Setting the Market Standards (Part 1)
Joseph W. Bartlett, Founder of VC Experts.com
Part 1 of a 4 Part series.
3 and Part
I have spent a number of years negotiating the terms of
commingled, private equity venture capital and buyout investment
vehicles. Distressingly, a large proportion of my time has been taken
up debating whether a given provision is "market," or "industry
standard," the notion being that the "market term should prevail". The
goal of these debates is for one side to bully the opponent into
admitting that the proponent's experience is more extensive. If the
opponent concedes, the discussion is over.
The problem is that discussions of this nature are often a
dispute without end, as one party contests that a certain term is
"standard", while the other side argues it isn't. Moreover, both sets
of lawyers desperately want to win, regardless of the importance of the
point, because a loss concedes that the other lawyer knows more.
Out of a personal desire to derail discussions of this sort in
the future, I have decided to take the bull by the horns. Since I may
be the oldest living active practitioner in this area, I have decided
to declare my version of the 'market standard' for a list of what I
believe to be the next commonly contested terms in the organizational
documents of venture and buyout funds. The list is
free from bias in the sense that I represent both sponsors and
investors on occasion, but neither side in this exercise. Moreover, the
source material I have used goes beyond the anecdotal, and is culled
from personal experience. While all judgments and accompanying
commentary are my own, the 'market standard' list is the product of:
- The controversial Mercer Report, by
- Other third-party information and data.
The following are, in no particular order, numbers 1-5 of the
29 questions and issues I have most frequently encountered in this
context and my view of the 'market standards'.
QUESTION: How long is the term of a
private equity fund?
MARKET STANDARD: The 'market standard' term is
10 years from the date of the initial closing (Note: not from the date
of subsequent closings) plus two (possibly three) one-year extensions
at the option of the general partner, with the extensions often subject
to the approval of the advisory board.
QUESTION: What is 'market standard'
MARKET STANDARD: The 'market standard'
management fee is 2% of committed capital, but this varies based on the
size of the fund. The 2% fee is too small to support smaller funds, and
excessive in larger fund. So, the 'market standard' is 2.5% under $50
million committed capital; 2% from $50 to $400 million committed
capital; and as negotiated above $400 million.
QUESTION: Is the management fee reduced
in the later years?
MARKET STANDARD: The 'market standard' is to
reduce the management fee in the later years, generally starting at the
conclusion of the commitment or investment period, but there is no
'market standard' target fee. The options include measuring the fee in
later years against the fair value of the assets remaining in the
portfolio and/or reducing the management fee in increments from 2% to
1%+, over time. The idea behind the fair value test and other
alternatives is that there is less to do in the later stages of the
fund's lifetime, and therefore the management fee should be lower in
the later years. A companion idea is that the managers have probably
raised another fund during this period, and therefore have other
sources of income. In fact, the commencement of a new fund often
triggers the beginning of management fee reductions.
QUESTION: Is the management fee
increased by a cost of living allowance?
MARKET STANDARD: The 'market standard' is "No",
although that feature is sometimes seen.
QUESTION: How much is the general
partner (GP) required to invest in the fund?
MARKET STANDARD: The 'market standard' is a 1%
investment. This number is a hold over from the days it was universally
felt that the GP had to have a 1% commitment to the capital of the fund
in order to qualify as a partner for tax purposes. There are other
methods of solving that requirement short of an outright commitment of
1% of capital, but the number persists.