LPs seek more carry protections

According to a survey by law firm King & Wood Mallesons (KWM), LPs are increasingly securing protection against overpayment of carried interest, whilst GPs are successfully resisting pressure on no-fault clauses on suspension and termination of the investment period.

The survey, the results of which were revealed at KWM's annual private equity investment funds seminar in London on May 19, analyzed the terms of 60 private funds across different alternative asset classes. Around three quarters of the funds surveyed had a European investment focus.

Michael Halford, KWM's head of UK investment funds, reported that 50 percent of all funds surveyed – up from 39 percent a year ago – had provisions for both the use of escrow accounts and clawback mechanisms to protect LPs from overpaying carried interest. Only 6 percent of funds had provision for neither. According to Halford, investors are increasingly insistent on including both of these clauses in limited partnership agreements.  

Halford also reported a slight downward trend in the level of management fees across all alternative asset classes.

However, the survey revealed that GPs were resisting pressure from investors on provisions for no-fault suspension or termination of the investment period. Only 26 percent of funds had a clause that forces GPs to suspend future capital calls to fund new investments or terminates early their right to do so. 

The survey also revealed a variance in how the management fee is applied during an extension period. Out of a small sample of GPs who have recently extended the life of their fund, a third made no change to the management fee, a third had reduced it and the remainder had waived the fee entirely. 

Elsewhere in the seminar, Ajay Pathak described how the lives of private equity funds were getting longer in some instances, unintentionally and by design. Some managers, particularly at the larger end, are promoting funds with lives of 15 to 20 years. Such structures are likely to be set up as distinctly different product offerings from their main funds and so attract LPs seeking more predictable but potentially lower returns and preferring longer holds and in return negotiating lower fees and carry. There are also likely to be fewer LPs in such funds, writing larger commitments. On the other hand, some GPs are considering longer-life funds partly in response to investor demand and partly recognizing that certain investments require a longer holding period.

In this context, Jonathan Blake, the founder of KWM's private equity practice, speculated that open ended structures or permanent capital vehicles might proliferate in traditional private equity, as has already been the case in related asset classes such as real estate and infrastructure. However, the traditional closed-ended structure is certain to remain dominant.