Less black and white

The 2023 edition of Addleshaw Goddard’s Funds Trends report highlights shifts in the relationship between GPs and LPs. “The narrative of fund terms becoming friendlier and friendlier to LPs is slowly changing and the picture is more nuanced,” observes Jan Grüter, a funds partner at Addleshaw Goddard. “Some changes we observe favour LPs, others are more in GPs' favour. For example, while management fees have slightly decreased across the board, for some strategies they have increased, GPs enjoy larger caps on organisational expenses and we have also seen a decline in no-cause removal terms over the long term.”

Addleshaw’s report shows shifts in private funds terms during 2021 and 2022, based on its own database of funds terms for mandates where it acted as GP or LP counsel. Additionally, it draws from wider market data supplied by Preqin for funds closed between the end of 2020 and the end of 2022.

Fees, carry and organisational caps

According to the report, the 2% management fee remains the headline rate set by GPs. However, it also found that management fee rates differ significantly across underlying investment strategies. Furthermore, actual management fees born by LPs are often lower, for example due to fee rebates or offsets against transaction costs.

Fund type	Average management fees percentage
Buyout funds	1.87
Growth funds	1.89
Direct lending funds	1.45
Distressed debt funds	1.59
Real estate funds	1.48
Infrastructure funds	1.55
Natural resources funds	1.80
Venture capital funds	2.00

For funds closed between 2019 and 2022, the report suggests an overall decline in management fees except for:

• VC funds, which reached a peak of 2.23% in 2021
• Infrastructure funds, which grew to 1.56% in 2022
• Natural resources funds, which peaked at 2.00% in 2020 and for which 60% of all natural resources funds raised/closed during 2021 and 2022 charged a management fee between 2.00% and 2.24%.

Mike Hinchliffe, head of the private equity practice at Addleshaw observes another potential impact on management fees: “Downstream, co-investments are the biggest disruptor. They also present an opportunity to work around management fees. Even more so, as LPs are increasingly focusing on co-investments, which can result in rivalry between different LPs and subsequently put the GP in a precarious position.”

While management fees have seen some shifts, the 80:20 split of carried interest largely remains, with 84.4% of surveyed funds adopting a 20% carried interest with an 8% initial hurdle. Since 2019, GP clawback obligations have needed to be increasingly supported by additional security including undertaking, guarantee or escrow arrangements.

Conversely, not much has changed around the terms for LP clawback obligations, with the LP clawback predominantly limited to 25% of amounts previously distributed, albeit more and more funds are pushing out the period for the clawback beyond the usual one or two years, with a significant proportion in the sample reviewed extending this to three years after the relevant distribution.

Organisational expenses remain capped for most funds; however the report demonstrates that these caps have become larger, which is particularly evident around medium to large funds.

• For funds between $100m and $249m, the average limit has increased from 0.52% to 0.55%
• For funds between $250m and $499m, the average limit has increased from 0.38% to 0.42%
• For funds of $1bn or more, the limit has increased from 0.15% to 0.18%.

Nothing wrong
The number of funds including no-fault removal provisions has declined, meaning less avenues for LPs to sever ties with the GP.

In 2015, Addleshaw Goddard observed from the data that 65% of all funds included no-fault removal rights for LPs; in 2022 it was 45%.

Nevertheless, this number did rise by 10% in 2021, which the report interprets as a reflection of less access to investor capital and perhaps an early indication that the negotiation landscape might shift back more decidedly in LPs’ favour.

“In the aftermath of Abraaj and others, and given the complexities involved in establishing ’cause’ conduct, we expected to see more and more funds including no-cause removal rights benefiting LPs,” comments Jeremy Cross, partner for fund finance at Addleshaw Goddard. “But there has been no noticeable increase, in fact the opposite, nor a stronger push for them, suggesting that Abraaj has not fundamentally impacted LPs' trust in the industry.”

While LPs continue to closely interrogate funds terms, they seem to have found no universal reason to distrust their managers, as the overall decline in no-cause removal clauses shows. And while management fees have slightly declined, carry remains a stable staple on the industry and caps on organisational expenses have increased, which is certainly good news for operational leaders of private equity.

The full report with its full key findings can be accessed here.