Competition eases fund terms for LPs: Preqin

Limited partners have grown increasingly wary of private equity firms’ power in negotiating fund terms, but a recent survey by Preqin suggests competition has made terms increasingly LP-friendly over the past year.

Almost 80 percent of PE investors polled by the London data provider said their interests are aligned with those of their managers, a 16-percentage-point jump from the year earlier. About a third of investors said fund terms had changed in their favor over the previous year.

Higher hurdle rates

Strikingly, a growing number of firms are offering funds with hurdle rates above 8 percent, long considered the industry standard, according to Preqin. This means general partners have to generate even greater returns for their investors before they can collect carried interest.

Meanwhile, the proportion of firms with no hurdle rate fell to 13 percent from 19 percent year-over-year, Preqin found.

Earlier this year, Advent International surprised LPs when it eliminated the hurdle rate from its most recent $13 billion fund. At Buyouts’ PartnerConnect Midwest conference in Chicago, LPs described instances in which fund managers fought to drop their preferred returns to as low as 6 percent.

“Our expected returns on our investments in private equity [are] well above 8 percent,” said panelist William Indelicato, a managing director at Portfolio Advisors. “If at best you can guarantee us 6 percent, we kind of scratch our heads.”

Preqin’s data suggests those instances are exceptions from the norm.

“While the largest and most experienced fund managers have been able to raise large vehicles quickly and successfully, this is not the case throughout the industry,” Preqin Editor Selina Sy wrote in an email.

“More and more funds continue to enter the fundraising market, creating an increasingly competitive environment. The onus is on funds, especially those which are run by less experienced managers, to stand out from the crowd and offer specific selling points in order to attract investors.”

Separate-account provisions

Meanwhile, many sophisticated LPs used that leverage to fight for higher hurdle rates and larger commitments from GPs, as well as provisions for separate accounts and co-investments, Sy wrote.

While Preqin’s findings indicate greater alignment between GPs and LPs, investors like California State Teachers’ Retirement System have raised caution flags over a perceived power imbalance.

“Market dynamics have shifted some power back in favor of general partners, and in some instances this has caused some progress to be reversed or become endangered,” CalSTRS staff wrote in a recent memo.

Action Item: For more information about Preqin’s findings, visit www.preqin.com

Visitors reach for one of the mugs of beer from the first barrel during the opening ceremony for the 182nd Oktoberfest in Munich, Germany, on September 19, 2015. Photo courtesy Reuters/Michael Dalder