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Emboldened LPs: The Latest LPA Request

It seems private equity investors have finally listened to our endless harping–they’re taking a stand against general partner impropriety.

Today, two separate sets of limited partners (LPs) took action against their GPs: In Munich, buyout fund Nordwind Capital’s investors blocked its deal for a fertility clinic roll-up play, claiming the deal is off-strategy. The firm decided to cancel the deal rather than force the resistant LPs into default (note: all of this happens back in February, but it only came out today).

And, in the U.S., investors in two Citigroup infrastructure funds have voted to ban them from making future investments, citing a key man provision and several failed deals.

These actions, while headline-grabbing, are just a piece of some of the behind-the-scenes LP uprisings. Cash-strapped or not, private equity investors are actually using this tough fundraising time to negotiate for better terms in their fund documents (LPAs).

Some of the terms they’ve asked for include lower management fees, lower or possible “waterfall” carried interest, lower transaction fees, stronger key man provisions, and even possible clawbacks on deals that have produced carried interest for GPs.

The latest one I’ve heard is a clause that requires the fund to raise anywhere from 66% to 75% of its target before it can become active. The firm is permitted to hold a first close on less capital but cannot put the money to work until a large majority of the target has been raised. If the firm can’t meet its target within a year, the LPs are freed from their fund commitments.

With fundraising so difficult, many efforts in the market have substantially lowered their targets. This worries LPs, not because it changes their allocations, and not because they will own a larger percentage of a fund, but because it may cause the GP to change its investment strategy. The firm may invest in the same size companies it planned to, but own far fewer companies, concentrating its funds too heavily on too few companies. Or, the firm may invest in smaller companies, which may be off-strategy for the firm’s managers and can change the LP’s allocation basket for the fund (for example, from mega-buyout to middle market).

The new term is a version of what led to the demise of West Hill Partners earlier this year. The first-time Boston fund, started by former J.W. Childs professionals, was shut down in March thanks to one large LP. Ontario Municipal Teachers Employees Retirement System committed $75 million to the fund, which had a $500 million target. When the firm only raised $120 million in around a year, its investors forced it to pull the plug.