Fund Formation: What is the Market on Terms and Conditions?

Ross Barrett, VC Experts, Inc.

5 minutes to read

Private equity is an asset class that offers potential high returns, somewhat higher risk and diversification from a traditional portfolio of marketable securities. In recognition of these potential benefits, many pension and other funds have adopted investment policies that contemplate an allocation to private equity.

Public and private fund investments have driven a significant amount of the evolution that has occurred in private equity. The range, size and complexity of offerings as well as the number of investors and partnerships have expanded considerably. While the investment merit, reputation and capabilities of general partners are of paramount importance in the decision-making process, private equity contracts have also evolved to become complex agreements and require considerably more attention.

In recognition of the increased complexity in private equity contracts, VC Experts, Houlihan Lokey Howard & Zukin and Thomson Venture Economics have undertaken a survey regarding the best practice and standard operating procedures in five key areas:

  • Fund Formation and Operation
  • Fees and Expenses
  • Distribution and Profit Sharing
  • Performance Returns
  • Corporate Governance of Funds and Portfolio Companies

This survey addresses these topics and is intended to help private equity investors and managers develop best practices to improve the efficiency of private equity investing. Responses were received from 127 firms and individuals, with General Partners representing the majority. However, we also had several attorneys (representing both LPs and GPs) responding. The Survey had a roughly even response rate from VCs and Buyout funds. Those that described their funds as "other" included: "a blend of VC and Buyout", "Secondary Fund", "diversified mix of mezzanine, LBO; growth equity" as well as "Senior, Restructured Debt Fund".

That being said, let's take a look at some of the more interesting data points on (1) time it takes to fund raise, (2) the increase in the GP contribution and (3) the disturbing trend toward defaulting Limited Partners.

Duration of Fundraising

It's taking a bit longer to raise funds. A wide variance can be seen in the total time it has taken to market and close the fund. The results are interesting. Almost two-thirds (64%) of the funds (75 out of 118) were raised in 12 months.

However, more than one out of three (36%) funds took over 12 months to a final closing.

What was the duration of fundraising from start to final closing?

0-3+ months graph 5% 6
4-6+ months graph 17% 20
7-9+ months graph 12% 14
10-12+ months graph 30% 35
13-18 months graph 18% 21
Over 18 months graph 19% 22

Defaulting LPs

43 respondents in this survey (37% of all PE and Venture Funds) have had to deal with a defaulting Limited Partner. Of this, 25 were venture funds and 18 were buyout funds. It is important to note that 54% of the respondents dealt with the defaulting LP through the secondary market and even more interesting that 44% of these sales had more than a 50% discount.


A look behind the data shows some interesting trends. Let's take a look at the size of the buyout funds that experience defaulting LPs.

Average: $797,764,706
Median: $260,000,000
Min: $15,000,000
Max: Over $6,000,000,000

What does this indicate? As larger funds experience defaulting LPs, could it be a leading indicator of a flight toward more quality, institutional LPs--thus making it harder for certain LPs to get into a trophy fund? It could also indicate that LPs are flexing their institutional muscle, and not following on to a fund that has a poor performance to date.

GP Contribution

One of the more interesting data points in this survey is the increase in GP contribution. The majority of funds had GP contribution between one and two percent. It should be noted that 26% of the respondents had GP contributions of over 3 percent.

Buyout Funds. 31% of buyout firms (15 out of 48) had a GP contribution over 3 percent. 22 out of 48 had between 1%-2% GP contribution, with just 11 buyout firms having a GP contribution between 2 and 3 percent.

Venture Funds. 17% of venture firms (9 out of 52) had a GP contribution over 3 percent. 42 out of 52 venture firms had a GP contribution between 1% and 2 percent.

What is the GP contribution, expressed as a percentage?

1% - graph 62% 72
2% - 3% graph 12% 14
Over 3% graph 26% 30

Management Fees

The typical arrangement is for a fund to charge an annual fee of 1.5% to 2.5% of total committed capital. Management fees seldom fall below 1.5%. There are alternatives: budgeted fees are perceived by many LPs to be an improvement over the flat management fee structure. Additionally, scaled fees are also useful for reflecting the higher level of effort by the general partner during the earlier years of the partnership, when the deal-making and due diligence efforts are more intense.

Most funds polled had some sort of scaled fee structure, and due to the varying range of responses we received in the data, it follows that management fee structure remains an area of negotiation. Of those polled, 79% had some sort of fixed fees on committed capital; 17% had sliding scale fees and 4% had budgeted fees. The maximum fee was 2.5% and the minimum was 1.5%.


All this and more is available in the full copy of the report. You will get an instant look at it online, as well as a hard copy.

For a full copy of the report, call Ross Barrett at 212-921-1442 or go to The VC Experts Bookstore or e-mail

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Ross Barrett. This work reflects the law at the time of writing, 2004.