THE MODERN FUNDRAISER a Guide to the Choices, Vehicles and Structures Available for Private Alternative Asset Fund Managers and Their Investors

January 2016 • www.privatefundsmanagement.net

FINANCE • LEGAL • COMPLIANCE • OPERATIONS • TAX

THE MODERN FUNDRAISER A guide to the choices, vehicles and structures available for private alternative asset fund managers and their investors

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January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 1 contents • JANUARY 2016 • THE MODERN FUNDRAISER

p. 6 on the record

5 Thepower of commitment Ridgemont Equity Partners partner Travis Hain tells pfm how the firm managed to close its second offering in only seven months 22 Cutting through the red tape Despite the challenges of AIFMD and emerging marketing rules, managing partner Neil MacDougall and Silverfleet Capital sailed past their hard-cap on Fund II 29 Proving your partnership Mike Arpey of The Carlyle Group expert commentary features gives the inside scoop on how to handle investor relations at a firm 3 Meet the modern fundraiser 6 Better, faster, stronger juggling multiple fundraises Proskauer’s Nigel van Zyl presents A panel of fund formation thought some of the current challenges leaders discusses what it takes to facing fundraisers today – and how thrive in an increasingly complex p. 17 successful GPs are overcoming them fundraising landscape 13 At the negotiating table: 17 Reading the fee leaves Ts & Cs that require attention Will the recent hype around Proskauer lawyers Michael fee transparency actually move Suppappola, Edward Lee, Lewis existing market terms on fees Phillips and Andrew Shore dissect the and expenses? top terms receiving careful scrutiny 20 CalSTRS speaks out on fees 30 Proskauer Head of private equity Meet the Private Investment Funds Margot Wirth talks portfolio Group at Proskauer monitoring fees and today’s market challenges p. 23 23 Careful what you wish for Oversubscription may seem like a fundraiser’s dream, but the reality presents some IR complications 26 Finding what works for you GPs are coming up with new strategies to keep up with investor demand for co-investment opportunities

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The days of having only to think about a fundraising once every three or four years are long gone

ing relationships with investors and potential investors have to juggle many competing demands and requirements. The days of having only to think about a fundraising once every three or four years are long gone. In the current fundraising environment investor relations professionals are constantly “fundraising”, developing and enhancing relationships with their investor base and seeking to build con- nections with new investors, coupled with anticipating where new sources of capital are likely to come from and The modern fundraiser: prepared to meet new challenges head-on which sources are likely to dry up. The importance of having an investor base that is diverse not only geographically, Meet the modern fundraiser but in terms of investor type was high- Successful fund managers are identifying, reacting and lighted following the global financial ultimately overcoming a plethora of new challenges presented crisis, when many of the banks that had been both significant and loyal inves- in today’s fundraising environment, writes Proskauer partner tors for many GPs disappeared. Nigel van Zyl The modern fundraiser has to give careful thought to fund terms, those successful fundraising is the partners manage the relationships with that will remain the same, and those lifeblood of any private fund their investors has radically evolved; that will change, as well as where “the management business. It allows capital raisings have become truly market” is on certain key terms; how theA investment team to execute on their global as general partners travel far investors might respond to changes to investment strategy, while providing and wide to raise money from poten- terms that are favorable for the GP, revenue to the firm and performance tial LPs and compete with more funds and whether the GPs believe that they incentives for the executives tasked looking to raise more capital than ever have sufficient momentum and support with sourcing the deals, investing and before. Regulations and securities laws from their investors to push through managing the capital with the goal of have become more complex and bur- with such changes. Reading the market delivering strong returns to investors. densome and impact on how capital is and investor sentiment, and getting the As the asset class has matured in- raised. Those individuals tasked with terms right at the outset is critical to a vestors’ expectations of how general the job of raising capital and manag- successful fundraising. Careful thought

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 3 expert commentary • OVERVIEW

needs to be given to fund terms such as and requiring far more detailed infor- hard-caps and “waterfalls”. GPs need to mation on these arrangements, as well consider the impact that pushing out as additional comfort that there are no the boundaries on terms could have on “hidden fees” being paid by portfolio the speed at which they manage to raise companies to fund managers that in- capital – a fine line to navigate. vestors are not aware of. In turn GPs In addition, today’s fundraiser is of- are focusing on the language in their ten tasked with managing investors’ LPAs to ensure it encompasses all nec- expectations and demands for co-in- essary provisions, and that there can vestment opportunities. Managing be no question of LPs not being aware competing demands from a diverse of and informed as to what a GP’s ap- investor base is no easy task – deciding proach is on these matters. what undertakings and commitments In demand GPs who have the ability are made to investors at fund closings to raise capital quickly have the “envi- and how co-investment opportunities able” challenge of managing excess de- are managed in a fair and equitable mand from LPs. Whilst a nice position van Zyl: successful GPs must juggle manner, while keeping all investors to be in, it is nevertheless a challenge, competing demands and the regulator happy is a minefield. and one that needs to be carefully and Moreover, ensuring that the investors well managed. Disappointing LPs who who are allocated the opportunity are do not get an allocation to a fund that Reading the there when the deal needs to close so they want to invest in, or being given a market and investor the fund is not over-allocated to an in- significantly lower allocation than they sentiment, and getting vestment is a key consideration. expected can strain relationships for Investor relations and fundraising many years – LPs can often be unfor- the terms right at professionals also have to bear in mind giving in this regard. The key to man- the outset is critical the tightening regulatory and securi- aging this issue is smart, clear and early to a successful ties law environment across the globe, communication to properly manage fundraising and how this impacts where capital is expectations while GPs harness the de- raised, where investors are based and mand in the market to achieve a speedy “marketed” to, and the timing of the closing while obtaining the commercial fundraising process. Whether it is re- terms they want. quirements for registering as “lobby- In an increasingly sophisticated ists” in California, complying with the fundraising landscape, we have needed AIFMD in the European Union and to adapt. Today’s investor relations and similar legislation in Switzerland, or fundraising professionals are the true the strict requirements in the Middle renaissance men and women of the as- East – these issues need to be carefully set class. Versatility and flexibility are considered and a clear marketing strat- proving vital to handling the challeng- egy taking these issues into account es, demands and pressures that come must be formulated. with managing a global investor base Recent findings, speeches and fines and ensuring the stream of capital, fun- levied on GPs by the US Securities and damental to any private fund manage- Exchange Commission in relation to ment business continues to flow. transaction and monitoring fees, ex- Welcome to The Modern Fundraiser. pense allocations and the allocation

of co-investment opportunities has Nigel van Zyl is a London based partner and resulted in LPs shining a spotlight on head of the European private investment funds these issues during their due diligence practice of law firm Proskauer.

4 private funds management • THE MODERN FUNDRAISER • January 2016 on the record • RIDGEMONT EQUITY PARTNERS

The power of commitment In this first of our three-part series interviewing GPs with recent successful fundraises, we ask Ridgemont Equity Partners partner Travis Hain how the firm managed to corral $995m for its Fund II in only seven months

Pfm: What was the timeline like for The terms of Fund I and the terms of raising Fund II? Fund II are very similar. The GP made a substantial commitment to Fund Hain: We started contemplating things I and an even larger commitment to in the fourth quarter of 2014 and we Fund II. Actually, the GP is among started talking to our placement the top four investors in REP II. That agent Brooklands Capital Strategies certainly resonates with investors from around that timeframe. We began to an alignment standpoint. It shows pull materials together and work on we’re really focused on the risk and a private placement memorandum return and driving attractive outcomes; (PPM), which all culminated in a that’s always important to folks and March 2015 launch. We had our first makes a big statement. We all have close in June at $750 million, which opportunities outside the firm from an was nice for us, because that was bigger investment standpoint, but if you see a than our first fund and allowed us the GP leaning in, that means they have a luxury of taking our time to make sure lot of confidence in what they’re doing. we were getting to the right group of This is a crowded market and there are additional LPs that we wanted to bring a record number of funds being raised, Hain: evolution, not revolution in. By our final close in October, we so everything that you can do to stand were oversubscribed. out from the crowd in a differentiated or special way helps. How was the fundraise for REP II We’re spending different from the raise for REP I? How did you communicate your more time with our message for REP II? portfolio companies The first fund took about 18 months to than ever before raise, so it was a longer period of time The things we were emphasizing this and a lot more work. The biggest reason time I’m sure were a little bit different is that this time around we already had than what we emphasized last time, Fundamentally our business and a base of investors, while REP I was a because some things are probably strategies haven’t changed so our key cold start and we had to educate the more important today than three or messages haven’t changed. We have market on who we were. We built up a four years ago. One piece that’s a little been together for more than two reputation and an investor base through bit different today is that we are more decades – our investment committee REP I, which made things significantly focused on the “hands on” aspect of is comprised of eight people who have easier for us in raising REP II. A vast driving value. We’re spending more been working together an average of majority of LPs from Fund I invested time with our portfolio companies 19 years – and that level of continuity with us again in Fund II, along with a than ever before. For example, many across a very strong team is unique in handful of new investors. of our strategic plans for our portfolio the middle market. We invest in four companies include M&A as a key sectors and have a track record that In what ways did your fund terms driver of growth in today’s slow paced corroborates that the people and the shift from REP I to REP II? economy. strategies actually work.

