Proskauer: European fund terms evolving

The distribution waterfall, a narrowing between gross and net IRR spreads and disclosure and transparency are among the key terms and conditions driving the GP-LP dynamic, according to the law firm.

Some European general partners are reconsidering the hurdle rate, arguing the low interest rate environment means it should drop below the standard 8 percent, according to research from law firm Proskauer.

While 90 percent of the funds the law firm looked at in its 38-strong sample still set the preferred return at 8 percent, a minority are using alternative approaches. Advent’s latest fund, for example, removes the preferred return and instead takes account of asset values. Another alternative method reduces the hurdle percentage, but also removes GP catch-up.

Alternative waterfall structures are also emerging among European funds, with some funds distributing on a deal by deal basis in a bid to incentivise junior team members, the research found.

“Innovation is more common among newer first-time funds. GPs seeking a change should be prepared to explain [why] as it is still unusual [to vary the distribution waterfall],” Edward Lee, senior associate at Proskauer said.

GPs are also under increased pressure to narrow the gross and net internal rate of return spread, according to the research. To do this, a number have sought to increase borrowing, which puts money to work quicker and reduces capital calls, and reused cash to get closer to 100 percent invested.

Investor views on increased borrowing are mixed, however, with those against it saying it impacts their own allocation, and there is an inherent risk to the increased leverage.

Disclosure and transparency is another area in which investors are becoming more demanding, a trend driven in large part by US Securities and Exchange Commission investigations and large European and US pension plans.

“Allocation of deal expenses and transaction fees between multiple products should be clearly disclosed. If investors in a particular fund may bear more than their proportional share of certain expenses, eg abort costs, disclosure should be clear,” Lee said.

The law firm’s findings are based on 38 predominantly European-focused buyout and/or growth capital funds raised in the past 18 months. Funds range in size from €100 million to €13 billion.