The article notes that large institutional investors often negotiate for preferential treatment in respect of management fees, carried interest splits, co-investment rights, and advisory committee seats; either due to the absence of a MFN clause or a tiered MFN clause, these preferential rights are not available to smaller investors. The article suggests that this trend is a negative development, with quotes from various participants—portfolio managers and lawyers—relating to transparency or unequal economic terms.

Now, one can approach this situation empirically and normatively.

I’ve seen—and negotiated—many of these rights in my time at Partners Group, which had a fund-of-funds arm that regularly invested in funds ranging from small local funds to large global funds. My observations of the fundraising processes of various private equity, real estate, and infrastructure funds from 2008 to 2014 suggest that almost all institutional investors were likewise negotiating for preferential treatment in side letters, based on the number of side letters that were circulated pursuant to the fund’s MFN clause.

Indeed, I would say that in order for a large institutional investor making a significant capital commitment to a private equity, venture capital, real estate, or infrastructure fund to not negotiate for preferential treatment, it would have to be exceptionally poorly advised.

Fact. Large institutional investors making a significant capital commitment to a fund, competently advised, will negotiate for and obtain some preferential treatment in exchange for their investment in a fund.

Fact. Top tier fund sponsors with excellent track records and new entrants with “cachet” will make the fewest concessions to investors, because they do not need to do so. Their funds are often oversubscribed and an investor that makes too many demands is likely to see its capital commitment reduced or eliminated in favor of more accommodating investors.

Should large institutional investors obtain preferential treatment not obtained by other investors? Should fund sponsors adopt tiered MFN clauses that permit investors to have the benefit only of preferential terms granted to investors that have made capital commitments equal to or less than theirs? That is a different question entirely, a normative question.

Eamon Devlin of MJ Hudson, notes that the adoption of tiered MFN clauses makes it very difficult for investors to understand how good or bad their terms are versus other investors. I do not dispute that fact. I do, however, think that an investor should be less concerned with comparing the terms they have negotiated with a fund sponsor with the terms negotiated by other investors and more concerned with assessing whether the terms they have obtained meet their needs. If, after competent negotiation, the terms offered by a fund sponsor to an investor meets its economic, governance, and informational needs, then the investor has arguably discharged its duties to its beneficial owners to obtain the best possible terms it can, regardless of whether another investor has obtained different terms.

Moreover, investors in a fund are not identically situated. Some investors may have made a larger capital commitment to the fund, and thus be in a position to request a management fee break and/or an advisory committee seat to reflect their larger stake in the fund; while others may have committed capital to the fund at its first closing and have received a management fee break to compensate them for their prompt commitment and support of the fund’s fundraising efforts; and yet others may offer strategic value (networks, industry expertise, etc.) to the fund sponsor that is being rewarded with preferential terms. To the extent that an investor has not made a capital commitment at the first closing or is committing less capital to the fund, offering that investor preferential terms would be unfair to those that have made a capital commitment at the first closing or committed more capital to the fund.

The practice of limiting investors to the preferential terms received by other investors of a similar size is also fair. Terms granted to larger investors reflect the greater bargaining power of that investor, and the fact that it is putting more capital (in absolute terms) at risk in the fund than smaller investors.

In short, I am not convinced that fund sponsors’ practice of offering preferential terms to a subset of investors is going to go away for the foreseeable future, at least until another boom cycle when fund sponsors have sufficient negotiating power to resist such demands. I am also unconvinced that there are strong normative arguments for insisting that all investors should get the same fund terms regardless of the value and capital that they bring to the fund.