MJ Hudson’s annual Private Equity Fund Terms Research for 2017 finds that there has been improved GP/LP alignment through stronger fund governance in the private equity world.
MJ Hudson’s annual Private Equity Fund Terms Research for 2017 finds that there has been improved GP/LP alignment through stronger fund governance in the private equity world.
The firm writes that last year saw unprecedented investor interest in private equity since the global financial crisis, with record fundraising levels and many LPs signalling their intention to increase allocations to private equity.
“However, the number of funds that closed in 2016 decreased when compared with previous years – LPs appear to be investing more capital with a smaller number of proven and well-known GPs, with the largest funds accounting for a greater proportion of overall fundraising.”
The impact of this is lower GP commitments and increased management fees but outside of economic provisions, many GPs are committed to offering other ways to meaningfully align GP/LP interests through fund governance.
MJ Hudson’s survey found that counterintuitively, LP pressure on GP commitment has softened with the majority of GPs making 1.5-1.99 per cent commitment while the 2016 report data showed the majority of GPs making commitments in 2-2.99 per cent range.
The firm’s 2017 data suggests that GP commitment is becoming less prominent than other factors in investors’ GP evaluation process. In terms of fees, the 2 per cent management fee dominates, with the number of funds charging 2 per cent increasing against the 2016 report data, being the dominant fee level by both number of funds and capital (with 62 per cent of capital in 2017 sample attracting 2 per cent). The 2 per cent management fee dominates small cap funds (<USD500 million) to large cap funds (USD1.5 billion-USD4.5 billion).
The report finds that 100 per cent catch-up is near ubiquitous, with the vast majority of funds reporting it as fast to the GP.
However, 88 per cent of sampled European funds offer whole-of-fund carry, and in North America that stands at 35 per cent, against 2016 data which showed only 20 per cent of North American funds offering whole-of-fund carry.
The 8 per cent hurdle rate still presides, the study finds, commenting that this is despite the fact that low interest rates have persisted for a number of years. Some 93 per cent of sampled funds report a 8 per cent hurdle rate. Another finding was that interim clawback features in 71 per cent of deal-by-deal funds.
“However, mainly based on pro-GP FMV test and only a minority of interim clawbacks have multiple test dates,” the firm writes. “The emphasis is still on getting carried interest out to the GP (and, ultimately, to the fund executives): in our sample, no deal-by-deal fund with an interim clawback offers carry escrow protection, with 80 per cent of such funds offering guarantees as an alternative to escrow restrictions on carry distributions to the GP. This raises questions as to the credit worthiness and enforceability of such guarantees.”
The general market norm for carried interest is a 20 per cent share of a fund’s profits. The firm writes: “However, our data shows some GPs offering alternatives to the traditional ’20 per cent’ carry model…These alternative carry structures suggest that carried interest, properly designed, is a formidable tool to align incentives between the GP and its LPs. Reforms to the taxation of carried interest that are expected on both sides of the Atlantic this year may lead to yet more disruption of the old certainties of the ‘two and 20’ model, traditionally an integral part of a private equity fund manager’s compensation arrangement.”