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 5 roundtable • FUNDRAISING Better, faster, stronger roundtable • FUNDRAISING

Navigating today’s fundraising market has become increasingly complex for both fund managers and investors – but those getting it right are reaping substantial rewards. What does it take to fall in that category? Late last year, pfm assembled an expert panel of industry insiders to find out

by NICHOLAS DONATO photography by JAMES CLARKE roundtable • FUNDRAISING

ight from the start, it was obvi- partner at fund of funds group Panthe- Around the table ous that things were going to be on, who was the first to offer such a ver- Sergey Sheshuryak interesting – and not just because dict. The pendulum’s swing back, how- is a partner at Rof the dazzling view of the financial dis- ever, has been limited, Steers believes. fund of funds trict from Proskauer’s London office. Delaney Brown, a senior principal at investor Adams Street Partners. After introductions were made, and the Canada Pension Plan Investment He is responsible pleasantries exchanged, our panel of Board (CPPIB), disagrees, saying that for managing the fundraising experts – a mix of fund the pendulum is better described as group’s investor managers, investors and legal advisors having swung significantly back in GPs’ relationships across Europe, and is additionally an LP advisory board – were asked a question bound to elic- direction. member of 17 private equity firms it strong, contrasting opinions: Has the “Managers with a good track record within the Adams Street portfolio. so-called ‘power pendulum’ swung back are generally less receptive to what in- Helen Steers is a towards GPs post-global financial crisis? vestors want,” says Brown. “A more partner and head of It’s a question that required our balanced conversation between LP and European primary roundtable participants to consider a GP occurs when you go beyond the top investments at host of factors, including the estimated quartile GPs – and more and more man- Pantheon, a fund of funds investor 2,000-plus fund managers on the fund- agers feel that they are in that category.” where she is also raising trail today; the lightning-quick Brown says that LPs did “a fair job” active in the group’s speeds at which top-tier GPs have of influencing terms in the years imme- co-investment program. Steers is managed to close multi-billion funds, diately after the crisis, when the pendu- a board member of Invest Europe (formerly the EVCA) with 25 years while others struggle or experiment lum is said to have gone the other way, of industry experience. with different funding models; and the but “not as great of a job as could have resoluteness of LPs while negotiating been done.” Nigel van Zyl is a London based investor protection rights and certain Soon after, the roundtable agreed that partner in the other terms. the question was hard to answer general- private investment “At the moment it’s swinging back in ly, and it varied based on managers’ size, funds practice of the favor of GPs,” says Helen Steers, a strategy, track record and terms. law firm Proskauer. van Zyl has over 14 years of experience advising private fund managers and institutional investors on a broad range of issues, including fund formations, fundraisings, secondary transactions and co-investment arrangements. David Tegeler is a US-based partner and global co-head of the private investment funds practice at Proskauer, a law firm. Tegeler has expertise in a broad range of matters, including fund formations, buy and sell side secondary transactions, direct secondary transactions, co-investments, restructurings and upper tier management governance issues.

8 private funds management • THE MODERN FUNDRAISER • January 2016 roundtable • FUNDRAISING

Around the table Delaney Brown is a senior principal at the Canada Pension Plan Investment Board (CPPIB), a Toronto based pension plan where he evaluates fund investments, secondaries transactions and co-investment opportunities. Prior to joining CPPIB in 2013, he spent eight years at Hermes GPE performing a similar role. Jeremy Lytle is an investor relations partner at UK mid-market firm ECI. He is chair of the British Venture Capital Association’s Responsible Investment Advisory Board and is additionally a member of That’s because the market is “hot raising process, which isn’t typically the trade body’s committee but still selective” at the moment, says worth the tradeoff. Equistone is a recent on investor relations. Adams Street Partners’ Sergey She- case study in this type of restraint. The Christiian Marriott shuryak. “Many smaller funds, that pan-European mid-market firm cor- is a partner don’t usually need as many LPs to ralled €2 billion in commitments after responsible for fundraising and reach a close, are having great fund- just six months in market, sealing a first investor relations raising success. Certain mega-funds and final close on its fifth buyout fund at Equistone with good performance and differen- earlier this April. Partners Europe, tiated approach, are accomplishing the “It does mean you stand in front of the mid-market firm that spun out from Barclays. same thing with larger pools of LPs to your colleagues and say ‘Yes, our suc- Before that he was IR director for consider. But some managers misread cess here indicates we could have asked Mezzanine Management the environment entirely by going out for better off-market terms; but do we (now MML Capital). with aggressive size targets and unusual really want to put additional risk in Vince O’Brien terms, and receiving less demand than our business by prolonging the fund- is a director at expected, despite a good brand name raising for an additional six months?’,” Montagu Private and decent historic performance.” says Equistone IR partner Christiian Equity, a European private equity Marriott. firm. He sits on the Managers: Secondly, regulators have entered firm’s investment Proceed with caution the mix with greater visibility since committee and Despite the general market shift in post-crisis regulations placed an un- is responsible for fundraising their favor, managers are exercising re- precedented level of scrutiny over the and investor relations. A former chairman of the British Venture straint when negotiating fund terms. private funds industry. After reviewing Capital Association, O’Brien The roundtable cited three specific rea- managers’ marketing materials, regu- has worked in the private equity sons why. latory filings, partnership agreements industry for nearly 30 years. For starters, GPs understand that un- and other records, inspectors are flag- favorable terms can prolong the fund- ging certain practices and expense al-

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 9 roundtable • FUNDRAISING

But with the fundraising spigot cranked left, one term in particular is proving hard for managers to resist moving, thus becoming a flashpoint during negotiations.

Bigger isn’t always better Hard-caps, which several roundtable participants pointed to as one of the most important terms during negotiations, are another area where GPs can inadvertently come across as self-serving. “The key question is: can you commit to a hard cap up front. Because if not, it looks like you’re out there to see what the market will give you and then take it all,” says Marriott, adding that GPs “who do their homework” and “understand their business and market well” should be able to include a hard cap in their PPM. Indeed, overall fund size is something locations as potentially violating GPs’ fundraise” or ending up “pushing too GPs don’t spend enough time thinking fiduciary duty to investors. hard on any one term” risk upsetting about or trying to justify, despite fund “Transaction fees, accelerated mon- their investor base – who are bound size affecting almost every aspect of a itoring fees and certain other terms to share their experiences with other, firm’s business model (including head- cited specifically in recent SEC en- possibly prospective investors, Lytle count decisions, internal organization, forcement cases are either staying put continues. co-investment and borrowing policies with additional disclosure to the LPs, However, not all terms appear static. and overall economics). LPs want to or becoming more conservative,” says For instance, London-based Proskauer know exactly why the target is what it is, David Tegeler, a US-based partner at fund formation Nigel van Zyl is notic- and exactly what consequences that has Proskauer, who co-heads the group’s ing funds switching back to the US- for a firm’s strategy and resource base. private investment funds practice. style deal-by-deal waterfall approach For Sheshuryak, there are many cas- Thirdly, terms that stray too far in after having conceded a European-style es when rising fund sizes are justifiable, GP’s favor can come across as oppor- “fund-as-a-whole” approach immediate- but he questions GPs who contradict tunistic to investors. Jeremy Lytle, an ly after the crisis. “It’s a trend particular- themselves by saying that their pipe- investor relations partner at ECI, says ly strong in the large-cap end of the mar- lines are “jammed full of potential” but that LPs like to see a certain level of ket,” van Zyl says. But even here further at the same time ask for longer invest- consistency from one fund to the next. qualifications are in order: While some ment periods (increasingly as long as six The UK mid-market firm closed its European GPs are abandoning their typ- years). “It doesn’t make sense. If you’re tenth fund on a £500 million hard- ical per-fund waterfall to dabble in deal- justifying a bigger fund by pointing to cap in September 2014 following a five by-deal carry, US managers are moving all these deals in the works, then why month fundraising sprint. in the opposite direction, incorporating do you need so much more time to ex- “If we attempted to adjust our terms more elements of the European waterfall ecute?” in our favor, given the current environ- into their carry provisions in order to The desire to raise the fund size, ment, it would have been very difficult satisfy LPs. “There’s a strong contrast to though, can come as much from LPs to justify why,” says Lytle. What’s more be made here between Europe and the jockeying to enter a popular fund as it is that GPs “behaving badly during one US,” van Zyl cautions. does from fund managers, says Steers.

