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Carry forfeiture following for-cause removal on the wane, says MJ Hudson

by The Drawdown team 3 October 2022

As recently as 2018, around a third of fund terms & conditions had provisions for full forfeiture in the case of for-cause removal, the firm said in its latest "Private Equity Fund Terms Research – Economics, Alignment and Governance" report.

By 2021, this shifted to a market where only around a third of funds have terms that require more than 25% of carry to be forfeited. This reflects changes in GP/LP negotiating power, as more money pours into the asset class, the firm said.

Other findings from the report include the fact that ‘2 and 20’ remains the standard management fee and carry arrangement, except for mega-funds with lower management fee percentages. "There is little change in the ‘standard’ 2 and 20 economic formula in the mid-market, but across larger funds we are seeing growth in the number of those paying 1.75% or lower management fees," the report noted. Mega funds (in excess of $5bn) typically come to market with a 1.5% management fee, suggesting real pressure on management fees in the market as fund sizes increase, the firm added.

On carry specifically, the report noted that there is very little evidence of the market moving away from 20% as the baseline figure. If anything, the proportion of funds charging more than 25% rose slightly in 2021 to 14.3%, compared with 11% the previous year.

The right to sell carry to third parties is more tightly negotiated, MJ Hudson also noted. Compared with four years ago, more managers are securing the right to transfer a proportion of carried interest to third parties over the life of a fund, but also fewer funds have come to market with terms that permit such transfers without any sort of limitation.

Now in its seventh edition, the research is conducted by MJ Hudson’s law practice and examines the current strengths and weaknesses of the fundamental economic, alignment and governance terms impacting private equity fund commitments. It includes comparisons with previously published research and discusses the factors driving change. It covers buyout, venture and growth funds.

This story was originally published on our sister publication Real Deals.

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