Three items are top of mind for European LPs in 2025 as they assess their ongoing relationships with private equity managers: i) improving terms and conditions, ii) alignment of interests and iii) GP transparency.
Arguably, the last few years have put LPs in a stronger position to negotiate terms given the slower pace of fundraising and the fact fewer GPs have been able to hit their first fund close targets. Pressure to return capital and exit portfolio companies is also a key factor as LPs look for favourable terms. This contrasts to the previous decade, where a more benign fundraising environment shifted the balance of power to GPs whose funds became oversubscribed.
In the current evolving environment, LPs are keen to set expectations that determine which managers will continue to attract capital going forward.
LPs now require detailed and candid information about fund performance, strategy execution, and the use of leverage in portfolio management. The scrutiny of fund economics and governance has intensified, with negotiation efforts centered more on governance structures and alignment of interests than just headline fee reductions.
This increased leverage is most evident in key areas of the Limited Partner Agreement (LPA). LPs are successfully pushing for more favourable fee structures, particularly concerning management fees and carried interest. Another critical point of negotiation is the strengthening of "key person" clauses, which provide LPs with greater protection in the event of key personnel departing from the fund manager.
Beyond economic terms, LPs are also focusing on improved governance provisions, including more robust succession planning.
First close fund economics
Ultimately, economics remain the key focus as LPs, especially at first close, look for ways to improve fund terms with GPs.
If GPs don't provide improved terms, some LPs like Bpifrance might immediately ask for a rebate on management fees and a much higher equivalent fee rate.
“Nowadays more LPs are less willing to invest in the first closing of a fund and this is due to several reasons such as budget constraints linked to distribution shortages,” comments Remi Berteloot, Managing Director, Head of Small Cap Funds Investments, Bpifrance.
“GPs need to rethink better terms to welcome LPs at first close, such as a rebate on the management fees of first closers, or a higher equivalent fee rate (EFR) because now we see subscription periods are, in general, longer than they were before. LPs’ positions where they want to wait till the final close is creating frustrations for some GPs but also for some LPs too. If everyone shared that rationale there would never be a first close.”
The equivalent fee rate represents the all-in cost of a private equity investment as a simple annual percentage. It combines management fees, carried interest, and expenses into one figure, adjusted for how long the money is actually invested.
Bpifrance is the French Sovereign Fund. Its goal is to favour the growth of the French economy by helping entrepreneurs thrive. Within private equity, Bpifrance invests in start-ups, SMEs and mid-cap companies through over 1,000 direct investments and 400 partner funds. It also operates a Europe-leading fund of funds investment vehicle.
Alignment of interests
Two key points remain firmly on the radar screen for LPs in relation to alignment of interests. One is the strengthening of key person clauses, which provide LPs with greater protection in the event of key personnel departing from the fund manager. Second is the size of the GP commitment, in terms of salary, bonus, dividends and the amount of carry that each of the general partners have achieved with their prior employer.
It is hard to put an exact figure on what the size of the GP’s commitment ought to be. It is largely down to common sense. Someone who earned significant carry at their prior organisation would be expected to make a strong commitment in fund one, and thereby underscore how much they value LP alignment. In other situations, a moderate performance in the first fund may mean the GP earned some carry but did not commit anything in fund two.
LPs are therefore looking to gather global information on the net worth of general partners as part of their due diligence approach.
“It’s not a new topic as such information is requested as part of due diligence package. This is something we look at carefully to ensure that we have a proper alignment of interests. A global analysis is made in order to determine what is the appropriate GP commitment for the fund and the LPs. Usually GPs put the minimum requirement in carry share alongside the fund and use a different type of shares, such as ‘no fee, no carry’ among others, into the fund to increase their commitment into the funds to ensure a right alignment of interest negotiated by the LPs.” observes Berteloot.
Another factor in protecting alignment of interests relates to LP diversification in the fund; that is, ensuring the GP is focused on diversifying the LP base and not relying too much on a small number of investors.
Family offices and HNW individuals are a big focus of this diversification. Due to the slow fundraising environment, the minimum fund size has fallen to less than 50% of the GP’s target size. LPs are paying close attention to this as they want to guard against the GP remaining in a disappointing fundraising cycle, leading to unnecessary concentration risk in the fund.
“Previously the market standard was to have around 50% of the target fund size to start to execute and invest the fund. As fundraising is taking longer, in order to avoid being out of the market GPs are asking to start deploying capital with a median fund size lower than 50%,” says Berteloot.
US managers get closer to their LPs
Transparency on fund expenses, fund performance and the overall quality of reported data being shared continues to leave investors wanting more. Technology has certainly helped elevate reporting in recent years but there is a lack of consistency from GP to GP. Berteloot describes instances where sometimes reports are not of an expected standard, with GPs not providing information sufficiently in advance. This can, over time, erode trust and hinder GPs’ ability to secure re-ups in future funds.
It doesn’t help that there are so many GPs in the marketplace. In the US, there are more PE fund managers than McDonald’s franchises.
“If you want to continue to have a good commercial relationship with LPs, you need to be transparent, not only in terms of data, but also in terms of the life of the fund to create a real partnership between LPs and GPs, if there is anything going on also within the team, etc. In order to achieve better transparency in the PE ecosystem, we believe that management fees shall be better used not only to reinforce the investment team but also admin, ESG or IR functions to take care of their LPs. Today such functions are keys to build a strong team and generate greater returns. The objective of the management fees is not only to generate dividends for the management company.
“My overall impression is that in the US, in general, the commercial approach is much stronger than in Europe. US firms are very keen on taking care of LPs, whereas in Europe there is a bit more distance between GPs and LPs. But this is maybe more cultural than anything else,” concludes Berteloot.