Fund Terms, Due Diligence and Transparency in a Hot Private Equity Fundraising Market

Fund Terms, Due Diligence and Transparency in a Hot Private Equity Fundraising Market
July 18th, 2017

The combination of a low interest rate environment and record distributions from private fund managers in recent years has not just piqued institutional investors’ interest in the asset class, but is leading to real allocation changes. Consequently, GPs that can show a strong track record are in high-demand and closing fundraises in increasingly shorter timescales for increasingly larger funds – take CVC’s record €16bn raise in just five months as just one example.

From an investors’ perspective, how is this overwhelming demand for private equity affecting the negotiation of fund terms, due diligence processes, and transparency in the industry? This was the topic that eVestment’s Director of Private Markets Solutions, Graham Paterson, posed to a panel of representatives from Cambridge Associates, MN and London Pension Fund Authority* at the recent Markets Group Private Equity Europe Forum in London. Read on to find out their views. (*To honor the Chatham House Rule invoked during the panel, quotes have not been attributed to individuals.)

Q: The need for LPs to move quickly in committing to a fund has been increasingly evidenced by a series of massive fundraises in very quick timelines. Is this speeding up of the fundraising process resulting in looser governance and looser money coming into the industry?

A: “While some decisions are made quickly, I think there are a lot of LP-GP relationships that weren’t there 10 years ago. So when LPs are presented with new funds, they are trying to leverage that long history and look for stability in the management team, stability in the process, and stability and belief of an underlying philosophy within the GP that hasn’t changed.”

“Well, there’s a big supply and demand imbalance that enables GPs to raise capital fast. I also think the ‘pendulum of power’ is quite far to one side and I think there are investors who are pressured, or think they need to be in those funds, and they do very quick decisions. It’s like buying a car, it might look nice from the outside, but you didn’t look under the hood, so you don’t know what you’re buying. It might be perfectly okay, but you don’t know for certain…”


Q: The private markets industry is facing an ever increasing amount of regulation. With this comes the increased reputational risk for the general partner and its investors in the event of a breach of regulation. How are your institutions addressing this in the due diligence process?

A: “We are doing more work on the Limited Partner Agreements (LPAs) but I see a trend right now, that might also be down to this ‘pendulum swing’, that law firms are advising on more aggressive terms in LPAs. It’s not only on fees and carry, but even trying to limit the fiduciary liabilities, which obviously is a no-go. And to address it? We put manpower behind it and be proactive in telling the GPs what we expect in the terms, even looking at past LPAs, if a new one hasn’t been issued, to share our thoughts on what we would like to see.”


Q. Why haven’t LPs in general been able to easily negotiate better terms over the years?

A: “The largest, most successful GPs do have very strong power over the smaller, new managers – people still prefer the larger GPs. There is less reputational risk in choosing an established manager.”

“For some LPs there is just no other choice: if you are large and need to write very large tickets, you can’t actually invest into a $100-$250m fund because you’re more than 50% of it, so unfortunately, there are only a limited number of funds which they can deploy to.”

“I also think that the larger LPs have the luxury of negotiating terms more easily than “normal” LPs.”


Q: Is increased regulation creating more of a burden for GPs? And is this a concern for LPs given where the ‘pendulum of power’ is?

A: “I think it is a burden for us and the GP, but we have to work together to solve it. I firmly believe that we enter into a partnership with GP. We want to ask the GPs to help to solve the problem and we also know that it impacts not only our business, but the business of GPs. So they have to change and accommodate. For instance, adopt the ILPA template or make administrative adjustments to fulfil the transparency or reporting requirements of investors.”


Q: How has your manager due diligence process evolved over time, and what are the current top areas which are consuming most of your bandwidth?

A: “We are looking at operational due diligence much more and making sure that all the boxes are ticked. We now have a dedicated team, which is called Business Risk Management, to focus on this. They go into a lot of details asking about fees charged, use of fees, and really asking all the questions which might otherwise not be asked.”

“One thing that’s very important for us in the last five to ten years is to increase the model for transparency and the way GPs report to us. It has much to do with what regulators, central banks and our clients demand from us. I think clients and regulators need much more breakdown on how costs are built up.”


Q: Given the increasing regulation and due diligence requirements, how should the industry be evolving in an effort to be more efficient? And how does technology play a part?

A: “I have a very strong opinion on that. I think that we should adopt technology in the industry much more – we should digitalize all our data. We deal with a lot of data, we need a lot of data, we transfer a lot of data but I think that we can do it much more efficiently. The transparency requirements that we currently have will grow bigger and we need more transparency going forward: the central banks are demanding this, clients are demanding this, so it’s something that is inevitable, and if we want to do it efficiently, and cost efficiently, we need to digitize and automate.”

“I think technology has a place in the evolution. If you look at the public markets, they tend to be data driven everywhere. It is inevitable it will come to private equity.”

“Totally agree. We need more standardization and how things are presented and how fees are accounted for. We have a whole team who just really go through the reports and put it into our systems, so we have all the managers comparable, but it would be much easier if the industry was more transparent and standardized.”


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