|Deal-by-Deal Distribution of Proceeds||A GP earns carry related to the specific deal for which distributions are being made, as long as LPs have received back their contributions made with respect to investments realized up to that point in time, and commonly also contributions made with respect to any write-down amounts on unrealized investments, as well as expenses attributable to both (plus any specified preferred return).|
|Earn-out Clause||An agreement included within a secondary transaction that protects the interests of the seller. The pricing of the offering is directly related to the future performance of the underlying funds and can be structured, mainly, in two ways:|
1. A minimum price can be agreed and paid in full, with the buyer agreeing to make further regular payments based on the performance of the funds.
2. A buyer can purchase a portion of the offering, with the remainder purchased at a later date when the price can more easily be calculated by taking into account the performance of the underlying funds.
|Fee Rebates to LPs||Common practice for funds to provide corporate finance and other services to the portfolio companies/assets that they own, and to charge for these services. These fees can be significant, often amounting to 1.0-1.5% of the value of companies acquired. In addition, the firms will charge monitoring fees and directors’ fees to the companies in the portfolio. It used to be common for managers to retain these fees, but now all or a significant proportion are rebated to investors in the fund, often offsetting against the management fee.|
|Fund Formation Costs/Organizational Expenses||Most partnership agreements make a provision for the costs of setting up the fund to be borne by the fund itself (as opposed to being an expense for the GP), up to a stated amount. Allowable costs generally rise with fund size. Placement fees are generally explicitly excluded from the costs to be borne by the fund, as these are the responsibility of the GP.|
|GP Carry||GPs managing most private funds earn a share of the net investment gains from the fund through the carry, which can be structured in two principal ways: on a deal-by-deal basis or on a whole fund basis.|
|GP Catch-up Rate||Once the hurdle rate has been met, the GP catch-up rate is the proportion of subsequent gains that are allocated to the GP until the GP has caught up to its predetermined share of overall profits. For example, a GP catch-up rate of 100% would mean that after investors had received all the returns up to the hurdle rate, the GP would then receive all gains thereafter until its overall share of all gains reached the stated rate of carry.|
|GP Commitment||The GP managing a fund generally makes a financial commitment to the vehicle on the same basis as the LPs in the fund, and this is seen as an important factor driving the alignment of GP and LP interests.|
|Hurdle Rate/Preferred Return||The level of return that must be achieved by the GP before they are able to claim carry.|
|Key-Man Provision||Key-man provisions or key-man clauses are an important non-economic governance factor for funds. The clause gives LPs the opportunity to terminate the fund’s investment period and/or appoint a new GP to manage the fund in the event that specified provisions are not met by the GP, including the number of original principals of the managing firm or the amount of time they have spent managing the fund.|
|LP Advisory Committee||The majority of funds have LP advisory committees, and include provisions for investors to be appointed to the board by the GP, with a majority of investors being independent of the fund manager. The membership of these committees tends to increase with fund size.|
|Investment Period Management Fee||Management fees during the investment period are almost invariably calculated as a percentage fee applied to the commitments made by the LP to the fund. The logic behind this is that the primary determinant of the workload for the GP is the search for potential investments, and this is driven by the size of total commitments to the fund, and not the actual amount invested at this stage in the fund’s lifetime.|
|Post-Investment Period Management Fee||Almost all funds base their management fees during the investment period on a percentage fee rate multiplied by the LP’s commitment to the fund. The investment period is generally the costliest period for managing the fund, due to the workload of finding and acquiring investments, and the management fees reflect this. Fees for most funds are reduced after the investment period, and the reduction can be effected through a range of mechanisms including a step-change in the percentage rate charged, an annual reduction in the rate charged, and/or changing the asset base for fee charging from commitments to the cost basis of the unrealized portfolio.|
|Minimum LP Commitment||Most funds impose restrictions on the minimum commitment that LPs can make to the fund. As might be expected, the minimum required size tends to be larger for funds targeting larger amounts of total capital.|
|No-Fault Divorce Clause||Funds have always had provisions for terminating the investment period and/or appointing a new GP to manage the fund in the event that the GP is guilty of gross misconduct or breaches material provisions of the partnership agreement. However, in a development aimed at improving governance and security for LPs, an increasing proportion of funds now have so-called no-fault divorce provisions, whereby a stated supermajority of LPs can elect to make these changes without cause. These provisions appeared during the late 1990s, and have now become an industry standard, with almost all funds now having a no-fault divorce clause included.|