Fund terms: LPs enjoy the freedom of choice

Global buyout house Apax Partners has officially launched its ninth buyout fund targeting $7.5 billion. Unlike its predecessors, Fund IX will offer LPs a choice between deal-by-deal carry distribution and the European model, in which carry is not distributed until all drawn down capital is repaid to investors and the preferred return is met.

Apax is the latest in a string of private equity firms to present its investors with options on fund terms.

Jason Glover, a partner at Simpson Thacher & Bartlett, says that in the wake of the Lehman Brothers collapse investors leaned heavily on fund managers to move to a per-fund carry structure to conform to guidelines set out by the Institutional Limited Partners’ Association.

Northern Europe-focused EQT is an case in point. The firm’s first five funds had a deal-by-deal carry structure. EQT VI, a 2011-vintage, moved to per-fund carry. For the €6.75 billion EQT VII, which closed last August, the firm offered LPs a management fee discount if they opted for deal-by-deal carry.

According to a source familiar with the fundraise, the majority of EQT VII investors accepted the offer.

John Gripton, a managing director at Capital Dynamics, generally prefers the European model, although “it’s better to have a choice than no choice”.

“I prefer to understand the options so it’s very clear to all that everybody’s being treated in the same way,” he says. “I’m certainly not against having the choice put to us by the manager, providing we think they’re reasonable choices.”

The one thing that all of the funds taking a chance on terms outside the perceived “norm” have in common is that they either are or anticipate being oversubscribed. 

EQT attracted €11 billion of interest in Fund VII; Advent International, which has scrapped the preferred return hurdle for its $12 billion Fund VIII, is said to be well on the way to beating its target.

“It is helpful to be a fund that is going to be oversubscribed, so that you are confident that, if the innovation proves to in fact be unattractive to a small group of investors, then there is still sufficient demand for the fund to reach its hard-cap,” Glover says.

LPs are also being presented with options around management fees. Bain Capital, for example, offered investors in both its $7.3 billion global buyout fund and its €3.5 billion Europe-focused fund the option of several management fee, carried interest and preferred return hurdle combinations.

As Gripton points out, depending on the investor, each option has its merits. A new entrant to the asset class, for instance, may be much more concerned about the J-curve – and therefore prefer the lowest upfront fee option – than longstanding investors.

“There’s been such an outcry about the level of management fees that I think some of the GPs have tried to find a way to help on that,” Gripton says. “They probably believe in the long term they will be better off with the arrangement that they’ve put in place, but at least in the shorter term they’ve accommodated what the investor wants.”

What’s more, an option such as “1-and-30” clearly demonstrates that the GP believes in its performance; after all, it’s giving up the upfront income and will ultimately be the one that suffers if the fund doesn’t perform.

“Investors are highly sophisticated,” says Glover. “They won’t sign up to something unless they think that ultimately it is appropriate.”