10 private funds management • THE MODERN FUNDRAISER • January 2016 roundtable • FUNDRAISING

That said, other LPs want to lim- “make or break a manager’s chances on And once the fund closes, many GPs it fund sizes in order to increase their the margin.” now send LPs questionnaires to better chances of being offered co-investment But there are significant challenges understand their level of interest in opportunities, says Tegeler. “They will when it comes to managing co-invest- co-investments, whether they have any want to limit the manager’s dry pow- ments. Tegeler says that one major chal- deal type preferences and/or their lim- der, resulting in the need to seek ad- lenge is finding LPs capable enough of its when it comes to reviewing transac- ditional capital from co-investors.” To analyzing deals and reaching an invest- tions, adds Steers. “One indicator that that same end, investors are negotiating ment decision within tight timeframes. an LP is interested in co-investments is stricter investment limitations set forth “If it’s a straightforward buyout deal, if they bother to answer the question- in the fund’s governing documents. it’s relatively simple to get it done. But naire at all,” Steers says. “So any one deal can’t be 15 percent if your fund is investing in, for example For van Zyl, the other major chal- instead of 20 percent of the fund size, a complicated infrastructure transac- lenge surrounding co-investments re- which creates that same need to bring tion, or one that includes complex fi- lates to compliance. on other investors to close deals.” nancial engineering, it becomes much “What we say to GP clients is: “It more challenging for the GPs to man- doesn’t matter what your co-invest- Co-investment challenges age the co-investment process.” ment allocation policy is – you can de- With the roundtable’s attention turned A temptation for GPs, Lytle con- cide what’s in the best interests of your towards co-investments, Lytle says that tinues, is to give the impression that fund – but be sure to clearly articulate “it’s really a trend taking hold in the co-investment opportunities will be how it will be done. So if it’s on a size larger end of the market. The market is plentiful, but managers “must be real- of capital basis, say that. Or if it’s based seeing bigger LPs quickly lose interest istic and transparent” about how many completely on your discretion, then in a fund if the co-investment opportu- they expect to do. “You don’t want to carefully explain that.” nity just isn’t there.” give your investors the wrong impres- Under any policy, however, GPs are Brown agrees, saying that co-invest- sion and then that they might expect going to have to tread delicately when ments, at all levels of the market, can too much.” talking to their LPs about the ratio- nale behind co-investments and other preferential agreements, the panelists agreed. That’s because co-investment opportunities tend to go to LPs with large sums to put to work, which can create different tiers of investors in the same fund.

The AIFMD effect As all fundraising conversations go, people’s attention inevitably turned towards the impact of regulation, with the Alternative Investment Fund Man- agers Directive (AIFMD) a strong area of focus. In 2009, during the initial drafting stages of the directive, there were legit- imate concerns that the AIFMD would erect a regulatory ring-fence around outside managers wanting in. Mean- while, confusing provisions around reporting, near-impossible rules requiring firms to isolate dealmakers from the

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 11 roundtable • FUNDRAISING

valuation process and costly depositary losing access to US mid-market funds The compliance questions brought arrangements were all cause for con- no longer comfortable with Europe’s forth by AIFMD and other recent regu- cern for EU-based managers. Six years new private funds regime. lation is resulting in LP advisory boards on, where GPs right to be worried? For managers already authorized, adding new sections geared specifically “From a practical standpoint, it wasn’t AIFMD simply means “managing their to compliance and regulatory matters, a great deal of grief,” says Montagu Pri- reporting, checking their compliance says Brown. “Five years ago you didn’t vate Equity director Vince O’Brien, timetables and up fronting the legals a have that.” whose firm went through the directive’s lot more during dealmaking,” says van authorization process. That’s not to say Zyl. For managers outside the EU, van Parting advice the extra regulation isn’t having any im- Zyl recommends senior management The roundtable closed with each pact at all. For all the hassle of authori- alongside compliance and legal person- panelist answering a simpler, less zation, the AIFMD rewards fund man- nel to “sit down and work out exactly unsettled question compared to the one agers with a pan-EU marketing passport where they wish to market, if they are asked at the start. What’s the one piece allowing for a more seamless fundrais- going to the national private placement of advice you would give a manager ing process. But O’Brien says that GP’s route and/or relying on reverse solicita- about to hit the fundraising trail? need to plan carefully. “Registering for tion to seal commitments.” Some answered the question by de- AIFMD purposes across Europe can Across the Atlantic, the directive scribing the fundraising process as on result in significant registration fees be- is having a more peculiar effect, adds ongoing exercise that shouldn’t only ing incurred in some countries, so if a Tegeler. be considered six months before fund GP does not expect to market in certain “Many US regulations make a dis- launch. “Meet with LPs year in and countries it is worth considering wheth- tinction between prospective investors year out, regardless when you’re fund- er there is any necessity to register at all.” and existing investors. It’s how US raising. And be clear about your time- Outside of the EU, “smaller GPs managers are trained to think. Un- tables. If you say you’re launching the less able, or less willing, to meet the fortunately, the AIFMD doesn’t make fund in the next six months, you need directive’s challenges are steering clear that distinction, so it’s creating compli- to honor that or risk losing their trust,” of Europe,” says Steers. Sheshuryak ance issues when a GP prepares for its says Lytle. agrees, noting that European LPs are next fundraise.” Others mentioned ESG reporting as a new priority, and doing more than just paying lip service to responsible in- Gaining lost ground vestment. “If you look across GPs’ web- Fundraising levels have rebounded after crashing in 2010, but the peak sites these days, they all say how much reached in 2008 is still some ways of they are embracing ESG. But having $bn specific policies, and demonstrating

548.0 that your deal executives have bought into the concept as well, is becoming a

431.2 must-have item,” says O’Brien. 392.3 Smart and consistent communica- 332.4 334.4 tion, however, was the one common de- 289.6 nominator in all the advice given. GPs 248.0 221.3 hoping to stand out from the crowd by 163.7 promoting key differentiators, such as 120.5 126.8 116.3 109.8 100.0 107.2 95.0 the promise of co-investments or the 66.6 80.1 80.9 84.9 60.1 62.7 40.3 36.4 50.2 55.2 46.1 45.5 32.0 40.4 expertise of their deal partners, will al- 12.0 42.8 ways capture investors’ attention. But 2008 2009 2010 2011 2012 2013 2014 YTD 2015 the roundtable stressed that a ten-year Private Equity Private Real Estate Infrastructure Private Debt commitment, like all long-term rela- Source: PEI Research & Analytics tionship, should be based on regular and open communication.

12 private funds management • THE MODERN FUNDRAISER • January 2016 expert commentary • TERMS

Regardless of the state of the market, At the negotiating table: there are several economic and governance terms that remain a continual Ts & Cs that require attention focal point for LPs when reviewing and negotiating fund agree-ments. Here are What are the focal points during private fund negotiations today? our top nine: Proskauer lawyers Michael Suppappola, Edward Lee, Lewis Phillips and Andrew Shore dissect key private equity Management fees terms receiving careful scrutiny A private equity fund’s management fee is generally utilized to support the fund manager’s overhead and operating costs, such as salaries, employee compensation, benefits, rent and office equipment. Most private equity funds calculate management fees during the fund’s “commitment period” based on a percentage of the fund’s committed capital, with post-commitment period fees calculated by reference to the acqui- sition cost of unrealized investments. The fee percentages are driven largely by fund size, the breadth of a GP’s back-office operations and, to a certain extent, strategy. Top-performing GPs have generally been able to resist recent LP pressure to reduce management fee levels. However, in light of the growing number of funds that remain in exis- tence long past their stated terms, LPs The fine print: fees and fund extensions are key talking points have increasingly focused their attention on management fee payments hroughout the years, private the “pendulum” of negotiating leverage following a fund’s initial term (typically equity fund limited partners shifted sharply in the direction of LPs, 10 years) in an effort to ensure that GP/ have sought to align interests culminating in the publication of the LP interests remain aligned in the later Twith general partners through the first version of the “ILPA Private Eq- years of a fund’s life. Accordingly, LPs good faith negotiation of private equity uity Principles” in September of 2009. have increasingly requested that GPs fund limited partnership agreements Although a number of oversubscribed place limitations on how long the GP and other governing documents. The GPs with distinguished track records can extend the term of a fund (typically relationship between LPs and GPs has were able to push through this period by requesting that LPs or LP advisory continually shifted as market condi- relatively unscathed, many other GPs board representatives approve term ex- tions and the private equity industry were no longer in a position to dictate tensions beyond a certain time horizon) have evolved. terms. and the amount of management fee that During the global financial crisis of However, in the more robust post-re- is subsequently payable during a fund’s 2007-2009 and subsequent recession, cessionary fundraising environment, liquidation period. severe economic headwinds resulted the fundraising pendulum has begun Although many GPs have successful- in a very difficult fundraising environ- shifting back to a wider group of gen- ly resisted LP pressure to reduce man- ment for many GPs. During this time eral partners that have exhibited a con- agement fee levels, a continued focus and for a number of years thereafter, sistent ability to procure strong returns. on the amount of transaction fees and

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 13 expert commentary • TERMS

other portfolio company remuneration received by the GP and its affiliates that will offset the management fee has recently seen a shift in favor of the LPs, with many funds moving to a 100 percent offset. Additionally, recent regulatory scrutiny regarding the collection and retention of such fees by the certain consultants, advisors and operating partners has resulted in increased disclosure and transparency around such arrangements. Finally, many GPs desiring to ex- pedite fundraising efforts in recent years have successfully implemented “early closer” management fee discounts, which provide investors with an incentive to commit capital at or near the fund’s initial closing. Volume discounts, whereby an investor pays a reduced percentage of management fee when committing above a certain tier of capital, have also become increasingly popular for GPs wishing to incentivize LPs to make additional commitments.

