(Repeating Thursday item to additional subscribers)
(For more Reuters DEALTALKS, click [DEALTALK/])
* Investors association recently met with PE execs
* Meeting seen as sign of association's power
By Megan Davies
NEW YORK, April 1 Private equity investors have
increased their clout since the financial crisis, but whether
they can really dictate major changes in terms and structures
of fund agreements remains to be seen.
The relationship between the private equity executives that
clinch multibillion dollar deals on the promise of outsize
returns, and the pension and endowment funds that put up the
capital is a delicate one.
Both parties need each other -- for capital and for the
high returns -- and the balance of power shifts accordingly.
Investors, known as "limited partners" (LPs) and private
equity executives, known as "general partners" (GPs), have
acknowledged for some time a shift since the boom years when
GPs had more leverage to dictate terms as investors scrambled
to get into their funds.
The tables started turning when funds found themselves
unable to exit investments at the prices or speed they
originally thought, putting fund returns under pressure, while
new accounting rules meant some had to mark down portfolios
significantly. Meanwhile, the amount of available cash LPs
wanted to invest in new funds diminished.
"It's a supply and demand issue," said Steven Kaplan, a
professor of finance at the University of Chicago. "The LPs
have a bit more power than they did three years ago. And when
the LPs have power they try to exercise it; just as when the
GPs have power they exercise it."
LPs have their own association, the Institutional Limited
Partners Association (ILPA), which gained prominence last year
when it issued proposed guidelines for fund agreements.
ILPA this week took the unusual step of holding a
closed-door meeting at a hotel in New York between some high
level private equity executives and influential investors.
Hot button issues such as fees were not discussed,
according to one person who attended the meeting and requested
anonymity, still, observers said the fact the meeting occurred
was significant in showing the power the body has attained.
ILPA's guidelines, or 'principles', include that management
fees should "not be excessive", GPs should have a high level of
cash in their funds and potential changes in tax laws should
not be passed onto investors.
The guidelines revisited some ground covered by a 1996
study by consulting group Mercer which called for further
alignment of interests between investors and buyout funds.
ILPA's principles are not binding, said Jeremie Le Febvre,
partner at Triago, which among other activities sells private
equity assets for investors. "But that said, they've reached a
point where they are recognized by the industry," as market
standards, he said.
As fund sizes increased dramatically between 2002 and 2007,
management fees also increased, said David de Weese, partner at
specialist secondary firm Paul Capital, raising questions about
whether fees had become more important than carried interest.
Carried interest is typically the 20 percent that private
equity executives take from the profit made on their funds,
after compensating their investors, and the amounts can be huge
if the funds perform well.
But in bad times, that profit drops, making the amount
generated from fees important. Investors say they want the
carried interest to be the incentive, not the fees, which are
typically charged at 1 percent to 2 percent.
Other issues some investors say they are unhappy with
include receiving 'clawback' money after tax rather than
before; and some would like a move to a more European model.
A clawback is paid when a fund performs worse than had been
hoped and the GP has to refund investors profit that may have
been have taken in the early life of the fund.
In the United States, profit typically gets paid on a
deal-by-deal basis, meaning there is the risk of the GP paying
a clawback; whereas in Europe it is typically calculated on the
whole fund's life and all its invested capital.
"Now you are starting to see situations in the U.S. where
the LPs are becoming creditors to the GPs, because the GP has
taken too much carry and can't pay it back," Paris-based Le
Still, some eyebrows have been raised by the potential for
LPs to collectively push through terms. One private equity firm
asked their outside counsel to look at potential issues of
antitrust if investors clubbed together to insist GPs agree to
terms, a source familiar with the situation said, in part
confirming a March report in the Wall Street Journal.
Fundraising has been low for a long time, meaning that
issues such as these have been avoided by many GPs. When they
come back to the market for fresh capital, investors will be
weighing their last funds' performance.
"If you're a really good fund, you are going to be able to
dictate terms," one investor who declined to be named said.
(Reporting by Megan Davies; Editing by Tim Dobbyn)