Current trends in limited partner agreements

One of the most important parts of the fundraising process is establishing the limited partner agreement (LPA), which spells out the terms of the relationship between general partners (GPs) and limited partners (LPs). Today, fund managers are facing new challenges in landing LPs, even those who have participated in multiple funds. In this evolving fundraising environment, fund CFOs and COOs have a key role to play in helping to negotiate LPAs. To better understand current LPA trends, SVB Global Fund Banking sat down with attorneys from two of the top firms in the fund formation industry,¹ Jocelyn Hirsch and David Lenzi of Kirkland & Ellis and Howard Beber and Ryan Carpenter of Proskauer.

Relative strength in negotiations

The fundraising environment has shifted dramatically, with US-based managers raising 50% less for 2023 vintage funds compared to 2022 vintage funds, according to SVB’s H1 2024 Global Fund Banking Outlook Report. This has tipped the balance of power from GPs to LPs, but has this shift resulted in different fund terms?

Do you see more LP-friendly terms during these periods when fundraising is more difficult?

David: It’s a nuanced picture. There are a lot of headlines that describe a profound shift of power, but despite the hype, the fundamentals are not changing. The basic structure of funds remains a durable model for private investment. Still, it is a capital-scarce environment, and GPs are in a more accommodating mode, trying to get to yes on requests that they might not have two years ago. On balance, agreements are getting done on a more LP-friendly basis, but it is more nuanced than the headlines might suggest.

Ryan: As always, LP-GP dynamics are going to vary on a case-by-case basis. Funds that have more success in this environment are often established incumbents with strong track records and those that demonstrated discipline during boom times and have been able to make distributions to LPs. For these funds, there will be less opportunity for LPs to renegotiate terms. Regardless of an individual GP’s position, there is currently more hesitation on the part of many GPs to try to move terms in their favor without having a compelling reason for doing so. Instead, many GPs want to take the friction out of the fundraising process as much as possible.

Howard: There are three kinds of managers: those that can raise a fund relatively easily, those that can raise a fund but take a while to do so and those that cannot close a fund. Each will have a different experience. Even in a tough fundraising environment, many top funds do not change anything substantive in their LPAs; they provide the same deal for LPs as they did in the previous fund to help fundraising go smoothly. The real shift during a difficult fundraising environment is in the size of the groups, with fewer managers being able to raise easily and more managers missing fundraising targets or not able to raise funds at all.

Side letters: An unavoidable reality

Side letters are an inescapable part of the fundraising process. With groups like ILPA² developing best practices for LP-GP alignment, one might imagine a long-term trend toward more standardization among LPAs, including fewer side letters. However, experts say the opposite could be true.

GPs often sign side letters with LPs to set out specific terms for an individual LP. Is this practice becoming more common or less common?

David: We don’t see any evidence that side letters are becoming less complicated, less common or a less important tool in reaching an appropriate commercial deal between GPs and LPs. If anything, they are becoming more common and complicated. As LPs continue to mature, they are getting more sophisticated about what they look for in fund agreements.

Ryan: Side letters have been prevalent for a long time, and we don’t expect that to change. GPs can be overwhelmed by different requirements relating to the same topics for different LPs. To mitigate that burden, there are certainly conversations about whether to build more standardized provisions into the LPA or to try to resist side letters in certain areas more generally. This can be difficult in a slower fundraising environment though, and managers seeing more fundraising demand may have more leverage than others.

Is there a move toward more standardized terms? What concessions have you seen in these side letters?

Jocelyn: Some LPs may seek to limit borrowing provisions or limit any requirements that they may have to sign investor letters or provide non-public financial information. Practitioners need to carefully review such side letters to make sure LP asks don’t affect overall bankability of the fund or impede its ability to get a capital call facility.

David: There is certainly a desire among GPs to standardize side letters from a compliance and administrative point of view, and we are always trying to standardize, simplify and streamline agreements. The reality, though, is that investors often have idiosyncratic issues that need to be reflected in specialized terms.

Howard: Generally, you won’t find a term in side letters that significantly changes the GP-LP economic arrangement, as they tend to be more administrative in nature to address an LP’s specific concerns or requirements. In general, the terms address issues such as additional reporting, notification rights or tax-related provisions. Operationally and administratively, they can be difficult for managers, because LPs are demanding more reporting and transparency than in the past.

Ryan: Just a few years ago, managing side letters was primarily a human effort to create appendixes and build out a grid of each provision and which LP it applied to, distilling that mass of information to a summary that clients can reference easily. Today, there are tech-enabled solutions directed at side letter management, and GPs are increasingly using those platforms to make the administration of their obligations easier. We expect that leading players will emerge in this space as part of full-service administrative platforms for private equity (PE) and venture capital managers.

Net asset value (NAV) loans: A growing area of focus

Due in large part to a depressed exit market, NAV loans have gained significant attention as a source of liquidity for PE funds. According to a recent SVB article, the number of funds using NAV loans could grow exponentially within just a few years. Without specific permission in the LPA, however, fund managers often must gain approval to use a NAV loan from their LPs through an LPA amendment.

How are GPs and LPs approaching this issue? Do you find that more LPAs are beginning to discuss NAV loans explicitly?

Jocelyn: Some fund managers want to supplement the debt language in their new funds’ LPAs to do NAV deals explicitly, while others decline to do so, deciding to deal with the additional language down the road. In a harder fundraising environment, LPs generally are not excited about a lot of changes to the LPA from one fund to the next. While there is more acceptance for NAV loans, it remains a “jump ball” whether this language will be included in a buyout fund’s LPA.

Howard: It is certainly true that in the past very few US fund LPAs (outside of credit and secondaries funds) contemplated any borrowing beyond a capital call line. At the beginning of a fund’s life, most GPs don’t know if they will use a NAV facility given uncertainty around future interest rates and exit markets. Starting a couple of years ago, though, some managers began adding NAV borrowing flexibility to their LPAs. However, higher adoption may require greater acceptance in the LP community and a lower interest rate environment.

If you’re a private fund CFO, COO or GP and would like to learn more about the trends discussed above, don’t hesitate to reach out to the SVB Global Fund Banking team.

Acknowledgments

Jocelyn Hirsch is a partner at Kirkland & Ellis LLP whose practice focuses primarily on the representation of private equity sponsors and corporate borrowers in complex financing transactions, including leveraged buyouts, cross-border facilities, asset-based facilities and sponsor capital call/subscription and NAV facilities.

David Lenzi is a corporate partner in Kirkland & Ellis LLP’s New York office, specializing in the representation of private investment fund sponsors.

Howard Beber is a partner in the Corporate Department and co-head of the Private Funds Group at Proskauer. His practice focuses on representing private fund sponsors in all aspects of their business, including fund formation, ongoing operations and internal structuring and compliance.

Ryan Carpenter is a partner in Proskauer’s Private Funds Group whose practice focuses on the representation of private investment fund sponsors and investment advisors operating growth equity, buyout, venture capital, private credit and fund-of-funds and other strategies.