The waterfall While “2 and 20” remains the general carried interest to the GP prior to the years often have stronger negotiating guidepost for private equity manage- fund’s liquidation period. positions than others. ment fee and carried interest, there has At the other end of the market, been an increasing amount of bifur- top-tier GPs have not only retained Fund size & GP commitment cation in the industry with respect to their deal–by-deal carried interest but An increase in a private equity fund’s the structure of distribution waterfalls. have also introduced “premium carry” size also tends to lead to an increase in Some GPs have been required to give up waterfalls, whereby the GP receives a the size of the GP’s team, and LPs con- their historic “deal-by-deal” carried in- higher carried interest percentage (e.g., tinue to focus on ensuring a strong GP/ terest structure (whereby carried interest 25 percent to 30 percent) if the fund LP alignment with respect to the GP’s is generally collected based on the per- meets certain IRR, NAV or other per- capital commitment to a fund. In recent formance of individual realized invest- formance objectives. The increasingly years, the market has witnessed a gen- ments) for a more LP-favorable “whole wide disparity in waterfall structures is eral increase of the percentage that the fund” model (whereby carried interest is largely the result of a maturing market- GP’s commitment represents of third generally collected only after a return of place. party commitments to the fund. When all capital contributions plus a preferred The balance of power in negotiating assessing fund size and the GP’s com- return). With respect to GPs who have these key economics is largely deter- mitment, LPs may also focus on addi- retained deal-by-deal waterfalls, LPs mined by the supply and demand for tional key factors such as whether the have increasingly demanded additional allocations to a particular fund. As a refund has a “hard cap” on the amount interim clawback calculations and/or sult, GPs who have outperformed their it may raise, use of leverage, the size of escrow mechanisms to address investor peers and have not sought to substan- the team, team succession matters, and concerns regarding over-distribution of tially increase their fund size in recent increased internal regulatory costs.

14 private funds management • THE MODERN FUNDRAISER • January 2016 expert commentary • TERMS At the negotiating table: Ts & Cs that require attention

Fund negotiations: Successor funds a point of interest

and “for cause” removal and/or dissolution votes.

GP removal rights Provisions giving investors the power to remove the GP are increasingly common. Negotiations surrounding potential removal rights will often focus on (i) whether the GP may be removed “for cause” and/or on a “no fault” basis; (ii) the types of bad acts and other events that may trigger a “for cause” removal; (iii) the voting threshold to trigger the removal; and (iv) the result of removal on the GP’s capital commitment and carried interest. In some situations, the fund agreement may require the newly appointed replacement GP to purchase the removed GP’s interest at a certain appraised value, and often at a discount in the event the GP is removed “for cause.” Focal points for negotiations between Key person clauses rather than requiring an advisory com- the GP and LPs over what amounts to Key person clauses are one of the most mittee or investor vote, but this may de- “cause” will include the relevant persons highly negotiated provisions in a fund pend on the circumstances of the trig- whose conduct will be considered (e.g. agreement. The actual key person event ger. There may also be some discussion the manager, GP, key persons, etc.), cer- trigger (i.e., the number and nature of regarding the GP’s permitted activities tain materiality standards, and the type the key persons who must abide by the during a suspension. Although a sus- of court decision required to trigger re- requisite time devotion standard) will pension period will typically result in a moval. depend on the structure of the partic- prohibition on investments in new port- As an alternative or supplement to ular GP’s team and business. The time folio companies, some investors will GP removal rights, LPs may also con- devotion required of the key persons push for additional limitations (such as sider requesting the right to commence should accurately and fairly reflect those limitations relating to follow-on invest- an early dissolution of the fund, either persons’ responsibilities to the GP’s ment activity) and/or advisory board on a “no fault” or “for cause” basis. general business and other investment oversight functions. products. It is increasingly common for When reviewing general investor Term and extensions individual key persons to be subject to protection provisions on a holistic ba- The traditional model for a private eq- different time and attention require- sis, an LP’s comfort level with the key uity fund provides for a fixed term of ments. person standard will typically impact approximately 10 years, plus up to 2-3 When triggered, key person provi- negotiations around other protections, extensions of one year each. There are sions typically result in the suspension from seeking potential “no fault” sus- often variations to this model depend- of the investment period. LPs will often pension of the investment period with ing on the fund’s strategy and the types look for the suspension to be automatic an investor vote to potential “no fault” of assets that the fund is acquiring. For

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 15 expert commentary • TERMS

example, debt funds may feature short- multiple funds with a large disparity follow-on investment, fund agreements er terms and infrastructure funds typi- in investment strategies and/or invest- may permit a successor fund sharing cally have longer lifespans. ment teams. the same investment strategy to make Following the financial crisis, many Successor fund restrictions are often “cross-over” investments in a portfolio private equity funds found it increasing- based on when a certain percentage of company of the prior fund. ly difficult to sell certain assets that were total commitments have been made The typical forum for resolving purchased during the early part of the by the fund (i.e., a successor fund is such conflicts is the fund’s LP adviso- decade. These difficulties have result- typically permitted when a substantial ry board. LPs have sought increasing ed in a large number of funds that are amount of the fund’s capital is invested transparency regarding conflicts in re- out of term extensions but still retain a and/or reserved for follow-on invest- cent years, and many LPs will request handful of remaining assets that cannot ments or expenses). LPs will also typi- that the GP have a stated allocation pol- be sold at a desirable value. In light of cally request that a fund’s management icy when investing on behalf of multiple these issues, some LPs are taking a prag- fee “ramp down” to the post-investment accounts with similar strategies. matic view on negotiating the basis on period formulation when a successor which a fund’s term may be extended, fund is raised. Side letters and preferring sales at an appropriate time most-favored nation over a premature forced liquidation. As Conflicts & allocations Side letters have become a burdensome noted above, LPs are increasingly fo- A GP may manage multiple funds mak- but necessary aspect of the fundraising cused on the level of management fees ing new investments at the same time, process for GPs in recent years. LPs paid during any extension and during such as successor funds and managed with considerable capital commitments liquidation. accounts. To the extent that multiple may seek protection against the general Some GPs are now contemplating funds or accounts have an overlapping partner agreeing to preferential terms longer terms for newer funds in an ef- with other investors through receipt of a fort to mitigate these issues on a go-for- “most-favored nation” provision, which ward basis. Moreover, the inability of would require the GP to provide (and, in GPs to efficiently liquidate existing The fundraising some cases, offer) to the LP certain side funds combined with increased LP pendulum has letter provisions the GP has agreed to pressure regarding liquidity has recently begun shifting back with other investors. The MFN may be led to the increased prevalence of com- included in the LPA, although is more plex secondary restructurings of end-of- to a wider group typically negotiated with individual in- life funds. of GPs that have vestors. MFN rights will also typically exhibited a consistent be subject to certain carve-outs, so that Successor funds ability to procure terms relating to, for example, advisory LPs will want to ensure that each GP strong returns board seats or an investor’s specific reg- they invest with spends an appropriate ulatory or tax status are not available to period of time investing their capital all investors. In addition, GPs will often and not end the search for new invest- seek to limit the MFN so that investors ments prematurely. The key persons investment strategy, the GP may be may only obtain the benefit of provi- are typically permitted to dedicate faced with allocation conflicts. For ex- sions given to investors with the same or time to a successor fund within their ample, should a new investment be al- smaller commitments. Oversubscribed time commitment obligations, and located to the prior fund, the successor GPs may seek to eliminate side letters therefore a restriction on when a suc- fund, or proportionally to both funds? altogether. cessor fund can be raised is important. Should follow-on investment opportu- GPs will typically want to ensure that nities be solely allocated to the fund(s) any restriction on raising a successor that previously invested in the related Michael Suppappola is a Boston-based partner in Proskauer’s Private Investment Funds Group, fund is only tied to products with a portfolio company? Even if a prior fund while Proskauer associates Edward Lee, Lewis substantially similar strategy, partic- is no longer making new investments Phillips and Andrew Shore are based in the ularly larger GPs that may manage and/or no longer has capital to make a same practice in London.

16 private funds management • THE MODERN FUNDRAISER • January 2016 features • TERMS & CONDITIONS

Reading the fee leaves Despite fee transparency having become a top priority in the LP community, a buoyant fundraising market is keeping many terms around fees and expenses firmly put. How long that lasts, however, appears to be an open question by CLAIRE COE SMITH

n the face of it, it would seem that managers are under im- The money will mense pressure to concede talk, and in the Omore favorable fund terms for LPs in end the market the partnership agreement. will move in the As regular readers of pfm are aware, fees have become a hot issue in the direction that the press, which has caught the eye of the LPs want it to go public sector. In July, a letter signed by 13 state treasurers and elected city offi- cials was sent to the US Securities and Exchange Commission (SEC) urging the regulator to require standardized private equity fee disclosures from GPs. Meanwhile, the California Public Employees’ Retirement System (CalP- ERS) and other LPs have been under intense media pressure to justify performance fees. Amid the controversy, the Institutional Limited Partners As- sociation (ILPA), which CalPERS is a member of, launched a fee transparency initiative last year that included a standardized fee reporting template for managers to use. If the court of public opinion determines private equity to be too opaque, or too expensive, LPs will have a more difficult time justifying their private equity portfolios to outside stakehold- ers, even when their alternative assets deliver superior returns – which investors could use as leverage during fund negotiations. But by far the biggest trend explain- ing this perception is the SEC and other regulators taking a more aggressive approach to enforcement when it comes to fees. Last year, Kohlberg Kravis Roberts and The Blackstone Group became the

