The balance of power is shifting in private equity investment negotiations.
Until now, private equity managers could dictate the rules of the game. But, with billions in dollars of commitments at stake, investors are playing hardball, using new sets of best practices as their playbooks.
Three similar sets of principles have been released in the past two months by the Institutional Limited Partner Association; the Oregon Investment Council (whose principles also apply to real estate); and Watson Wyatt Worldwide.
Among key points shared by all three:
• fees should not give general partners more than 20% of the profits;
• management fees should amount to no more than normal operating costs; and
• fees and profits generated by the general partner should be used predominantly for fund expenses.
“I think this is a fundamental shift in the private equity industry and one that limited partners believed they should have encouraged in the past, but never had the bargaining position,” said Mark Calnan, London-based senior investment consultant and head of the private equity team at Watson Wyatt Worldwide. “That marketplace has changed and investors have gotten smarter about pooling their bargaining power.”
This is not the first time the institutional investment community tried to get the upper hand on contract negotiations. In 1996, nine public pension funds commissioned a study by Mercer LLC that analyzed principal terms of limited partnership agreements. But the recommendations were never implemented because general partners refused to accept the terms and institutional investors were not solidly behind them, according to industry insiders.
This time is different. Private equity fundraising is at a low point, according to Preqin, a London-based alternative investment research firm. What's more, existing relationships are counting for little in this environment. Eighty-five percent of investors refused to reinvest in subsequent funds of existing private equity managers, according to another recent Preqin investor survey.
More than 60 institutional investors have endorsed the ILPA proposals that were released in September. At the same time, Watson Wyatt came out with a white paper making its own proposal — backed by 10 large global institutional investors, including sovereign wealth funds — that closely mirror ILPA's principles.
The California Public Employees' Retirement System, Sacramento, was one of the first institutions to endorse the ILPA Private Equity Principles.
System officials view them as a “template for discussion” with general partners, according to Clark McKinley, spokesman for the $196.6 billion Sacramento-based system.
“After almost two decades of private equity investing, we believed it was time to bring some order to how LPs relate with GPs — that we could reach mutual accommodations that would benefit both kinds of parties,” Mr. McKinley said in an e-mail response to queries.