movement on terms and conditions may be a reflection of the quality of funds raised in the two years since the crisis. The firms to successfully brave the market have been sufficiently differentiated – whether it has been through strategy niche or past performance – to demand fairly “traditional” fund terms.  As the fundraising log-jam starts to shift in 2011, perhaps it will bring with it the long-awaited swing in fund terms.