The frustrating reality of fund negotiations

Last week, the California Public Employees’ Retirement System (CalPERS) held a day-long workshop on private equity that revealed just how tense fund negotiations can be these days.

CalPERS counsel Marte Castanos told the investment committee that the $300 billion pension plan was enduring “an uphill battle” with GPs, who are successfully employing a “divide and conquer” approach to fund negotiations with LPs. One of the specific issues he flagged was fund formation attorneys pressuring the pension into agreeing more favorable terms by citing CalPERS’ past agreements with other funds.

If CalPERS – arguably one of the most influential private equity investors in the world – is feeling frustrated on the fundraising front, it’s safe to assume that other LPs are too. So what’s going on here?

For starters, it’s important to remember that antitrust statutes prevent investors from negotiating contracts in unison. During the workshop, CalPERS board member JJ Jelincic asked if a large institutional investor like CalPERS should take the lead challenging those statutes – which is an interesting idea, given the suggestion that some GPs – or by extension, their attorneys – are indeed swapping notes on LP negotiations to fund managers’ benefit.

While it’s hard to imagine rival law firms sharing such information systematically, it does seem to be the case that different funds represented by the same law firm are sharing data, which raises questions around confidentiality agreements and best practice.

“Lawyers on both sides of the negotiating table wouldn’t be doing their job if past contracts were the driving forces of a new negotiation,” says Kirkland fund formation attorney Daniel Lavon-Krein when asked about the matter. Each negotiation should stand on its own merits, considering each fund is different, and market terms are constantly evolving.

That said, it’s also hard to ask a lawyer to simply forget about past negotiations, which could in fact benefit the LP. Several sources told pfm that some attorneys will cite past agreements, which underwent weeks of negotiation over a particular term, as a shortcut to finalizing a similar term in a new agreement. But whether that lawyer is saying ‘I know you’ve agreed XYZ term before’ to an investor, as CalPERS seems to have experienced, versus a more palatable ‘here are some terms I’ve structured for investors in the past,’ is crucial to get right in terms of best practice.

Tensions at the negotiation table are real. Investors have been witnessing the pendulum of power swinging back towards GPs’ favor, but how the industry can best address the concerns raised by CalPERS – or indeed if Jelincic’s idea is practical and positive – deserve more analysis and attention.

To explore in greater detail the current fundraising landscape, and what terms are becoming flashpoints at the negotiation table, pfm will publish a special fundraising supplement to accompany our January issue. Stay tuned.