{"id":1276,"date":"2024-09-27T14:48:56","date_gmt":"2024-09-27T14:48:56","guid":{"rendered":"https:\/\/iqeq.com\/gb\/insights\/the-impact-of-the-increased-use-of-side-letters-and-separately-managed-accounts-on-private-equity-cfos\/"},"modified":"2024-10-10T08:50:59","modified_gmt":"2024-10-10T08:50:59","slug":"the-impact-of-the-increased-use-of-side-letters-and-separately-managed-accounts-on-private-equity-cfos","status":"publish","type":"post","link":"https:\/\/iqeq.com\/gb\/insights\/the-impact-of-the-increased-use-of-side-letters-and-separately-managed-accounts-on-private-equity-cfos\/","title":{"rendered":"The impact of the increased use of side letters and separately managed accounts on private equity CFOs"},"content":{"rendered":"
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By Niamh Cheung, Client Services Director, Funds<\/em><\/p>\n

In the current macroeconomic environment, private equity firms are experiencing a significant shift in the balance of power between Limited Partners (LPs) and General Partners (GPs). <\/strong><\/p>\n

This change has led to a rise in the use of side letters and separately managed accounts (SMAs), each of which presents distinct challenges and opportunities for Chief Financial Officers (CFOs) and Chief Operating Officers (COOs) within these firms.<\/p>\n

The relative abundance of capital within sovereign wealth funds (SWF) constituencies gives them significant negotiating leverage. As a result, we\u2019ve seen an increase in the frequency of side letter requests from SWFs, especially in the Gulf Cooperation Council (GCC) region.<\/p>\n

In this article, we\u2019ll discuss the impact of both side letters and SMAs for private equity CFOs.<\/p>\n

1. The increased use of side letters<\/h2>\n

Side letters are agreements between private equity funds and specific investors which are supplemental to the standard terms of the main legal documents of the partnership, granting these investors more favourable terms and rights than those offered to other investors.<\/p>\n

Regulators over the years have made it clear that although there is no restriction on the use of side letters, there is a requirement for transparency. It\u2019s generally accepted that the terms of any side letter shouldn\u2019t attempt to contradict the terms of an LPA or give preferential treatment to individual investors.<\/p>\n

There has been a notable increase in side letter usage since the SEC\u2019s private funds rules were made defunct. This deregulation has allowed LPs to leverage their enhanced negotiating power to secure more customised terms.<\/p>\n

2. The rise in SMAs<\/h2>\n

SMAs are investment structures where a single investor collaborates with a fund manager to create a tailored investment portfolio.<\/p>\n

The proliferation of side letters and SMAs significantly impacts the administrative and back-office functions of private equity firms. CFOs and COOs must handle a higher volume of customised terms and complex reporting requirements, which strains existing administrative systems and necessitates advanced tracking capabilities. Similarly, SMAs, while offering benefits such as tailored investment strategies and better alignment with investor goals, impose additional burdens in terms of reporting and compliance.<\/p>\n

To manage these challenges effectively, CFOs and COOs may consider outsourcing certain functions to alleviate the administrative load, though it\u2019s crucial to ensure that these outsourced services align with the firm’s strategic goals and regulatory requirement.<\/p>\n

Key considerations for CFOs<\/h3>\n