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Over one third of PE managers now committing 3 per cent or more to their funds, says MJ Hudson study

Thirty five per cent of private equity managers are now committing 3 per cent or above in capital to their funds, above the equivalent proportion in each of the three prior years, according to research carried out by MJ Hudson.

Alignment, part II of MJ Hudson’s Private Equity Fund Terms Research (5th Edition), reveals that a further significant proportion of GPs are committing between 2 per cent and 2.99 per cent of total commitments to the fund, while 29 per cent of the funds surveyed have a GP commitment in this range.

Alignment”examines the key terms that impact upon the alignment of interests between LPs and Managers, including: the size of the GP commitment; management fee offsets; successor fund restrictions; and co-investments.

MJ Hudson’s Private Equity Fund Terms Research provides detailed analysis and insightful commentary on private equity and venture capital fund terms and the implications for both investors and managers. It includes comparisons with prior years’ research and discusses the drivers for any significant changes. Now in its fifth edition, the Private Equity Fund Terms Research is an established measure of the industry, providing both LPs and GPs with an enhanced understanding of the current strengths and weaknesses of the fundamental economic, alignment and governance terms impacting private equity fund commitments.

According to the study, 95 per cent of all funds offer a transaction fee offset, while a full, 100 per cent offset is by far the most common formulation, with 97 per cent of funds that offer a transaction fee offset providing for a 100 per cent fee offset.

Some 94 per cent of all funds include restrictions on the ability of the GP to transfer the GP interest in the fund, while 74 per cent of funds have some restriction on the ability of the principals to transfer their economic interest in the GP. 69 per cent have some restriction on the ability of the GP to transfer their entitlement to receive the carried interest.

Ninety two per cent of funds meanwhile, have successor fund restrictions. The earliest trigger for the next fund’s raise in a Manager’s stable is usually the earlier of the investment period expiry or a minimum of commitments being invested/reserved or allocated.

GPs are given wide discretion where co-investment is concerned. Only 43 per cent of the funds that contemplate co-investments in their LPAs require co-investment to be on substantially similar terms as the fund’s investment. Only 27 per cent require co-investments to be acquired/disposed of at the same time as the fund’s investment.

A mere 5 per cent of the funds that contemplate co-investments in their LPAs provide that the GP cannot charge management fee or carried interest in respect of co-invested amounts.

Shervin Shameli, Partner of MJ Hudson | Law, says: “We are pleased to release part II of our Fund Terms Research, which discusses the alignment – or sometimes misalignment – of interests between LPs and Managers of private equity and venture capital funds. Our research, and our wider market experience, shows that alignment between LPs and GPs has improved and we continue to believe that this is a trend that is set to continue. The picture is, however, far from perfect. There remain areas of detail that can serve to misalign interests and drive a wedge between the outcomes for LPs and the motivations for Managers. Acting on mandates for LPs and the GPs affords us a clear view of the motivations on both sides and we hope our analysis will encourage further positive developments.”

“Alignment” follows the publication in June of “Economics”, the first part of the MJ Hudson’s latest research. A third part (Governance) of this edition is to be published later this year.

Part I (Economics) examined the core economic terms that govern a private fund. It provided analysis of the levels and calculation methodologies of management fees (both during and post the investment period); the prevalence and nature of management fee discounts; and the operation of distribution waterfalls and carried interest models (including hurdle rates, ratchets and catch-up). Innovations in carried interest models and the distribution waterfall were examined, and deal-by-deal enhancement (eg, interim clawbacks, carry escrows and guarantees of GP clawback obligations), were likewise covered.

Part III (Governance) will describe the governance of private funds and present current trends in the key investor protections: GP removal (with cause and without); key person events; change of control provisions; indemnification; conflicts; the role and operation of the Limited Partner Advisory Committee; reporting provisions; and the application of the most favoured nation treatment.
 

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