🎉 Happy Friday, funds family!

This is the sixth in a multi-part series on 💼 Negotiating Co-GP Deals. This week, we’re going to discuss how capital providers lock down operators with restrictive covenants and similar agreements.

🔐 Restrictive Covenants in GP Agreements

In contracts generally, restrictive covenants are provisions that prohibit a party from doing something.

In GP agreements, the following restrictive covenants are often negotiated:

• Non-compete: The person with a non-compete can’t directly compete with the GP, management company, fund, or any of their affiliates.

• Non-solicit (investors/employees): The person with a non-solicit can’t try to poach investors or employees from the GP, management company, fund, or any of their affiliates.

• Non-disparagement: The person with a non-disparagement clause can’t talk trash 🗑️ about the other parties after leaving the business.

Restrictive covenants are typically effective during the time a person has an interest in the GP, plus a tail period of anywhere between 6-36 months. We often see tail periods of 12-18 months, but agreements differ.

Typically, the beneficiary of a restrictive covenant can waive it. So if an operator is subject to a non-compete, the capital provider could waive the requirement on a case-by-case basis.

🧮 Pro Rata Rights

Often, capital providers will negotiate pro rata rights in future investment vehicles sponsored by the operator.

Let’s assume that a capital provider is investing $10 million as an LP in the underlying fund ($100 million target) and is also getting 20% of the GP (carry). In such a case, a capital provider might negotiate the following rights:

• Capital provider has the right to invest up to 10% of the capital in any investment vehicle sponsored by the operator for 5 years

• So long as the capital provider invests at least $10 million in each such investment vehicle, the capital provider gets 20% of the GP in respect of each such vehicle

• Capital provider loses this right if they fail to hit the $10 million threshold for two consecutive investment vehicles sponsored by the operator

Capital providers want a piece of everything the sponsor does, in exchange for initially helping the sponsor to launch their investment management business. 🚀 

Co-Investment Rights

In some cases, investment funds might get a juicy allocation to a company…that’s too big for the fund.

For example, let’s say a $50 million VC fund made an $8 million Series A investment. Now the company is doing its Series B round, and the fund has a $20 million allocation. Realistically, a $20 million investment is too big for a $50 million fund.

A common solution is for the GP to form a co-investment SPV to take down some of the allocation. The fund might invest $5 million (either directly in the company or through the co-investment SPV), and the remaining $15 million would be offered to fund LPs to invest directly. In some cases, the $15 million might be offered to other third parties, too.

Capital providers often negotiate preferred co-investment rights, which enable them to get a healthy allocation to these SPVs. Plus, depending on the deal, they might get a reduction (or even a full waiver) of fees and carry in respect of the co-investment SPV. Capital providers love ❣️ fee-free co-investment opportunities. It’s the fastest way to their heart.

⚠️ Note: This newsletter is for informational purposes only and nothing should be considered legal advice. For that, hire a lawyer! I am a lawyer, but not your lawyer (unless I actually am your lawyer because you’ve signed an engagement letter and we’re working together). This newsletter may be considered attorney advertising.