Investors in US private equity funds have started to gain the upper hand in negotiations over fund terms in recent months. Several fund lawyers have highlighted a notable shift in bargaining power—from fund managers to their limited partners—in a tight fundraising environment.
As general managers scramble to raise new capital, increased competition for investor capital is handing power back to LPs, which are able to obtain investor-friendly fund terms—including those that allow dissatisfied LPs to break up with their GPs more easily, attorneys said.
“We began to notice increased LP leverage over the last six months or so,” said TJ Bright, a partner at law firm K&L Gates.
For a long period, GPs had been able to negotiate terms in their favor. Now more of them are willing to accept LP-friendly provisions, added Kenneth Holston, another partner at K&L Gates.
These provisions include reduced management fees; more LP agreements with key-person clauses; and the no-fault divorce clause, which allows LPs to drop a GP without cause.
It’s rare to see LPs walk away from their GPs, and typically, fund contracts only permit for-cause removals when a GP engages in serious wrongdoing such as committing fraud or materially violating securities laws.
But with the no-fault divorce clause, LPs have the right to part ways with a GP without a specific reason, as long as they secure a sufficient number of votes from investors in the fund. One common trigger for such a clause is when the majority of investors find the fund’s investment performance falling short of expectations because the GP didn’t properly manage the fund.
“That provision had all but disappeared in the last three or four years, but we are beginning to see a return of the no-fault divorce provisions,” Holston said.
Moreover, even certain top-performing managers have now agreed to include this provision in fund contracts, marking a departure from the previous standard.
“For a long time, it had been somewhat more common to get a no-fault divorce provision from an emerging manager, and nearly impossible to get one from a first quartile manager,” Holston said.
Now, first quartile managers are more willing to bend to these terms.
Private equity fund performance softened last year amid a decline in valuations and higher borrowing costs. Preliminary data from PitchBook shows global PE funds recorded a quarterly return of negative 0.2% in Q4 2022.
In addition, the attorneys said they have seen LPs increasingly able to include a distribution waterfall that prioritizes the payments of investment returns to LPs from emerging managers, in particular.
Other changes in fund terms are also arriving to benefit LPs, according to a recent survey conducted by law firm Barnes & Thornburg.
Notably, some GPs have asked to extend the investment period, as dealmaking has slowed over the last year. In exchange for approval from LPs, certain fund managers will agree to charge management fees as a percentage of the fund’s invested capital, instead of the total capital committed to the fund, said Scott Beal, a partner at Barnes & Thornburg.
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