How COVID-19 Could Affect Private Capital Fund Terms

Analyzing GFC-era shifts in fund terms suggests that the balance of power could tip toward LPs

In recent years, fund managers have had the upper hand in setting fund terms favorable to GPs over LPs. Following the 2008-2009 Global Financial Crisis (GFC), yield-hungry investors poured large sums into private capital funds, helping to drive total assets under management to $6.96tn as of September 2019. This search for yield tipped the balance of power toward fund managers.

But in the wake of COVID-19, the global economic outlook is grim. Earlier this month, the International Monetary Fund indicated that it could revise down its April forecast for a 3% drop in global real GDP – already the most marked decline in growth since the Great Depression. Businesses were shut and consumers stayed home as governments across the world implemented mass quarantines. In private markets, fundraising has begun to slow, and investors are cautious. Could the GP-LP balance of power start to shift toward investors as a result?

Ahead of the launch of The 2020 Preqin Private Capital Fund Terms Advisor, we take a look back at GFC-era data. Using the 2009 edition of the Fund Terms Advisor, we analyze how the GFC affected fund terms then – and what that could mean for fund terms today.

How the GFC Altered Fund Terms
The GFC created a tough environment for fundraising. Although many investors faced liquidity issues, some were able to secure more favorable fund terms in this climate. The few LPs with fresh capital to commit found themselves in a stronger position to negotiate fund terms and conditions in their favor. And some fund managers were able to compete for this investor capital by offering more LP-friendly terms and conditions.

In a survey of private equity investors we conducted back in 2009, the largest proportion (43%) of respondents told us they had witnessed a shift in the balance of power in favor of the LP following the GFC. In contrast, only 2% said that negotiating power had swung more toward the GP.

One of the main changes to fund term dynamics that investors observed after the GFC was the rate of management fees charged by GPs. For buyout funds raising capital, the average management fee had been stable at around 2% for several years, but fell by around 20 basis points for funds raising in 2009 to just over 1.8%. What’s more, the largest funds made the most significant cuts to their management fees. Among buyout funds of $1bn or more in size, those of vintage 2009 and/or raising at the time dropped the average management fee by 25 basis points compared to funds of a 2008 vintage.

How COVID-19 Could Affect Terms & Conditions in 2020
Preqin data suggests that COVID-19 has had a negative impact on fundraising. In Q1 2020 the number of private equity & venture capital funds closed fell 27% on Q1 2019 to 267 – one of the lowest quarterly totals in recent years. And in private real estate, the amount of capital secured fell by about 65% to $18bn. What’s more, among alternatives investors we surveyed in April 2020, 59% said they plan to make fewer commitments to alternatives in 2020 as a result of COVID-19.

Given current market conditions, fund managers may again look to attract investors by offering more LP-friendly terms and conditions. This includes lowering management fees. The mean management fee for buyout funds has consistently risen between vintages 2015 (1.84%) and 2019 (1.99%), Preqin data shows. True, investors are still on the hunt for yield. And interest rates are unlikely to rise anytime soon. But from an LP perspective, the time to negotiate better terms might well be now.

Stay tuned for the launch of The 2020 Preqin Private Capital Fund Terms Advisor, the definitive guide to fund terms & conditions in the private capital industry. For more information or to register your interest, contact us at info@preqin.com.

For more insights and analysis on the impact of the pandemic on alternative assets, take a look at our COVID-19 Knowledge Hub.