Further proof that the buyout bubble is mirroring the tech bubble: GPs and LPs are speaking in hushed tones about GP clawbacks. Meaning, some firms scored big returns via dividend recaps or regular exits in the early days of their fund and took carried interest on them. But now, the fund’s wheels have fallen off and the fund will break even or lose money. LPs have a right to that carried interest money, and depending on your limited partnership agreement, GPs must return it.
Will it happen? Probably not in the near term. We’ve heard rumors of one or two firms doing clawbacks, but most LPs don’t expect PE firms to cough up their carry for awhile. It does come out of pocket, after all. And technically, a firm could wait eight or nine years until they’re required to give money back, or they could read the writing on the wall and score a refreshing LP relations coupe by offering it back preemptively. Several LPs I talked to laughed out loud at the preposterous suggestion that GPs would be so generous, but stranger things have happened. I mean, Battery Ventures did it in 2002. People said PE firms wouldn’t shrink their fund sizes and that’s happened almost across the board. People said they wouldn’t allow LPs to shrink their commitments, and TPG has started the party on that. For a firm with a very clear zero, it isn’t completely out of the question.
One LP told me, “We’ve discussed the possibility of our funds doing that, but if I got a pre-solicited offer to settle the problem, that means it is much, much worse than we thought, since they know their portfolio better than we do.”
The next question this raises, of course, is the case of a secondary owner. Say the carry was taken on a deal while it was under the ownership of one LP, who then sold it to a secondary buyer. Who would get the clawback money—the LP that owned it during the liquidity event, or the secondary buyer who currently holds the crappy fund? From what I’ve heard it can vary and is negotiated with each secondary transaction, but generally the clawback goes to the current holder, the secondary buyer. Buyers and sellers on the secondary market have been more aware of this possibility and are negotiating clawback terms more carefully than before, one secondary buyer told me.
Image source: Flickr