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 17 features • TERMS & CONDITIONS

two most recent high-profile examples manager having to switch to a European regulators and investors, and the enor- of this trend, with both GPs agreeing to waterfall in quite some time, and indeed mous drive for transparency and clarity. eight-figure settlements for SEC charges some larger high-performing European “The ‘partnership expenses’ section related to broken deal expenses and ac- managers have been able to agree deal- used to be a small paragraph; now it’s a celerating monitoring fees respectively. by-deal waterfall arrangements that are full page in the fund agreement, listing But here’s the thing: despite these cross-collateralized. out every single thing that will be borne trends, today’s bullish fundraising mar- Others agree that, despite all the re- by the partnership in fine detail, so that ket is limiting investors’ ability to move cent attention on fees, LPs are not nec- there is no doubt about it.” terms on fees, expenses and carry mod- essarily pushing back harder on the is- But will greater regulatory oversight els. sue during fund negotiations. start to move certain terms in the time Sean Hill, a Boston-based partner “The bigger funds are all getting ahead? with Proskauer, who is also co-head whatever they want when it comes to “I expect to see GP compensation of the law firm’s private investment GP compensation at the moment, and certainly becoming more efficient –and funds group, says that when it comes that is the standard 2 percent annual a desperate need for more alignment to GP compensation, investors are not management fee and 20 percent carry coming from investors. The money focusing on any one issue, which may over an 8 percent preferred return,” says will talk, and in the end the market decrease their leverage to significantly David Waxman, managing director at will move in the direction that the LPs move any one term in their favor. Azla Advisers, a fundraising and sec- want it to go,” predicts Mounir Guen, “Smarter and more experienced insti- ondaries advisory firm. founder and chief executive of MVision, tutional investors are looking at it more “Even for the smaller or newer funds a placement agency. holistically, focusing more broadly on in the US, who most likely have to go That’s a view shared by Waxman, alignment of interests. Investors cer- with the European waterfall, they are who argues that longer term, investors tainly want to pay less, but for managers still also pushing for 2-and-20,” Wax- will be able to get much more bespoke with a strong track record and a good man continues. arrangements on GP compensation by reputation, to the extent that they have At that smaller end of the market, or focusing their attention on separately in place the so-called US waterfall, they for first-time funds, he says he has seen managed accounts, which are rapidly have been able to retain that.” GPs more willing to negotiate on fees growing in popularity. The US waterfall, or deal-by-deal wa- and carry in order to attract LPs, and a He says: “Managed accounts are a terfall, is more favorable to GPs than the tiered carry structure is not uncommon, huge trend and are something the large alternative “fund as a whole” European where carry increases once certain per- managers are doing a lot of with their approach. Hill says he has not seen a US formance criteria are met. biggest investors, and there everything “We have seen models with 17.5 per- is negotiated – fees, carry, everything. cent, 20 percent and then 22.5 percent Those are fully negotiated on all terms, carry, depending on performance. GPs regardless of who the manager is. That’s are interested in doing that kind of where everything is headed, because thing to align interests and introduce the very large LPs would rather do that LPs to their funds.” than be in a pooled vehicle where they are subject to standard terms.” More disclosures He adds that the bulk of large buyout Although greater regulatory scrutiny firms’ assets under management used hasn’t necessarily moved fund terms, to be in pooled vehicles, but things are the SEC and other agencies are cer- beginning to move to the opposite end tainly prompting GPs to include more of the spectrum. “By 2020 we will see a disclosures in their marketing materials major shift to a much larger percentage and fund documents. of assets being in managed accounts, Hill says it is in the expenses provi- and that’s a function of negotiation, be- sions that GPs are seeing the real impact cause LPs will then be able to get the Hill: watching waterfalls of the conversation going on between terms they want.”

18 private funds management • THE MODERN FUNDRAISER • January 2016 features • TERMS & CONDITIONS Reading the fee leaves

“The first thing that LPs are looking at is being fair,” says Guen. According to him, this involves looking at a firm’s finances, with leeway given to smaller groups who may need limited transaction fees, or higher management fees, in return for better alignment in the profit share. The idea is that smaller groups, who are raising a couple of hundred million dollars or less, tend to tighter on their internal budgets. “The first thing investors do is try to understand the budget of the fund, and then they try to assess how much money those at the senior level of the partnership have made for themselves, which drives GP commitments. From that, they come back with recommendations, suggestions and ideas,” says Guen. Waxman says he has also seen examples of smaller managers able to secure an agreement that they can charge due diligence fees to the fund, where the management fee would not be sizeable enough to cover such expenses. Meanwhile, at the larger end of the market, LPs committing hundreds of

WPPILOT millions to a fund expect this tailored SEC: pushing disclosures, not terms approach to result in savings. “That recognition can be made by a GP giving them some form of co-invest- Skin in the game main objective will be to protect and ment confirmation relative to their con- While compensation-related terms may grow their own capital alongside that of tribution, which allows them to blend not experience significant movement for investors.” their fees. That may not be a straight-up some time, if at all, investors are expe- Remarkably, he went on to say that, at discount, but it is a reduction because riencing success in certain other areas. Terra Firma, that meant “not sponsor- of the blend – we see models where in- For instance, investors see the amount ing any fund, or any deal, unless we can vestors commit €500 million to a fund of management team commitments as put at least 10 percent of our own mon- and may then have the same amount of a key element in aligning GPs interests ey into it. We are not going to make our co-invest, which means they can deploy with their own, and so while 1 percent money on fees – we are going to make it €1 billion at 0.75-and-10 rather than used to be standard, there are signs of through carry, and we are only going to 1.5-and-20,” observes Guen. this moving higher, and closer to 2 per- get paid if our investors make money.” All told, the fee transparency debate cent. In a recent speech, Terra Firma boss and other recent trends may not being Guy Hands picked up on this sentiment. Tailored approach significantly changing GP compensa- “If an investment team has a substan- It is a sentiment that many LPs find espe- tion models at the moment, but as in- tial portion of their liquid net worth cially welcoming as they look for ways to vestors’ increasingly tailored approach invested in a fund, you know that they tailor their views on GP compensation to to fund negotiations indicates, things are not motivated just by fees – their the specifics of the team involved. rarely stand still for long.

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 19 Q&A • THE LP PERSPECTIVE

CalSTRS speaks out on fees The ‘real’ story behind portfolio monitoring fees and today’s market challenges were among topics we discussed in Sacramento recently with Margot Wirth, head of private equity for the $188bn California State Teachers’ Retirement System

Pfm: Are you loving the asset class Are you worried about upcoming NAVs these days or …? because of public market volatility? You’re a fool if you ignore fees but you’re Wirth: I always love the asset class. Not in the long-term. also a fool if you What’s challenging in today’s mar- A number of large LPs are moving to- focus on fees to the ket? wards separate accounts or product detriment of focusing offerings that blur the lines between on performance The challenge is high entry prices – it’s asset classes. Is that of interest to a cyclical issue – certain opportunities CalSTRS? exist in non-cyclical sectors and situations and of course the opportunity to Those are of interest. Some fund man- such a point that for the next generation sell … [is] a chance for us to perform agers are also coming out with yet an- of buyout funds, the majority, have 100 well relative to the public asset classes. other product that I call the Warren percent offsets. The investment spectrum is compressed Buffet strategy, the long-hold approach. When I look at my chart of fee-off- and it’s really hard for any asset class to We’ll be looking at it. sets circa 2000, they were in the 50 per- excel, but hopefully private equity will cent range; that was the most typical. perform well; I think it has been per- In terms of fund commitments, is it Circa 2005, most of those were going forming well in terms of investments business as usual? Or are you reduc- to 65-75 percent, and now, post global made since the global financial crisis. ing relationships? financial crisis, we’re at 80-100 percent. We never really over-indulged in terms So the ‘real’ story has been that these of number of relationships. Plus, we’re fees have been largely neutralized in always pruning; I think we’ve shown most cases going forward. That’s im- fairly good discipline. portant both because they’re so significant and also because they’re hard to Have portfolio monitoring fees be- track and less objectively specified. come more important given recent media attention? The SEC has taken an interest in Portfolio monitoring fees and trans- accelerated and evergreen portfolio action fees combined have historically monitoring fees; what’s your view? been (probably) the third most important fee stream for the GPs, after carried The accelerated monitoring fees and interest and management fees. Some the evergreens were a black eye on the members of the general press discov- industry. I think those were wholly in- ered them three or four years ago and appropriate when the GP benefitted presented it as news that these fees exist disproportionately. Sometimes however, and the ‘dumb LPs’ have been oblivious overall portfolio monitoring fee issue to them, when in fact LPs have waged and this issue [of accelerated or evergreen a long-term battle for at least 15 or 20 fees] get conflated. The evergreen agree- Wirth: performance trumps all years and driven these fees down to ments were insidious because we didn’t

20 private funds management • THE MODERN FUNDRAISER • January 2016 Q&A • THE LP PERSPECTIVE Q&A • THE LP PERSPECTIVE

expect them, we didn’t factor them into our models when we were trying to esti- mate overall fee loads. Once LPs realized what was happening, we started pushing back. The first thing that happened was that those evergreen agreements stopped being written onto new deals (or at least not being written when sharing ratios are not favorable or at least neutral for LPs). Then GPs started to either volun- tarily forgo or greatly reduce the amount they would realize on legacy evergreens … and with this latest SEC action, now we’re recovering some of the past fees charged.

Have fees become more of a talking point generally?

