Despite a number of disruptive events in 2016, or perhaps because of them, private equity funds remain the favoured access point for institutional investors looking for a return from their private investments.
Given the ability of these investors to tie up capital in long-term investments and their full coffers after a sixth successive year of distributions out-stripping capital calls, the fundraising environment has arguably never been better for general partners.
However, it continues to be a crowded playing-field with reports of a record number of funds already in, or planning to be in, the market in 2017. So the question is: how does a GP stand out from the pack and ensure its fund gets serious consideration?
While at Buyouts Insider’s PartnerConnect East 2017 event in Boston last week, I gleaned a few tips on this subject from keynote speakers, panelists and other participants. Here are the top 10.
- Crafting the investment strategy
Ensuring the entire GP team consistently articulates a sharp and concise investment strategy may sound like a given, but LPs report being underwhelmed by presentations, both written and verbal.
According to a Preqin survey, almost half of LPs receive more than 10 fund pitches each month, and almost 40 percent of the respondents said that fewer than 5 percent of fund proposals made it past an initial review.
Ensuring LPs understand the investment thesis without having to wade through too much information is critical to ensuring success. Where an edge or advantage of a fund or team is highlighted as being part of its success, ample data should be provided to support the assertion.
- Reliance on track record
In the battle for LP consideration, a proven record of performance is obviously a distinct advantage. GPs must be prepared, however, to provide detailed data and defend the track record.
LPs reported data being selectively included by GPs to support an alleged investment sweet-spot and related track record. GPs should assume LPs will want to take a deep dive into all deals over a long period. For this reason, providing information up front establishes a level of trust.
- Succession planning
Adequate succession planning is top-of-mind for LPs, which is not surprising given the maturity of many top funds and their management teams. LPs not only want to know who is in line to manage the fund into which they are investing in years to come, they also want to see these individuals playing a key role and having a seat at the table now.
GPs should expect LPs to conduct diligence on how fees and carry are allocated amongst the team. That’s because they want to ensure the heir apparent is adequately compensated and will in fact be there to take up the reins when the time comes.
- Allocation of investment opportunities
Given the torrid pace of fundraising and high level of dry-powder, it is an understatement to say that good deals are hard to come by for buyout funds.
As a result, LPs are particularly concerned about a sponsor’s investment allocation policy amongst its other funds and managed accounts, in particular where there is any overlap of investment objectives. LPs are not interested in limiting a GP’s ability to raise funds or expand their business, but they want to ensure a GP has a transparent, robust and equitable deal allocation policy that is rooted in a GP’s fiduciary duties.
- Dismantling of Dodd-Frank
The Wall Street Reform and Consumer Protection Act of 2010, better known as “Dodd-Frank”, requires all PE firms with more than US$150 million in assets to register with the SEC in the category of “investment advisers” and report information covering their size, services offered, investors, and employees, as well as potential conflicts of interest.
While it is anticipated certain requirements under Dodd Frank, including those that relate to PE funds, are to be scaled back, GPs should expect LPs to require the same level of reporting and transparency.
- Transparency of fees and expenses
Similar to the reporting discussed above, LPs continue to be focused on allocation of fees and expenses and the reporting and transparency related thereto.
The fee and expense reporting template published by the Institutional Limited Partners Association has now been publicly adopted and supported by almost a dozen leading GPs. Funds in the market should expect to commit to this requisite level of detail and transparency, regardless of whether it continues to be required by law.
- Amendments to fund documents
Given the potential for big changes in the PE fund industry, including around key areas such as tax treatment of carried interest, LPs understand there may be a need for a GP to revise a fund’s constating documents during the lifetime of a fund.
However, LPs are focused on the process and transparency related to the amendment process, in particular unilateral amendment rights that are solely for the benefit of the GP. Where a GP wishes to include such a unilateral amendment right, they should expect the LP to negotiate that fees related to such amendment process be borne by the sponsor.
- Co-Investment rights
GPs should anticipate that many LPs will request co-investment rights in order to commit to a fund, and, at least the sophisticated LPs with in-house investment capability, intend to act on them.
While such co-investment rights erode GP fees, the positives are many and include strengthening the LP-GP relationship, expanding the deal network, tapping into LP expertise and, most importantly, allowing the GP to have access to (smart) capital when it is needed for a large transaction.
Furthermore, denying co-investment rights to a potential LP will likely lose the fund the investment and the LP may still continue to compete as a direct investor.
- Background and reference checks
Principals and other professionals in a GP team should anticipate facing ever-increasing levels of scrutiny from current and prospective investors. LPs will often request that executives provide personal information, such as social security numbers, credit reports, and disclosures of past transgressions as part of their due diligence of a fund.
While a fund manager may feel that such background checks are irrelevant to the objective of providing a strong return to investors, to resist such requests is at their peril. It is worth bearing in mind that many of these institutional investors are not merely interested in whether or not an individual is going to make money next year. They are also worried about reputational risk.
- Deviating from the standard
While high-performing GPs have been taking advantage of an environment of over-subscriptions to negotiate more favourable terms, most PE firms that are jostling for investments in the middle territory are advised not to over-reach.
For example, certain top funds have gone off-market and either eliminated or reduced the hurdle rate, being the minimum rate of return for a fund required before the manager begins to earn its carry. The overall market has not shifted on the approach to hurdles, however, and such an alternative approach may ostracize potential investors.
In order to secure an investment, staying with the standard terms is the safer approach.
Mary Abbott is a partner in Osler, Hoskin & Harcourt LLP‘s corporate practice. She advises domestic and foreign companies, as well as Canadian pension plans, on mergers and acquisitions, complex corporate restructurings and securities law matters, including financings.
Photos of Mary Abbott courtesy of Osler, Hoskin & Harcourt LLP
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