When a corporation makes mistakes, the CEO resigns. When a PE firm makes mistakes, it cans portfolio company management. With all this talk of a PE firm shakeout, will the heads of firms resign? It doesn’t seem likely. In fact, I am not sure that has ever happened in the history of private equity. The keyman provision and ten-year tie-up period make PE heads accountable in different ways than managers of public companies. When a firm messes up royally, the top dogs stick around.
Yet today we saw the head of one of the largest PE firms in the world resign. Philip Yea, CEO of 3i, stepped down after news that the company’s investments plunged 21%. The difference here, of course, is that 3i is a public company.
Maybe those PE firm heads don’t need to resign (although I’m sure some LPs would like certain GPs’ heads on a platter). Instead, they could benefit from extending an olive branch in LP relations. Judging by the commentary at this conference and Wharton, LPs are imploring GPs to “do the right thing.” For example, Solomon Owayda of SVG Advisors, said the top two things GPs should do now is lower their fees and increase the amount of GP commitment to their own funds.
Regarding fees, he said the fee structure originated to cover the bare essentials in the cost of managing the fund. As fund sizes increase, it has become a profit center for PE firms. It needs to go back down to cover just the costs. James Kester of Zurich Alternative Asset Management added, “Management fees should do nothing more but keep the lights on.”
In typical self-defeating LP nature (stick up for yourself, guys!), Kester said, “We’re the ones to blame. We’ve put too many people in business and have continued to fund them.” He did issue a battle cry: “We have to stop that. We have to stop keeping marginal GPs in business and no longer permit a misalignment of interest where private equity is an attractive profession to be in regardless of the performance of your funds.”
Owayda also brought up transaction fees. He said that back in the day, 100% of deal fees went to LPs. Can you imagine? Then it shifted to an 80/20 split, and now its close to 20/80. That trend will likely reverse itself, he said.
Lastly, Owayda suggested, firms should do a “waterfall carried interest,” at the end of the fund, instead of on a deal by deal basis, to avoid clawbacks. Not the first time we’ve heard about GP clawbacks.
(Sidenote: Talk about a fast news cycle-it’s only been a few days since we posted a liveblog of 3i CEO Philip Yea’s speech at the Wharton conference! You can revisit his obsolete plans for carrying 3i through the downturn.)