Yes, but first of all, let me state that this program has delivered a lot of value over the long-run to our beneficiaries. I would also like to state that our accounting and reporting systems meet or exceed industry standards and that all of our performance figures are net of all fees and carry. Fees are always very important – fees and carry take a large portion of

the gain so they’re terribly important. COOLCAESAR However, performance varies quite a bit CalSTRS HQ: high-performing managers welcomed in this industry and so it is ultimately net performance that determines the nomics (just like better baseball players ing key-man; is that something to be success or not of a private equity pro- get more lucrative contracts). Fees are concerned about? gram. In other words, performance in important, but just as important can be this industry typically varies a lot more fund size and other factors – waterfalls, I think those are the exceptions. Some than fee loads. You’re a fool if you ig- GP commits, GP guarantees, claw- groups do have more of an institutional nore fees but you’re also a fool if you fo- backs, and so on. strength, rather than being tied to an cus on fees to the detriment of focusing Just so I don’t get taken out of con- individual, and some of these funds on performance. text, let me state for the record that may not have a key-man clause. Often Performance and fee levels are often obviously, all other things being equal, though, those same funds might have negatively correlated: the funds with lower fee loads are always better. We a relatively low threshold for their no- the higher fees often have the higher seek lower fee loads, not higher fee fault divorce clause activation. Overall performance (on a net, after fee and loads. Ultimately though, we seek the I’d rather take a low threshold on a no- carry basis). This isn’t shocking to peo- best risk adjusted net returns. fault, which gives you universal flexibil- ple who are in the industry, that it’s a ity. But again, you can’t look at terms market-based system that sets these We’ve heard of some GPs doing away in isolation, you’ve got to look at the fees, and better groups drive better eco- with hurdle rates and clauses includ- whole package.

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 21 on the record • SILVERFLEET CAPITAL

Cutting through the red tape In this second of our three-part series interviewing GPs with recent successful fundraises, we ask Silverfleet Capital managing partnerNeil MacDougall how his group tackled AIFMD and other new rules while busting past its $850m hard-cap for Fund II

Pfm: How did Silverfleet adjust to but in some cases an LP responded, How do you navigate these in-depth the regulatory changes that occurred “You’re the only fund that we’ve en- LP negotiations, especially when between the close of Fund I and the countered so far that’s actually asked your fund is nearly oversubscribed? launch of Fund II? us to send one of these letters.” It was interesting because we were doing it You try to minimize the set-up costs MacDougall: Here in Europe, we had by the book, and we wondered, “Does for your investors and you’re perma- to deal with the Alternative Investment that mean everyone else is winging it?” nently torn, wondering “Is this issue Fund Managers Directive (AIFMD). It In Europe, we have LPs from Finland, really essential and how much are we was new, and how people were dealing Sweden, Norway, Demark, the Neth- going to spend on it?” We had one in- with it was emerging rather than estab- erlands, Germany, Switzerland and the vestor who did a deep dive on every- lished. UK, and there was quite a lot of varia- thing, and it probably cost seven times One tedious part was the premarket- tion from investor to investor and from as much as the average investor to set- ing. The new rules regarding what you country to country. tle their LPA comments. But it was a needed to do in order to market a fund As time has gone by, it has become reasonable check in terms of size, so it in each European country were far from more established what customer prac- was worth it. clear. And what we defined as reverse tice needs to be in each country. Once We were lucky that from Fund I to solicitation wasn’t necessarily what the we were fully AIFMD approved and Fund II, all the investors who were LP or their legal advisors would regard signed off by the Financial Conduct Au- able to invest again did. Unfortunate- as reverse solicitation. That had to be thority, we had a passport and we were ly, some who we worked with closely ironed out. able to market. in Fund I didn’t have the money or Our legal advisors sent letters to the couldn’t justify coming into a fund of LPs to set up the reverse solicitation, What kind of challenges did you face our size, so it was a smaller re-up rate bringing non-European investors than you would expect, but those who onboard? did re-up were the bigger investors so the number of euros raised was quite We were in contact with investors from significant. You can manage the situ- Saudi Arabia and had to go through the ation so that the people who want to right way to market to them, as well as be in the fund can be in the fund and some from Israel, and the way they’re you don’t end up with LPs doing lots of regulated is unique as well. That pro- work for no benefit. duced some interesting negotiations in the LPA. What was one of the more heavily But I think the most surreal moment negotiated terms? was when a US investor’s Employee Re- tirement Income Security Act of 1974 There’s much more sensitivity as to what (ERISA) counsel was disagreeing with the role of the LP advisory committee a European investor’s counsel on the is. Nobody on the advisory committee interpretation of how ERISA should be wants to be sued, but they also want to documented in the LPA. So it’s not just have a fair amount of say in how the GP MacDougall: meeting regulators’ Europe, there were some other places we deals with certain situations, so there’s challenges had to think through carefully as well. an inherent conflict.

22 private funds management • THE MODERN FUNDRAISER • January 2016 features • FUND CLOSINGS

body out without any warning, it’s not great PR for the GP to just decide not to deal with an investor’s questions… because they never know what’s going to happen next time around.” She points out that, by handling the process badly on any particular fundraising, the GP damages relations with investors and its reputation within the broader investor community for future funds. “Communication is really important,” says Klein. GPs should be upfront with investors about their timetables, and if a LP is taking too long on due diligence, especially relative to others, they should be informed sooner rather than later that they risk getting left behind. GPs can “get really cocky” and ignore questions from certain LPs that they don’t need, but that can result in reputational damage down the road, she warns.

Smashing the target size: GPs challenged to handle with more care Plan ahead One of the first challenges can be to identify the potential for oversubscrip- Careful what you wish for tion early enough in the process to be It’s a nice problem to have, but managing a fundraising that is able to manage expectations. Often the subject of far more interest than it can handle is fraught the managers of over-subscribed funds with investor relations challenges for GPs find themselves facing accusations of over-marketing when they realize, further down the line, that many of the by CLAIRE COE SMITH But while oversubscription may seem new leads they have been chasing down like a fundraiser’s dream at the start might have to be turned away. he number of private equi- of a process, working out the criteria Equistone Partners Europe closed its ty funds finding themselves that should be applied when it comes fifth fund at a €2 billion hard cap in oversubscribed at fundraising to choosing which investors make it April 2015, exceeding its initial target Thas been following an upward trajec- in, and managing the communications of €1.75 billion and completing the pro- tory year-on-year since 2009, with challenges associated with those deci- cess in just six months. Approximately 260 managers facing the problem of sions, can be far from easy. 80 percent of the capital committed demand outstripping supply in 2014, Audrey Klein is senior managing di- came from existing investors, but the as against 83 in 2009. In the first rector and head of fundraising at Aeri- oversubscribed fund followed a previ- nine months of 2015, 183 funds have um Finance, the European real estate ous fundraising that closed in January been oversubscribed, according to fig- fund manager. She says: “One of the 2013 at €1.5 billion after nearly two and ures from PEI Research & Analytics, things that GPs must be aware of is that a half years on the road. meaning this year could top even last investors talk to each other; so besides Would the firm have been wise to year’s total. the fact that it’s wrong just to shut some- conduct less marketing? Equistone

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 23 features • FUND CLOSINGS

of very proactively keeping in touch Capital magnets with them and constantly making them The number of oversubscribed vehicles in market is returning to aware of the timeframes others are pre-crisis levels working to. Otherwise he says there is a risk that when those investors do get Number of oversubscribed funds their ducks in a row, they will be disap- pointed to find out they have been left behind.

How to say no There are a few important criteria that should be applied by GPs faced with the problem of deciding which LPs to turn away. “Managers should ideally have clear 176 83 129 171 195 224 260 183 and fair guidelines, so that you are not 2008 2009 2010 2011 2012 2013 2014 YTD 2015 only being fair, but also being seen to be fair,” says Andrew Bentley, a partner at Source: PEI Research & Analytics Campbell Lutyens, a placement agent. “For example, investors will under- Shooting for the stars stand if you treat existing investors in a slightly preferential way to newer inves- The average difference between capital raised and targeted across tors, and you may also decide to distin- oversubscribe vehicles from 2008 to Q3 2015 guish between those that commit to the Average difference ($m) fund earlier and on time and those that don’t. That is also a good way to manage the timetable.” Some managers seek to diversify their investor base and so give preference to LPs coming in from parts of the world not currently in the fund. “In setting allocations it is under- standable to give preference to X or Y geography, but really only if you have 221 179 101 164 172 189 198 221 been clear on your strategic aims from

2008 2009 2010 2011 2012 2013 2014 YTD 2015 the start. Ultimately the GP has to right to accept whoever they want into the Source: PEI Research & Analytics fund, but the aim should be to leave no LP feeling upset, because LPs, if treated badly, can remember that for a decade fundraising and investor relations part- come from that experience and then not or more,” says Bentley. ner Christiian Marriott says that, in the market to too many people, because our Klein says the LPs that are going to be end, the firm only had to turn two in- job is to de-risk the process and secure real partners, and may be able to invest vestors off completely. the capital base of our business for the across multiple products longer term, “Our last fundraising took a long next ten years. I don’t think there was are the ones to take forward. She adds: time, because we were just coming out any other way to do it.” “The other criteria should be diversity, of Barclays and it was at the height of What he does advise against is letting because it’s really important to have di- the Eurozone crisis. It was quite hard to slower-moving investors drift, instead versification of types of investors, and

