The pendulum swings back

General partners are flexing their muscles again.

As well performing and highly sought-after GPs run through fundraising in an increasingly friendly market, there has been a weakening of governance standards in fund documents.

This is not across the board, but it is a trend being noticed in the LP world, and one that does not make investors happy. However, as is usually the case in a bull market, many LPs (not all) will accept terms they don’t like so they can get access to the best performing shops. The consequence of that decision – good or bad – won’t be apparent for years.

This latest iteration involves approvals a GP needs for certain fund contract amendments to extend the investment period or the life of a fund.

The way many LPs believe this should work is to allow the full LP base to vote on an extension of an investment period or fund life. Approval is usually achieved with some percentage of the whole LP base.

What has been happening recently is GPs have been asking for, and in some cases receiving, a fund structure that calls for approval of a certain percentage of the LP Advisory Committee. The LPAC is meant to represent LPs in a fund and usually gets the closest contact with the GP.

But some LPs complain the LPAC is “stacked” by the GP with large investors who, by the nature of their large commitments, are getting friendly economics, and who aren’t likely to rock the boat.

Putting an important decision like the extension of an investment period or fund life in front of the LPAC that may be GP friendly skews too much in favor of the manager.

“As GPs have become more bold, they’re trying to push for this more, as opposed to going to the broader LP base,” according to one source who works with LPs. “GPs are always looking for ways to have more control over the GP/LP relationship without having to go to the broader investor base. LPACs aren’t always representative of the investor base as a whole,” the source said.

In the contract for its most recent vehicle, Dutch firm Waterland Private Equity Investments included provisions that allow an investment period extension at the discretion of the GP and approval of at least 50 percent of the LPAC, according to documents for Waterland’s Fund VI seen by Buyouts.

The investment period (also called commitment period) expires on the sixth anniversary of the first closing, or “such later date” as determined by the manager with approval of at least 50 percent of members of the LPAC, the documents said.

“I’ve never seen that,” said an LP familiar with the fund, describing the provision as “exceptionally robust control of the advisory board.”

Despite reservations among some LPs about the lower approval threshold, Waterland raised Fund VI quickly, collecting 1.25 billion euros ($1.4 billion) for the main fund and 300 million euros for an overflow vehicle.

Waterland did not respond to questions about the fund structure.

Sources said terms overall have been getting looser, especially with GPs that are in high demand. LPs today try to commit more money to fewer managers, choosing only the best performing shops. Because of this, there is a scramble to get allocation into the best funds, leading to what some have described as poor decisions on the part of some LPs.

“LPs are not uniting against GPs on terms because they’re divided on allocation,” said the source who works with LPs. “Because of that, GPs are pushing all these little things in there.”

Another area where LPs have seen GPs pushing for looser terms is around key-man provisions, sources said. Instead of designating one or two executives as key individuals, GPs are pushing for whole groups of executives as key men, including those “lower down the list” who LPs have never met. A larger group of key men means the threshold is higher for activating the key-man provision.

These are just a few examples of what LPs and those who work with them are describing as the pendulum swinging back to the GP – a reversal from the way the world set up after the global financial crisis. It’s something, unfortunately, LPs have to accept in cases in which they want to get with the best in the business.

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