A THOROUGH UNDERSTANDING OF PRIVATE EQUITY

RETOUR SOMMAIRE

A CACEIS PRODUCT DEVELOPMENT PUBLICATION - 2010

PERSPECTIVES FOR THE INDUSTRY

4.3

The evolution of the GP/LP relationship

The evolution of the GP/LP relationship and the shift of power in favour of LPs have been largely highlighted in the past months. In September 2009, the Institutional Limited Partners Associa- tion (ILPA), which gathers 220 US LPs, reminded GPs of the best practices expected by LPs in terms of alignment of interests, governance and transparency 57 . These suggested best prac- tices are intended to serve as a basis for continued discussion among and between the GP and LP communities with the goal of improving the private equity industry for the long-term benefit of all its participants. LPs are becoming increasingly selective about who they partner with. In the future, they can be expected to work with a smaller, more exclusive selection of GPs with strong investment strat- egies. LPs expect GPs to have a coherent and robust strategy for each individual investment that can be thoroughly tested in due diligence. Discipline, a track record of success and robust investment methodologies are coming to the fore. Each GP should have a sense of where in- vestments fit into the overall investment plan and a strong understanding of the sector and associated risks. Risk management in general is expected to be tightened up 58 . Increasingly selective LPs The alignment between GPs and LPs became distorted in the boom years and resulted in a disparity between the risk exposure and returns enjoyed by GPs as compared with LPs. Returns for private equity investors suffered their worst decline on record in 2008; GPs made $148 billion in capital calls from LPs, but only distributed $63 billion in return 59 . An increase in capital calls, decrease in distributions and the scarcity of debt financing for deals have made it difficult for private equity firms to raise financing for new funds. In light of the current crisis, LPs are expected to be more pragmatic in future and to see returns and evidence of real value creation, a basic principle that some GPs had sometimes forgotten during the boom years 60 . For those investors that have decided to commit to new funds, they have been increasingly able to negotiate more investor-friendly terms in the funds’ limited partnership agreements. Last year’s large discrepancy between the amount of capital calls and distributions seems to have emboldened institutional investors to seek greater contractual rights and better financial terms from GPs. Thus, there is today an increasing pressure from LPs on GPs of the largest funds to reduce the management fee rates for new vehicles looking to raise capital. Investors are seeking to bring management fee levels more in line with the actual costs associated with running funds of different size and type. The average management fee demanded by GPs is now estimated at 1.8% (compared to an average rate of 2%, which had held steady for the past several years) and there is likely to be increased pressure for further reduction. LPs have also been able to win some concessions on restrictive covenants. Financial negotiations

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57 Source: ILPA, “Private equity principles”, 8 September 2009 58 Source: Ernst & Young, “Shifting sands, Limited Partners’ perspectives on the future of private equity”, September 2009 59 Source: Preqin Ltd, 2009 60 Source: Unquote France, Issue 100, “Private equity set to be public relations nightmare”, April 2009

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