The 2015 Preqin Private Equity Fund Terms Advisor by Preqin
Here we present the Executive Summary of the newly released 2015 Preqin Private Equity Fund Terms Advisor, the most comprehensive guide to private equity fund terms and conditions ever produced.
Navigating the Private Equity Fund Terms Space
Private equity fund terms and conditions are an important aspect of fund agreements between GPs and LPs. It is essential that the interests between the two parties in this area are closely aligned to ensure a harmonious and positive working relationship during the lifetime of the fund, and potentially thereafter in the form of reups or positive sentiment within the investor community. Should this sensitive area be neglected and fund terms and conditions favor either the GP or LP, problems may be compounded and over the longer term, parties can lose out economically. Fundamentally, it is important for GPs to be appropriately remunerated and incentivized for good performance while LPs have the right to guarantee clauses that protect their capital and to ensure that they are getting a fair deal on their investments.
For GPs, adopting the most appropriate fund terms and conditions is no easy task. For one, it is well known that the opaque and confidential nature of private equity investments means that fees are rarely disclosed to those outside the fund, and as such, it is difficult to benchmark fund terms and conditions against other GPs and competitors throughout the wider industry. Moreover, LPs may have a perceived idea of fund terms industry benchmarks which may not be in line with what GPs are offering, or perhaps the increase in LP negotiating power in this area is something that GPs do not fully understand. Without solid evidence or awareness of current sentiment, this may cause investors to question the fund terms that they are being offered by GPs, or even decide against investing in a fund due to the proposed terms and conditions, which 91% of investors claim to have done on a frequent or occasional basis.
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The 2015 Preqin Private Equity Fund Terms Advisor is here to help. In its 10th iteration, the Fund Terms Advisor compiles data from our current databases, historical datasets and LP and GP surveys to provide comprehensive and accurate insight into the private equity fund terms universe. Using fund terms for over 4,500 funds with terms data, Preqin’s Fund Terms Advisor is the market-leading source of data and intelligence in this area.
Alignment of Interests between GPs and LPs Is Improving
A recent Preqin study shows that 70% of private equity investors reported that the interests of GPs and LPs are properly aligned, an increase from the 63% and 67% of investors that thought the same in 2014 and 2013 respectively (Fig. 1). This is encouraging news, considering the debate surrounding fees and the transparency of private equity firms, and CalPERS’ recent appearance in the financial press at the forefront of this issue. The largest US public pension fund reported that fees paid to private equity firms were not explicitly disclosed or accounted for, but this does not look to have harmed GP/LP relations among the investor community.
Furthermore, Preqin data shows that 47% of LPs are looking to increase their number of GP relationships over the next two years, as shown in Fig. 2. This is an eight percentage point increase on those that Preqin spoke to last year, illustrating the opportunities available to GPs to acquire new relationships with LPs looking for additional private equity investments. As fund terms remain a top concern among the LP community in relation to better alignment of interests between partners (Fig. 3), it is imperative that GPs make the effort to ensure that their fund terms and conditions are favorable to LPs so as to attract quality institutional capital in a competitive fundraising environment. For more information on LP attitudes towards fund terms and conditions, please see Chapter 6.
Outside financial clauses, Preqin data shows that GPs are offering other ways to meaningfully align interests between themselves and their investors, such as key-man clauses, no-fault divorce clauses and LP advisory committees, among others. Preqin data shows that a significant proportion (77%) of direct private equity funds (raising or closed with a 2014 or 2015 vintage) have a key-man clause, showing GPs’ commitment to offer non-financial clauses to LPs to better their fund agreements. Moreover, such key-man clauses and other non-financial clauses are offered on various levels or activated after certain thresholds, indicative of the complex and sophisticated terms and conditions that LPs are expecting. For more information on non-financial clauses, please see Chapter 10: Governance.
However, Despite Improvement, Areas of Contention Still Exist
Although it would appear that the alignment of interests between GPs and LPs has notably improved, 30% of LPs reported that interests between GPs and LPs are not aligned. Fig. 3 shows where alignment between GPs and LPs can be further improved from the perspective of the LP. The largest proportion (40%) told us that management fees are an area that could influence the relationship and is in need of improvement. However, this proportion is a reduction on recent years: 54% and 59% of investors thought the same in 2014 and 2013 respectively, indicating that progress looks to have been made in terms of management fees in favor of the investor. Chapter 8 gives an insight into the management fees of the industry using actual fund terms data broken down by peer group, vintage year and strategies, and the key determents that arguably form the biggest area of contention between GP and LP interests.
Accessing Private Equity Funds through Non-Traditional Offerings Is Gaining Traction
New to this edition, the 2015 Preqin Private Equity Fund Terms Advisor explores non-traditional avenues through private equity and the terms and conditions that surround these areas. Preqin data shows that the terms and conditions pertaining to separate accounts and co-investments offered by GPs are notably different to those of their traditional commingled counterparts, reflective of the unique and diverse characteristics of such offerings. Indeed, the growing appetite for alternative routes to private equity could threaten the traditional, commingled fund structure, forcing GPs to consider adapting and changing their offerings in the evolving fundraising environment to better meet the needs of LPs.
Fig. 4 shows that 48% of private equity separate accounts use the traditional 20% carry rate figure, compared to 85% of traditional commingled funds that employ this rate. This suggests that GPs largely do not appear to adhere to the industry standard of a 20% carry rate when managing separate accounts. The extra administrative efforts and resources on the GP side that are used to run separate accounts mean that it is more common to see the larger investors with bigger ticket sizes accessing private equity strategies in this way. For this reason, GPs are more willing to negotiate fees to secure the backing of a large institutional investor, which may not necessarily be in line with the perceived standard 20% carry rate. For more information on separate accounts, please see Chapter 4.
Furthermore, Preqin spoke to 300 private equity GPs from around the world about their experiences and attitudes towards offering co-investments; the majority (69%) of GPs reported that they offered co-investment rights to LPs. Co-investments are typically passive, non-controlling investments, a provision of separate equity not subject to fees (or at least subject to reduced fees). They also offer LPs the possibility of discounts on existing fees within the fund. The attraction of co-investments is not lost on investors, with many looking to take advantage of the benefits of investing this way. Indeed, while private equity co-investments have long been a part of the industry, the US Securities and Exchange Commission (SEC) has recently taken steps to securitize private equity co-investment practices and activities to provide a regulatory and uniform stance across the industry, illustrating the prominence of this investing method. Eighty-four percent of GPs that spoke to Preqin look to offer co-investment rights to build stronger relationships with LPs. Moreover, Fig. 5 shows that nearly half (48%) of GPs surveyed remove the carry rate for LP co-investments compared with LP fund commitments, showing the benefit of investing alongside GPs in portfolio companies. For more information on co-investments, please see Chapter 5.