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Fund terms and fees

Big LPs secure increasingly bespoke terms amid tight fundraising

Private equity lawyers report an uptick in the use of separately managed accounts.

Against a challenging fundraising backdrop, large limited partners are using their bargaining power to secure highly tailored investment relationships with fund managers.

Funds of one or separately managed accounts are far from a new phenomenon, but large LPs in particular have been returning to the structure as a way to secure more favorable arrangements with GPs.

“In the last 12 to 18 months we have seen a marked increase in the number of these arrangements being negotiated,” said Vincent Ip, a partner in law firm Ropes & Gray’s asset management group. “And because the dollar amounts tend to be high, it has been very noticeable.”

Billy Zhang, counsel in Ropes & Gray’s asset management group, notes that not only has there been an increase in SMAs but also in the amount of tailoring that is being sought through them: “Everything becomes negotiable.”

Vincent Ip

Vincent Ip

Ropes & Gray

Each SMA will vary, but common benefits for the LP include lower fees, fee structures that incentivize more frequent deal flow (as fees are often charged on deployed rather than committed capital), deal flow covenants, and more control and oversight over the deals a GP pursues.

For GPs, such concessions can be worthwhile to secure significant funds from the biggest LPs. “These investors are the largest asset allocators—sovereign wealth funds, the largest pension funds, investors that have the ability to write very large checks,” said Ip.

This uptick in SMAs has taken place in a congested and difficult fundraising environment for PE. In 2023, there was a mismatch between the volume of funds being sought by PE managers and the capital that LPs had available, putting LPs in a strong position to prioritize certain GP relationships above others.

Consolidation of GP relationships

“During the last two years, LPs have been re-underwriting every relationship,” said Laura Leyland, managing director at placement agent Asante Capital. Whereas in more normal market conditions re-ups take place almost by default, Leyland said every potential re-up is currently being scrutinized and LPs are choosing to end some relationships. “We’re seeing a concentration theme, where LPs are working with a smaller cluster of GPs but seeking to do more with them—so larger tickets and more meaningful relationships.”

Karl Adam, partner at placement agent Monument Group, suggests that this consolidation of relationships by some LPs has been happening for the last five years or so, although it has amplified more recently.

“Bigger commitments naturally means that relationships tend to be deeper and more strategic, and can involve SMAs or agreements of that nature for the larger ticket LPs,” Adam said. “So, they have become more prevalent, although the structure itself is not new.”

He highlights growing interest in the Middle East as a source of PE funds as a potential driver behind increased SMA use. “Some investors in that region do tend to make large commitments, which may be negotiated via an SMA,” he said.

Stand-alone arrangements

SMAs are different from sidecar funds, which are normally linked to larger, standard commingled funds, whereas an SMA will typically be structured as a stand-alone arrangement. Zhang pointed out that in the past, investors tended to commit capital to a sponsor’s flagship fund and then negotiate a sidecar. Now, large investors will often approach a manager and ask for an SMA as their starting point and agree to put a smaller sum into their flagship fund as a sweetener.

SMAs may be structured around one private market strategy or cover a GP’s activity across several different areas, such as PE, private credit, real estate and infrastructure. So—just as they are most commonly associated with large LPs—they are also usually negotiated with the largest multistrategy investment managers. Each SMA also requires dedicated legal structures and appropriate reporting. The additional administration involved means larger GPs tend to be in a better position to support such arrangements.

However, LPs will sometimes seek these arrangements with smaller, regional managers if that manager is pursuing a strategy or specialist area an LP is particularly interested in.

Sachin Mitra, global co-head of relationship management at private markets advisory firm Aviditi, said deeper LP relationships, including SMAs, can be particularly beneficial for newer PE firms or emerging managers “as a way to create track record and demonstrate their ability to source deals before raising more traditional funds from a wider group of investors.” He added, “For the investor too, it puts them in prime position to be a partner of choice for the long term.”

SMA due diligence

The increasing prevalence of SMAs means all LPs need to be mindful of what arrangements a GP has with existing investors when deciding whether to commit capital.

“All investors need to make sure they understand what the implications are of the SMAs that a sponsor has in place,” said Ip. “For instance, there could be consequences in terms of deal flow, so parties need to discuss how investment opportunities might be shared as between an SMA on the one hand and a sponsor’s other funds on the other.”

However, if the fundraising environment loosens—as some expect it to this year—it’s unclear if their increased usage will continue.

“The continued difficulty of the fundraising backdrop [has been] very relevant,” said Monument Group’s Adam. “In a better environment, GP’s wouldn’t feel the same need [to offer concessions to secure investment].”

Featured image by Peter Dazeley/Getty Images

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