Private equity houses are facing an uphill battle to secure future fund commitment as GP-LP relationships take a tumble - mainly due to fee structures - and rigidity of investor principles. Tables are turning on the relationship between general partner (GP) private equity houses and their limited partner (LP) investors in Europe. GPs looking to raise new funds will face increasing pressure to secure commitments from LPs. This is largely due to the hefty fees certain players are charging their fund investors - without delivering sufficient returns. Many LPs consider these fees to be excessive and a major contributor to the increasing misalignment within the LP-GP relationship. “The whole model is under pressure,” one European LP remarked, questioning why GPs should charge transaction fees in addition to the already high management fees in place. “GP commitment is minimal in many funds and sometimes paid directly out of the management fee, so there is no real money on the table from the GP,” he added. In his eyes, GP’s carried interest should be more closely linked to performance rather than the statutory 20% and management fees should be linked to a budget, rather than automatically standing at 2%. Meltem Ankara, senior banker at the European Bank for Reconstruction and Development (EBRD), is in agreement over this point. “EBRD has never accepted aggressive transaction fees. Fees generated by day-to-day activities should be offset against the management fees,” she said. Some of the larger private equity groups are concerned LPs might get exasperated due to the exorbitant fees being charged by a minority of larger, quoted private equity firms, one partner at a large European PE house said. "The private equity industry will pay the price as LPs find it a sensitive and emotional topic and will push really hard on transaction fees," he noted. One result of LPs requiring GPs to keep transaction fees low might be that private equity houses are less incentivised to keep abort costs to a minimum, opined the same GP. However, the European LP warned against private equity houses minimising abort costs, as this could reflect a lack of external due diligence. “GPs should spend the necessary resources to diligence a deal in detail and LPs will accept abort costs as long as the GP has a good explanation for each deal,” he said, adding that it is a sign of discipline if GPs can say no to a deal after extensive due diligence costs. “The concern of LPs is really the net fee income after broken deal costs,” he said. The Institutional Limited Partner Association (ILPA) issued guidelines last year covering a number of points including enhanced governance, investor protection rights and recommendations on fee structures and carry models. A number of LPs are using the ILPA principles as a wish list when negotiating terms with European GPs telling European private equity funds “to make their funds ILPA-compliant,” according to Nigel Van Zyl, partner at SJ Berwin. However, many of the principles are easier for larger funds to adopt and are inappropriate for smaller funds or first-time funds,” Zyl warned. Reducing GP management fees by 100% of the transaction fees charged to portfolio companies is one such example. Previously GPs used to retain around 20% of this sum, which is often considered key to bottom-line profitability of smaller groups that don’t have a significant revenue stream from prior funds under management. Not all LPs are in favour of the ILPA principles. Ioannis Tsakiris from the European Investment Fund is not backing the initiative. “It was formed on the other side of the Atlantic and we have a European perspective,” he said. A partner at a European fund-of-funds group pointed out it is unfair that not all organisations are accepted under the ILPA umbrella. “They are not applicable for fund-of-funds, which could negatively influence their relationship with GPs,” he said. In EBRD’s case, it has not gone out formerly to back the ILPA principles. “We reserve the right to do so on a case by case basis,” said Ankara. “They are complicated to endorse, but we encourage GPs to print them out and have answers ready for the points they do not adhere do.” The European Venture Capital Association (EVCA) has its own set of reporting guidelines, which LPs such as EBRD, prefer to follow. EVCA is speaking to ILPA on a regular basis, to try to coordinate reporting guidelines for the industry, according to a source at EVCA. EVCA set up an LP platform as part of its organisation structure in November last year to give LPs a voice regarding industry regulation and put them on an equal to GPs. “LPs and GPs need to come to an agreement,” he said. In general, there has been a distinctive shift in power in favour of LPs, noted Natalia Popova, director at Switzerland-based LP investor Akina. “LP advisory boards are getting stronger on corporate governance,” she noted. Transparency demands from LPs have also increased. “LPs are looking at EBITDA levels, currency of loans and refinancing dates for investee companies, which is a shock to GPs unaccustomed to providing this degree of detail for smaller firms,” Ankara remarked. By Fay Sanders
This item is not available.