I met with an LP the other night for drinks at one of the fancy bars financial types frequent. We chatted about the state of the market, and as is usually the case, the LP wanted to compare notes about certain GPs. “What have you heard?”
I usually get that question when an LP is considering committing to a GP, but in this case, it involved the level of annoyance this particular GP had achieved with LPs in the market.
Certain names have come up recently when LPs complain about GPs with “unfriendly” terms. Think of many of the big shops in the market today with more demand than they can handle, and a few of those have probably made some investors angry.
Heavily sought-after GPs are coming back with terms that, from an LP’s perspective, are much worse than the prior fund. These GPs don’t have to worry about annoying a few existing investors because LPs with no exposure to the firm want in — desperately. If an existing LP decides the new terms are too onerous to re-commit, the GP needs only to select an LP from the “waiting list.”
This is the fundraising environment we are in today, and for many LPs it is a tough place to be.
“There is almost universal frustration with the fundraising environment,” a public system LP told me. “But I hear very little actual push back against GPs. Lots of private moaning, then they hold their nose and ask for larger allocations.”
The LP added: “The evidence suggests that GPs have the leverage and any pullback from LPs will come only when it’s too late.”
I have heard anecdotes of firms changing their carried interest distribution structures from the LP-friendly European model, in which GPs only start to collect carry after LPs have been paid back in full, to deal-by-deal carry.
LPs were surprised when Advent International chose to drop its preferred return from its eighth flagship fund, which is in the market targeting $12 billion.
Waterland Private Equity Investments included provisions in its latest fund that allow an investment period extension at the discretion of the GP and approval of at least 50 percent of the LPAC, which one LP described as a weakening of governance standards.
LPs have also expressed concern over fund size increases in several funds that are in high demand. One of those, Audax Group, is targeting $2.25 billion for Fund V, compared to the $1.25 billion it raised for Fund IV in 2012. Clearlake Capital Group closed its fourth flagship fund on $1.38 billion earlier this year, a big jump from the $785 million it raised for Fund III in 2012.
Existing LPs, who rightly feel entitled to some deference from GPs for their past loyalty, are being cut back and even shut out of new funds as GPs look to diversify their LP bases. This is hitting small U.S. investors particularly hard as GPs welcome money from huge pools of capital in the Middle East and Asia.
The feeling is, GPs are using this environment to be aggressive with terms and fundraising “because they can get away with it,” said a fund-of-funds LP.
But as always, LPs have ultimate power in the relationship, they just need to use it. “If you’re not happy, don’t write a check,” the LP told me.
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