24 private funds management • THE MODERN FUNDRAISER • January 2016 features • FUND CLOSINGS Careful what you wish for

investors from different areas and dif- existing investors too, some of whom which means that in the offering docu- ferent parts of the world.” may be waiting to see what the level of ment you are committing to an amount Howard Beber, a partner with the demand is.” of money that you will not go above. law firm Proskauer, and co-head of its At Equistone, investors coming in to The concept of movable hard caps can investment funds practice, echoes the the first close and proposing to commit be pretty frustrating for a lot of LPs,” sentiment that some level of LP diver- an amount of money that was less than says Marriott. sity is good in a fund: “You want to €100 million were given their alloca- Bentley says bumping up the fund look at your LP base, and in most cas- tion at that stage, whether they were size is tempting but not always a good es it’s important to have a good mix of new or existing LPs. Marriott says: “We option: “Managers should be cautious endowments, sovereign wealth funds, didn’t tell anyone we were going to do about it when the fund size sits at the funds of funds and so on, because often that, and in fact we said we couldn’t heart of the proposition that you have those groups invest in cycles, and you sold to LPs, because if someone has tak- don’t want to be over-concentrated in en this to investment committee on the one type or another.” basis of a particular strategy, and then Still, managers should always provide you take it outside of that segment or special attention to their current LP Managers should blur the lines, then the whole proposi- base, says Jeremy Lytle, an investor re- tion becomes a bit compromised and lations partner at ECI Partners, which ideally have clear and LPs will justifiably feel irritated.” closed its tenth buyout fund, ECI 10, fair guidelines, so that For him, the biggest no-no in an over- at the hard cap of £500 million in five you are not only being subscribed fundraising is setting LPs up months last year, having been signifi- fair, but also being for a fall in front of their own invest- cantly oversubscribed. ment committees. He cautions: “Man- “Really, most people end up giving seen to be fair agers should be reading the book well priority to existing investors. Some peo- enough to judge when to slow down the ple may use the fundraising to change marketing so that they minimize the out certain LPs, or target new geogra- oversubscription problem at the end. phies, but one of the aims of the fund- guarantee allocations even at first close, Some oversubscription is often unavoid- raising is really to hit the hard cap as because even by that time we had start- able but the key point is to avoid letting quickly as possible and then get back to ed to believe that we were going to be LPs going through final investment ap- the day job. The easiest way to get there oversubscribed. So for some people that provals thinking they have got a specific is to look after your existing investors.” was a positive surprise, because they allocation, and then end up not being He adds: “We spent a lot of time with were expecting to be scaled back, but able unable to provide that. Commu- existing investors first, finding out how it meant that the first close took us to nication of the pressures in advance so they were positioned, and then you can roughly 75 percent of our hard cap.” they are forewarned is important.” start to get a feel for the level of demand. At final close, new investors were Beber concludes: “Where I have seen If you’re getting a re-up rate of 80 per- scaled back less than existing inves- trouble is when GPs were perhaps not as cent, which is what we were getting last tors who might reasonably have been forthright, and then at the last minute summer, then you quickly know where expected to have made it into the first they had to disappoint people, which is the holes are.” close, but did not meet the timetable. a quick way to upset people and damage For new investors, the ECI approach One thing Equistone was committed relationships with investors who might was to encourage them to move quick- to was a hard cap that was immovable, otherwise have been prospects for suc- ly. Lytle says: “For the bigger prospec- and which was set out in the fundrais- cessor funds.” tive investors, we said if you can drive ing documents at the outset. “We made Foresight and forewarnings, along- hard and get into the first close, and a conscious decision to set up a hard side clear, consistent and fair commu- give us a strong indication of your de- cap up front, and we did something nications, appear to be the key things mand and level of appetite, then we that I think is becoming more com- to bear in mind if you are to avoid up- can accommodate you. That inevitably mon, which is that we put that hard cap setting the investor base and burning ends up moving along some of your in the private placement memoranda, bridges for future raisings.

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 25 features • CO-INVESTMENTS

Finding what works for you As investor demand for co-investment opportunities escalates, GPs are considering new ways to manage the process, including the creation of a ‘chief co-investment officer’, making less promises during fundraising and whether to raise separate top-up funds

by CLAIRE COE SMITH point of investor relations risk management. here is no doubt that demand for co-investment opportuni- The IR factor ties has sky-rocketed among Stephen Cavell is head of investor rela- Tthe limited partner community in re- tions at Graphite Capital, a private equi- cent years. But sponsors are struggling ty investor focused on the UK mid-mar- to keep up with investor demand to ket. He says: “In our experience almost team up on deals, and with regulators all LPs want co-investment, and they baring down on them, many are re- increasingly ring up about it. But when thinking how to satisfy demand in a you offer co-investment opportunities way that works for everyone. to LPs, it can be quite a cumbersome In 2014, $5.8 billion was raised for process, and it is not always harmoni- co-investment funds, while $10 billion ous. If you have a limited amount you has already been raised in the first nine can offer, do you offer that to X, Y or Z? months of 2015 alone, according to Or do you offer it to everyone, and ev- data from PE Research & Analytics. eryone ends up with tiny amounts? That LPs are queueing up for more opportu- can be very difficult to manage.” nities to put additional capital to work David Smith, a managing direc- alongside their favorite managers, leav- tor and co-head of co-investment at ing GPs in a quandary and in need of Capital Dynamics, a major investor more sophisticated answers. in private equity funds around the Crucially, dealing with sourcing world, echoes the sentiment. He pre- ‘chief co-investment officer’ role, in extra capital to top up the fund’s dicts more GPs to allocate additional the larger funds in particular, because commitment on larger transactional resources to systems and controls in interest in co-investment and its prom- opportunities has moved from being co-investments, because it is an area inence is becoming such a significant a deal-team issue, to being a critical that can no longer be primarily man- aspect of business for most GPs.” aged by the investor relations function. In fact, the complexity of fundraising No promises made today, which requires careful manage- Co-investments offer several potential When you ment of various LP relationships and attractions to LPs, not least a chance offer co-investment new regulatory burdens, is already a to reduce fees. Private equity firms that opportunities to full-time job for IR staff. Adding co-in- ordinarily charge a management fee of LPs, it can be quite a vestments to their list of responsibilities 2 percent and take 20 percent of profits can start to “stretch their capacity,” says in carried interest will bring in partners cumbersome process, Smith. on co-investments with much reduced and it is not always He offers a solution to the problem: fees, and sometimes none at all. Given harmonious “I think we will see the advent of a that private equity remains a relative-

26 private funds management • THE MODERN FUNDRAISER • January 2016 features • CO-INVESTMENTS Finding what works for you

Co-investments: GPs piecing together new ways to manage the process

the private equity industry has increased more than I would ever have imagined – now, no promises are made. It will come up in a fundraising conversation, and the GP will ask the LP whether they would be interested, but there is no legal right. Most serious LPs with a co-investment appetite and demonstrable execu- tion credentials will make sure that that appetite is noted and described in a side letter.”

Strategies pursued But are GPs wise to keep things open-ended? Kate Simpson, a partner in the private investment funds practice at law firm Proskauer, says yes. “The general approach is for GPs to keep a softer, more discretionary co-investment approach, so they say that they acknowledge the LP’s interest, but they will approach any opportunity on a case-by-case basis. There are people that do harder things in the limited partnership agreement, or offer co-investment rights as a first-close incentive, but most GPs want to try to exercise discretion.” GPs have in the past sometimes ly expensive asset class for investors to to their investors that they are great at promised co-investment rights pro rata access, and returns are under pressure, doing it and it will enhance returns, to each LP’s commitment to a fund – that has a big appeal – as does the but really a lot of LPs talk the talk but some have delivered LPs as much as chance to get a bigger slice of the action then when you want them to get their three times their fund commitment in alongside a popular manager, and deal- act together and commit, they are busy co-investments. by-deal investment selection. doing something else or they are not Graphite’s solution is to set up and But as one investor relations part- set up to respond.” raise a separate top-up fund, at the ner at a private equity firm points out, Smith says there was a time when same time as the main fund, that in- investor demand for co-investments is sizeable LPs such as Capital Dynamics vests in the larger deals where syndi- becoming a challenge for GPs: “Our could have bilateral discussions with cation would be necessary. That blind observation is that, firstly, LPs are general partners at fundraising stage and co-investment pool is open to all LPs quite often motivated by their own secure a co-investment rights agreement, interested in such opportunities. economics to do it: they either have guaranteeing them a true legal right to Cavell says: “The positives for the in- carried interest deals or some other ar- make co-investments. Now, he says: “As vestors are that they get a bigger expo- rangements internally that are pushing co-investment has become more popular sure to Graphite funds, which is attrac- them to do it. Secondly, they make out – the demand for it and its profile within tive especially to larger global investors

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 27 features • CO-INVESTMENTS

who want to put larger checks to work. It also reduces their overall costs of Rebound enthusiasm being in our fund, because the top-up After experiencing a dip in 2013, co-investment funds experienced fund comes at a lower cost, with a fee a resurgence in popularity during the first nine months of 2015 that is only charged on invested money $bn No with deal-by-deal carry. The negative is that it’s a blind pool, so they can’t pick 42 41 which deals they get in to.”

