Tenex offers half cash, half waiver for Fund II GP commitment

  • Firm to split GP commitment between cash, fee waiver
  • Percentage of GPs using waiver falls to 16 pct
  • “Large funds just don’t deal with it anymore,” says one LP

Tenex Capital Management’s commitment to its second flagship fund will be split evenly between a cash contribution and a management fee waiver, according to an investment memo from the state of Rhode Island.

The general partner’s allocation to Tenex Capital Partners II will equal 3 percent of the fund’s aggregate commitments “through 50 percent cash and 50 percent management fee waivers,” according to the investment memo. Tenex set a $600 million target with a $750 million hard cap for the new fund.

The firm declined to comment.

Many limited partners dislike GP commitments funded through management fee waivers because they effectively reduce fund managers’ personal tax burdens, according to an LP.  

The waiver converts management fees paid by LPs, which are taxed as regular income, into the GP’s capital contribution to the fund. Earnings generated by capital contributions are taxed at a lower rate as long-term capital gains.

The practice attracted considerable scrutiny in recent years from regulators who view waivers as a tax dodge. In July, the IRS proposed rule changes to curtail the use of management fee waivers, mirroring similar regulations in the United Kingdom. New York State Attorney General Eric Schneiderman launched an investigation into the practices in 2012. The case is under seal, Fortune reported.  

Once common — more than half of the funds in the California Public Employees’ Retirement System’s $27 billion private equity portfolio use waivers — the practice began to fall out of favor as regulatory scrutiny intensified.

Approximately 16 percent of North American buyout funds fund a portion of their GP commitment by waiving management fees, according to Buyouts and VCJ’s 2016-2017 PE/VC Partnership Agreements Study. In the 2014-2015 version of the same study, 28 percent of firms funded their contributions with waivers.

“From a purely economic position, it doesn’t mean that much … It’s still their money,” said one LP. Many investors prefer direct cash commitments, however, and “given the heat that fee waivers are getting from regulators, what you see is large funds just don’t deal with it anymore.”

In the current fundraising environment, smaller firms marketing their debuts often lack the clout to negotiate a management fee waiver, sources said. Conversely, mature general partners earning carried interest from earlier funds likely have the cash on hand to commit to their own fund.

Tenex falls squarely between those two examples, which provides the firm with enough leverage to opt for a GP commitment via management fee waiver, two LPs told Buyouts.

The firm has realized just two of the investments from its $425 million debut fund, which held a final close in 2011, according to a New Jersey Division of Investments memo. The returns from those two deals have been superb, however, which gives Tenex room to negotiate as it hammers out terms with its LPs.

Tenex grossed a 63 percent internal rate of return and 4.1x multiple on its September 2015 sale of Medical Solutions, a clinical staffing company, according to the New Jersey memo. In the other deal, Techniks, which produces industrial cutting tools, returned three times its invested capital. Rhode Island pegged the combined return at 3.58x invested capital with a gross IRR of 52 percent.

Overall, Fund I netted a 16.1 percent IRR and 1.4x multiple as of September 30, according to New Jersey documents.

New Jersey approved a commitment of up to $100 million to Fund II. Rhode Island State Investment Commission committed $20 million to Tenex Capital Partners II in January. Both commitments remain subject to negotiations.

In addition to its GP commitment, Tenex will also offset LP management fees with any transaction, investment banking, break-up, advisory, monitoring, directors’ and other similar fees charged to Fund II’s underlying portfolio companies, according to Rhode Island and New Jersey documents. The firm will also have to clear an 8 percent return hurdle before it collects carried interest.

Tenex is based in New York City. The firm has $464 million under management.

Action Item: See Rhode Island’s memo on Tenex here: http://1.usa.gov/1Rlolu4

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