Strategies for General Partners (Sponsors) and Limited Partners (Investors)

Negotiation is key when establishing real estate syndications and seeking investment funds. Both the General Partners (GPs or sponsors) and Limited Partners (LPs or investors) need to understand the strategies and tactics that can help them achieve favorable terms. In this article, we will explore various negotiation strategies for both sponsors and investors and provide you with some insightful tips to help you navigate the process effectively.

Key Negotiation Strategies

Negotiating investment funds or syndication documents can be a complex process. Both sponsors and investors need to employ effective strategies to achieve favorable outcomes. Here are some key strategies to consider:

Revising Fund Documents: After the GP creates the initial draft of the fund documents, they share these with potential LPs. At this stage, investors can choose to invest, decline, or negotiate for better terms. If the investors choose to negotiate, sponsors can either revise the terms, stick to their original terms, or enter into side letters with specific LPs.

Utilizing Side Letters: A side letter is a contract between the syndication or GP and a single investor that grants special rights not offered to other LPs. This approach allows sponsors to make targeted adjustments without changing the terms for all investors. Common provisions in side letters include fee reductions, carried interest reductions, and special information rights.

Revising Fund Documents

Changing the terms of the fund documents is a straightforward method of negotiation. For example, if the fund has a management fee of 3% and an investor wants a fee of 2.5%, the GP can revise the documents to reflect this change. However, this adjustment will apply to all investors and may affect the GP’s overall income. This method can simplify the process but may also lead to significant financial changes for the sponsors.

Utilizing Side Letters

Side letters offer a more flexible and targeted approach to negotiation. These agreements allow individual investors to secure specific terms without altering everyone’s fund documents. For instance, a side letter might grant an LP a fee reduction or special rights to transfer their interest to an affiliate. This method is less disruptive and can be tailored to meet the needs of particular investors.

Common Provisions in Side Letters

Some of the common provisions in side letters include:

  • Fee reductions
  • Rights to invest in future funds
  • Carried interest reductions
  • Special tax or regulatory provisions
  • Rights to obtain or have access to special information 
  • Right to be excluded from certain forms of investments
  • Rights to transfer fund interest to an affiliate.

Most-Favored Nations (MFN) Clauses

Most-Favored Nations (MFN) clauses are critical elements in side letters. An investor with an MFN clause can review other investors’ side letters and adopt the best terms. For example, if another investor receives a carried interest reduction from 25% to 20%, the LP with the MFN can claim that reduction too. This provision ensures that no investor gets better terms than the one with the MFN.

Tips for MFNs:

  • For Investors: If you are a significant investor, consider asking for an MFN clause to ensure you receive the best possible terms.
  • For Sponsors: Be cautious when offering side letters with MFN clauses, as later investors with MFNs can claim favorable terms given to earlier investors. Avoid offering multiple MFNs per syndication or fund.

Creating Classes of Limited Partners

Another strategy for sponsors is to create different classes of investors based on their investment size. For example, Class A might include those investing at least $1 million, while Class B includes those investing less. 

Additionally, Class A investors might enjoy benefits like lower carried interest, lower management fees, higher preferred returns, or special information rights. This approach can serve as an incentive to encourage larger investments. It can also be an effective way to attract substantial capital.

Detailed Negotiation Tips for Specific Fund Terms

Here are some specific negotiation tips for various fund terms that can be useful for both sponsors and investors:

Carried Interest and Management Fees

  • For Sponsors: Create different classes of investors with varied fees and returns. Avoid management fee offsets and include a GP catch-up in the distribution waterfall.
  • For Investors: Ask for lower carried interest and management fees through side letters. Negotiate fee offsets for excess expenses. Large investors may request a piece of the carried interest.

Subsequent Closings

  • For Sponsors: Offer fee discounts to early investors and special terms for those who join early.
  • For Investors: Negotiate to waive the “catch-up” interest if investing after the initial closing.

Fund Expenses

  • For Sponsors: Maintain a broad but reasonable list of fund expenses. Keep costs low to return capital and earn carried interest quickly.
  • For Investors: Negotiate the removal of certain fund expenses, like GP salaries and office rent. Include a cap on organizational expenses.

GP Removal

  • For Sponsors: Allow removal only “for cause” or avoid including a removal provision. Require a high percentage of investor votes for removal and narrow the definition of “cause.”
  • For Investors: Include “for cause” and “for any reason” removal provisions. Require a low percentage of votes for removal and broaden the definition of “cause” to include various misconducts.

Co-Investments

  • For Sponsors: Retain discretion over co-investment allocations and set your own fees and carried interest for co-investments.
  • For Investors: Negotiate pro-rata rights for co-investments and seek reduced fees and carried interest for co-investments.

Clawback

  • For Sponsors: Exclude clawback provisions where possible. Avoid personal guarantees for clawbacks and resist other clawback-related demands.
  • For Investors: Insist on including clawback provisions. Require fund principals to guarantee clawbacks personally. Test clawbacks multiple times during the fund’s life and keep some carried interest in escrow before distribution to the sponsor.

Conclusion

Negotiating investment funds and syndication documents requires a strategic approach from both sponsors and investors. By understanding the key terms and employing effective negotiation tactics, both parties can reach favorable agreements that align with their interests. Whether you’re a GP looking to structure your fund or an LP seeking the best terms, these strategies can help you navigate the negotiation process successfully. Remember, effective negotiation is about finding a balance that benefits everyone involved and being willing to compromise when necessary.

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