He says Graphite decided some time 33 ago that the classic co-investment 29 27 model is ineffective in the mid-market 23 for two reasons. One, the firm refuses 18 to underwrite larger transactions and then sell them down in case circum- 9 stances change suddenly. And two, the alternative route of taking LPs along to 7.92 0.64 3.99 7.66 2.59 15.76 5.82 10.06 deal meetings so that they can make 2008 2009 2010 2011 2012 2013 2014 Q1-Q3 decisions on whether to come aboard is 2015 too complicated to execute. Total capital raised Number of co-investment funds closed He adds, “We arrived at this deci- Source: PEI Research & Analytics sion because we looked at the structure of our 2007 fund and at the market, and we decided we didn’t want to raise and say we are here to do deals that are that it requires co-investors, and that has an enormous amount of capital, and the right size for the fund.” to be decided based on clear criteria be- we wanted to stay in the mid-market fore any consideration is given to which without the pressure of a huge amount Regulatory concerns LPs might be offered the opportunity. of capital to deploy. We did see a lot of That challenge is compounded by regu- Then allocations may be offered based large opportunities, though, which we latory scrutiny. In 2012, the US Securi- on any number of criteria, ranging from didn’t want to put into the main fund ties and Exchange Commission (SEC) the size of the LP and the size of its com- for fear of risking that fund, but we began taking an interest in conflicts of mitment, to the geography, industry sec- saw no reason why we couldn’t manage interest arising in co-investments, and it tor or strategy of the target business. them.” has since increasingly focused on the of- “The SEC is very close to this at the The Graphite model deals with both fering process, making sure all opportu- moment,” says Simpson, “and the ex- the fundraising challenge and the al- nities are represented clearly and fairly pectation is that GPs will have a policy. location problems associated with to all LPs. Most people may not have it fully doc- LPs desperate to secure co-investment In light of this, Simpson says the umented, but they have always had a rights, and Cavell expects it to become best way forward now is for GPs to policy, so the point is that they need to more commonplace. have a very clear and well-documented memorialize it now. Investor relations It also helps with the messaging, policy on co-investment strategy, and are important for all GPs, so there has which can be a real challenge, as Guy to communicate that widely. She says: long been the driver to be seen to be Hands, founder and chairman of Terra “All GPs should have a co-investment doing things fairly and reasonably, so Firma Capital Partners, recently set out policy saying how they look at oppor- as not to be risking relationships, not in a speech at pfm’s Investor Relations tunities as they arise, and how they al- just so that they are doing things by and Communications Forum Europe. locate them in the best interests of the the book.” He said: “You can’t go to one group of partnership.” As with all investor relations issues, LPs and say this is all about co-invest- The first decision will always be transparency, clarity and good com- ment, we’ll give you great co-invest- whether it is in the best interests of the munication appears to be the order of ment, and go to another group of LPs fund to do a deal that is of such a size the day.

28 private funds management • THE MODERN FUNDRAISER • January 2016 on the record • THE CARLYLE GROUP

Proving your partnership In the final installment of our three-part series interviewing GPs with recent successful fundraises, we ask The Carlyle Group’s head of global investor relations Mike Arpey how firms raising multiple, simultaneous funds approach investor relations

Pfm: With the recent trend among in terms of how we communicate but LPs to consolidate their GP relation- the expectation is to be high-touch, and ships, how do you ensure that LPs we’re responding that way. continue working with Carlyle? And it’s not just our IR people who are reaching out. The people managing Arpey: You have to do more listening the money are in touch as well. After than talking. LPs are looking to get wrapping up our large cap European more out of the GP/LP relationship fund, Carlyle Europe Partners IV, this than just commitments, and they’re summer, two of the fund’s managing thinking holistically. It’s not just that directors went out to Asia to sit down they’d like more co-investment, it’s with some of their investors just to catch beyond that – they’re looking for in- them up on what’s going on in the Eu- formation, they’re looking at thought ropean market. Moments like that are leadership, and they’re looking to have important. We can’t forget whose mon- a partner. One of the best ways to en- ey it is. sure that we’re relevant is that we’re in touch with our limited partners and we Looking back on Carlyle’s recent understand what their needs are. What Arpey: embracing new ways to fundraisings, what’s the biggest shift we do is germane to what LPs tell us communicate with LPs you’ve seen in the GP/LP relation- they need and want. The best way to ship? measure that is to look at what you of- that. That winds up being very helpful fered and ask, did people consume it? to clients thinking holistically about More emphasis is being placed on the Did they commit to these funds? If their portfolios. word “partnership.” When people talk you’re not listening well, you may be about General Partners sometimes the offering opportunities they don’t want What is your approach to investor word “partner” gets lost in the process. to buy. communications, and how are you Overarching everything, LP and GP The other aspect is that you have to handling investors’ increased report- interests are converging and there’s a execute. Carlyle has done a very good ing demands? real partnership mentality taking hold, job generating realizations through whether that means greater alignment a variety of cycles. LPs see that across We’re in very regular communication of interest or more mutuality around our platform and view Carlyle as a core with our LPs, whether that’s in person information and thought sharing. The holding for them. LPs working with during site visits or conferences; over years of the “presidential cycle” in in- fewer managers plays out for us, because the phone, one-on-one, or in calls with vestor relations – only seeing people they take comfort in the quality of Car- multiple investors; and through web- every four years when you’re trying to lyle and also can be tactical in how it based portals that LPs use to access and raise money – is over. If people take is that they deploy capital with us. We slice and dice information. We’re also that approach, they do so at their own give them choices; we don’t have a one- using our external affairs folks to do peril. If you’re not in communication size-fits-all approach. If they want to podcasts and research reports and in- with your LPs, someone else will be. allocate specifically to Europe, or spe- crease communications with regards to The emphasis has to be around the cifically to small cap in Asia, we have events in the market. It’s multifaceted partnership, and that’s where we live.

January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 29 profile • PROSKAUER PRIVATE INVESTMENT FUNDS GROUP

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Our Private Investment Funds Group is a dynamic, interdisciplinary team of lawyers offering a complete package of services to private investment funds and institutional investors globally. We are consistently ranked as a top-tier practice in leading industry publications, including as one of the top five “most active law firms” for sponsor-side fund formations and most recently as “Fund Formation Team of the Year” in Chambers.

In 2015, we advised sponsors in closing more than Sponsor representation 100 funds with well over $26 billion in committed capital. > Buyout funds > Funds of funds Institutional investors on more than > Growth capital funds 180 investments, representing over $7 billion. > Debt, credit, mezzanine and distressed funds > Venture funds And on more than > Secondary funds 60 secondary transactions. > Real estate funds > Natural resources and energy funds Valuable Insight into Market Trends > Hedge funds > Spinouts and restructurings With over 300 GP and 100 LP clients globally, our experience representing > Co-investments both sponsors and institutional investors across the alternative asset class on a daily basis gives our clients access to our unparalleled insight into trends, developments, and terms and conditions. We have extensive Investor representation familiarity with the terms and conditions found in typical partnership agreements, segregated accounts, funds of one and specialized investment > Public and private pension funds mandates, having written, reviewed and negotiated such documents both > Funds of funds for general partners and limited partners. Our ability to advise on fund > Private foundations structuring, capital raising and investment activities on a daily basis gives us > Endowments and universities unmatched insight into market terms and trends. > Sovereign wealth funds > Family offices Areas of specialist expertise > Global asset managers > U.S. regulatory issues, including the Volker Rule and ’40 Act > Special-purpose vehicles > AIFMD and other EU regulations > Public charities > Compensation and Incentives > Co-investments > FATCA > International tax Secondaries > Management vehicle structuring > Complex structured and > ERISA synthetic secondaries > Fund litigation > Direct secondaries > Fund restructuring

30 private funds management • THE MODERN FUNDRAISER • January 2016 profile • PROSKAUER PRIVATE INVESTMENT FUNDS GROUP profile • PROSKAUER PRIVATE INVESTMENT FUNDS GROUP

Key contacts

London Bruno Bertrand-Delfau Robert Gaut Partner Partner dd +44.20.7280.2126 dd +44.20.7280.2064 [email protected] [email protected]

Peter McGowan Oliver Rochman Partner Partner dd +44.20.7280.2066 dd +44.20.7280.2069 [email protected] [email protected]

Catherine Sear Kate Simpson Partner Partner dd +44.20.7280.2061 dd +44.20.7280.2068 [email protected] [email protected]

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Boston Howard J. Beber Sarah K. Cherry Partner Partner dd +1.617.526.9754 dd +1.617.526.9769 [email protected] [email protected]

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January 2016 • THE MODERN FUNDRAISER • www.privatefundsmanagement.net 31 profile • PROSKAUER PRIVATE INVESTMENT FUNDS GROUP

Boston Mary B Kuusisto Arnold P. May Tax Partner Partner dd +1.617.526.9760 dd +1.617.526.9757 [email protected] [email protected]

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Michael R. Suppappola David W. Tegeler Partner Partner dd +1.617.526.9821 dd +1.617.526.9795 [email protected] [email protected]

New York Ira G. Bogner Niamh A. Curry Partner Partner dd +1.212.969.3947 dd +1.212.969.3474 [email protected] [email protected]

Bruce L. Lieb Amanda H. Nussbaum Partner Partner dd +1.212.969.3320 dd +1.212.969.3642 [email protected] [email protected]

Chip Parsons Marc A. Persily Partner Partner dd +1.212.969.3254 dd +1.212.969.3403 [email protected] [email protected]

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