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Removal for-cause provisions almost universal among private equity funds, says new MJ Hudson report

The ability for private equity investors to remove a GP/manager for cause is almost universal with 93 per cent of funds currently having GP removal for-cause provisions, according to a new report from asset management consultancy MJ Hudson.

‘Governance’, the final instalment in the 4th edition of MJ Hudson’s research into private equity fund terms (Private Equity Fund Terms report), reveals that this very closely matches the percentage of funds with this removal mechanism in last year’s report (96 per cent).
 
‘Governance’ provides detailed analysis and commentary from MJ Hudson on private equity fund terms and the implications for both investors and managers. It includes comparisons with last year’s research, and discusses the drivers for any significant changes.
 
The report considers the internal governance of private equity funds and examines current trends in the key investor protections: GP removal (with cause and without); key person events; and the application of the most favoured nation treatment.
 
How decision-making and governance is implemented and conducted by fund managers, and the extent to which investors are involved and have visibility and control over the operation of the funds, is also examined.
 
According to the report, no-fault removal clauses are much more common in European funds than in US funds, with 73 per cent of all sampled European funds have no-fault removal rights – compared with only 18 per cent of US funds, which are more likely to favour a no-fault suspension of investment.
 
In addition, change of control provisions are common, with 75 per cent of funds have change of control provisions, protecting investors should an unapproved change in ownership of the GP take place.
 
Key person protection is almost universal, with 95 per cent of funds include key person provisions’ while 83 per cent of funds that include key person provisions suspend the investment period automatically upon the triggering of the provisions.
 
Some 61 per cent of funds that have key person provisions also allow for automatic termination of the investment period if the key person event is not cured within a certain time period.
 
Only 54 per cent of funds provided a most favoured nation (MFN) clause in their fund terms.
 
Some 30 per cent of funds with an MFN also contained tiering provisions, whereby the applicability of a concession to a particular investor is conditional on that investor meeting the commitment size of the investor whose terms it wishes to avail itself of.
 
Edyta Brozyniak, Partner, MJ Hudson | Law, says: “Good governance gives confidence to investors that the obligations a fund manager owes to its investors will be fulfilled. Whilst fund documentation, along with side letters, will typically contain a number of provisions and mechanisms designed to protect the interests of the LPs in a fund, investors must ensure that they are enforceable. As always, there are nuances in drafting that can have a significant impact for investors, and the negotiation of governance terms is a vital component in professional fund investing.”
 
“Acting on mandates for both LPs and GPs, we understand how to create a governance framework that is equitable and which, in turn, provides for a truly collaborative and aligned investment partnership. We find this delivers the best outcome for all parties.”
 
The ‘Private Equity Fund Terms’ report provides an enhanced understanding of the fundamental economic and governance terms impacting private equity fund managers and investors in their funds.
 
Part III follows the publication of Part I (‘Economics’) and Part II (‘Alignment’) in July and October of this year, respectively.
 
Part I (‘Economics’) focussed on the core economic terms of investment funds: management fees (and discounts); hurdle rates; carried interest and escrows; and clawbacks of carried interest. It examined key trends in the market and any change in incidence and rates, as well as the investor friendliness of the terms.
 
Part II (‘Alignment’) examined how the alignment of interests between investors and fund managers is safeguarded. It discussed the size of the GP (sponsor) commitment, including analysis of the differing levels of commitment between first-time funds and successor funds, as well as levels of commitment by fund type. Additionally, the report examined additional alignment mechanisms, including management fee offsets, change of control, and distributions in kind.

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