No GP likes to ask their LPs for more time to deploy capital. When funds aren’t invested in the normal five to six year timeframe, it inevitably raises questions about a manager’s ability to find and source deals. In some cases, it may flag an underlying problem that an extension just won’t solve.
Yet this uncomfortable conversation has been happening much more often lately, as funds closed during the industry’s boom years hit the end of their investment periods. Last week Apax Partners emerged as the latest firm to have sought an extension from LPs; Bridgepoint and Terra Firma are two other notable recent examples.
But requesting an extension doesn’t have to be an ordeal. One US-based LP told PE Manager that he wouldn’t want fund managers investing capital just for the sake of hitting a deadline – especially given the volatility in the markets since the onset of the crisis (which has made valuing assets difficult). Equally, LPs generally prefer to give their chosen GPs more time to strike good deals rather than settling for bad ones. So interests are often aligned on both sides.
What really makes an extension request less painful, however, is preparation.
Typically, GPs look to commit 80 to 85 percent of committed capital before an investment period expires, with the remaining 15 to 20 percent reserved for expenses, bolt-on acquisitions or follow-on investment in existing portfolio companies. So the best-prepared GPs closely monitor how much capital needs to be spent years out from the investment deadline, to see whether they’re on track to meet that threshold – and adjust accordingly if not. If the timetable seems off, LP advisory committees can be briefed on the reasons for deal flow being slow and the types of transactions on the horizon.
GPs further along the due diligence process for new deals are better suited to seek investment period extensions, advisors add. The typical LPA allows GPs to complete deals already in process post-investment period – but the wording is often vague enough to include deals a GP has just started kicking the tires on, all the way through to deals where a memorandum of understanding has been signed. It’s the deals closer to completion that investors like to see, though; they are easier to review and provide LPs with a greater sense of certainty about future capital calls, which is important for portfolio management purposes.
Another strategy is to offer LPs sweeteners in exchange for an extension. Private funds lawyer Shukie Grossman, co-head of Weil, Gotshal & Manges’ US private funds practice, says many firms concede lower management fees during the extension period (and sometimes thereafter) in return for more time. Quite rightly, that often means investors begin paying fees based on invested, not committed, capital. Modifications to the carry waterfall can also be an option, Grossman says. Another possibility is to offer LPs equally good (or possibly even better) terms to roll over their remaining commitments to a successor fund.
Care is required, however. Most GPs typically test the waters for an investment extension with the fund’s biggest LPs first. With their support, the thinking goes, enough momentum can be created to bring other LPs on board. It’s a logical strategy, but it’s worth thinking about how the smaller LPs will feel if they only find out at a later stage. No LP wants to be in the dark about important issues like this. So in some scenarios – and particularly for funds with a relatively small LP base, say less than a dozen or so – a GP may be better off speaking to everyone at the same time.
There’s no single formula for GPs to follow when requesting an investment extension. The right approach will depend on the particular circumstances; and as these examples show, a lot of different tactics are currently being used. But preparation is the key: GPs who have given due consideration to all the available options – including the less orthodox ones – and kept their investor base well informed throughout are the most likely to succeed. LPs are amenable to extension requests at the moment – as long as they’re comfortable with the rationale and the future exit strategy. Because if the advisor needs to ask for another extension one or two years down the line, that’s when things can get really awkward.