GP/LP Negotiations: Key Terms LPs Push Back On and How to Handle Them
By the time an institutional LP or a sophisticated family office gets to your LPA, they have seen hundreds of them. They know exactly which provisions to push on, which concessions to ask for, and which terms signal that a manager is not ready for institutional capital.
The negotiation between the GP and its LPs is where the real economics and governance of the fund get set. The LPA is the starting point, but the final terms are shaped by the back-and-forth between fund counsel and investor counsel across multiple closings, and increasingly through side letters that layer on bespoke rights for specific LPs.
This article covers the terms that draw the most negotiation heat in fund formation, how managers should think about concessions, and how side letter and most favored nation provisions interact with the broader LP relationship.
Topics covered:
• Management Fee Terms That Draw LP Scrutiny
• Preferred Return, Catch-Up, and Waterfall Mechanics
• Key Person Provisions and GP Removal Rights
• Investment Restrictions and Concentration Limits
• Co-Investment Rights and Allocation
• Side Letters: What LPs Ask For and What You Should Protect
• MFN Provisions: How One Side Letter Can Reshape Your Fund
• Conclusion
1. Management Fee Terms That Draw LP Scrutiny
LPs are not just looking at the headline management fee rate. They are looking at the fee base, the step-down mechanics, and the offsets.
The most common area of pushback is the transition from committed capital to invested capital as the fee base after the investment period ends. Some managers try to hold onto committed capital as the base for the full fund life. Institutional LPs will almost always reject that. The market expectation is that the fee base steps down to invested capital, net invested capital, or NAV once the fund shifts from deployment to harvesting.
Fee offsets are the other flash point. If the GP or its affiliates earn transaction fees, monitoring fees, or directors’ fees from portfolio companies, most LPs expect those fees to offset the management fee, typically at 80% to 100%. Managers who try to retain these fees without offset will face resistance from experienced investors and may signal to the market that their terms are not institutional-grade.
Managers should also expect scrutiny on organizational expense caps. LPs want to know how much of the fund’s capital will go toward formation costs, placement agent fees, and other startup expenses before any dollars are deployed into deals. Caps in the $300,000 to $500,000 range are common for smaller funds. Amounts above the cap are typically borne by the management company, not the fund.
2. Preferred Return, Catch-Up, and Waterfall Mechanics
The distribution waterfall is where GP and LP economics collide. Every term in the waterfall directly affects how much money the manager takes home and when.
A standard four-tier waterfall looks like this:
• First, return of contributed capital to LPs.
• Second, preferred return to LPs, typically 8% compounded annually.
• Third, GP catch-up, where the GP receives distributions until it has received its carried interest percentage (usually 20%) of total profits distributed so far.
• Fourth, residual split, typically 80/20 between LPs and the GP.
Where negotiations get granular:
• Whether the preferred return compounds or accrues on a simple basis. Compounding is more LP-friendly and is market standard for most PE and real estate funds.
• Whether the catch-up is a full 100% catch-up to the GP (meaning the GP receives all distributions in the third tier until parity is reached) or a partial catch-up (such as 80/20 in the catch-up tier). A full catch-up is more GP-friendly, but institutional LPs are generally comfortable with it as long as the preferred return is market.
• Whether the waterfall is calculated on a whole-fund basis or deal-by-deal. Whole-fund waterfalls protect LPs by requiring that losses on bad deals be netted against gains before carry is paid. Deal-by-deal waterfalls let the GP collect carry on individual winners even if the overall fund is underperforming. LPs strongly prefer whole-fund. If you go deal-by-deal, expect to give a robust clawback in return.
• Clawback mechanics. If the GP receives carry early in the fund’s life and later deals underperform, the clawback requires the GP to return excess carry so that the LP’s preferred return is preserved on a cumulative basis. LPs will negotiate the scope, timing, and security around clawback obligations carefully.
3. Key Person Provisions and GP Removal Rights
Key person clauses are not boilerplate. They are governance tools that LPs use to protect against the risk that the individuals they underwrote walk away or become distracted.
A typical key person provision triggers a suspension of the investment period if one or more named principals ceases to devote substantially all of their business time to the fund. During the suspension, the fund cannot make new investments (though it can fund follow-ons and complete deals already in process). If the key person event is not cured within a specified window, typically 90 to 180 days, the investment period terminates.
LPs will push on the definition of what counts as a key person event, the cure period, and whether the suspension is automatic or requires an LP vote. Managers should resist overly broad definitions that could be triggered by temporary absences or reasonable outside activities, but should also understand that a narrow key person clause will not satisfy institutional investors who are betting on a specific team.
GP removal (or "no-fault divorce") provisions give LPs the right to remove the GP by supermajority vote, usually 66.7% to 75% of commitments, without needing to prove cause. These provisions are now standard in institutional funds. The key negotiation points are the vote threshold, whether removal triggers a wind-down or a continuation with a replacement GP, and what happens to the GP’s carry and fee stream upon removal.
4. Investment Restrictions and Concentration Limits
LPs invest in your fund because of a defined strategy. They expect the LPA to hold you to it.
Common restrictions include:
• A cap on the percentage of commitments that can be invested in any single deal (typically 15% to 25%).
• Restrictions on the types of investments the fund can make (for example, no public securities, no lending, no investments outside a defined geography or sector).
• Limits on the use of fund-level leverage.
• Restrictions on recycling (reinvesting proceeds from early exits). LPs will want to cap recycled capital, often at 100% to 125% of total commitments, to prevent the fund from becoming a de facto evergreen vehicle.
Managers sometimes view these restrictions as a nuisance. That is the wrong frame. Well-drafted investment restrictions give your LPs confidence that you will stay disciplined, and they make the fundraising conversation easier. The negotiation is about calibrating the limits so they are tight enough to be meaningful but flexible enough to let you execute your strategy without needing LP consent on every deal.
5. Co-Investment Rights and Allocation
Co-investment rights have become one of the most requested LP terms in the market. LPs want the ability to invest alongside the fund in specific deals, typically on a no-fee, no-carry basis, which lets them increase their exposure to your best opportunities at a lower cost.
From the GP’s perspective, offering co-investment can be a powerful fundraising tool. It lets LPs deploy more capital with you, strengthens the relationship, and can make your fund more competitive against larger platforms.
But the allocation process needs to be thought through carefully. Questions that will come up:
• How are co-investment opportunities allocated among LPs? Is it pro rata based on commitment size, at the GP’s discretion, or rotational?
• What happens if an LP declines a co-invest opportunity? Does that affect future allocations?
• Does the co-invest vehicle bear its pro rata share of broken-deal costs, or only fund-level expenses?
• What are the timing mechanics? LPs need to move quickly on co-investments, and some will need internal approval that takes weeks. If your deal timeline does not accommodate that, the co-invest right becomes theoretical.
Document the co-investment policy clearly in the LPA or in a separate co-investment allocation policy that you can share with investors during diligence.
6. Side Letters: What LPs Ask For and What You Should Protect
Side letters are where the negotiation gets personal. Each institutional LP will submit a side letter request that reflects its own internal policies, regulatory requirements, and bargaining position.
Common side letter requests include:
• Fee discounts or fee waivers, particularly for anchor investors or early close investors.
• Enhanced reporting and transparency rights, including portfolio-level detail, quarterly valuations, and ESG reporting.
• Excuse rights, allowing the LP to opt out of specific investments that conflict with its investment policy (for example, investments in certain industries or geographies).
• Withdrawal or transfer rights beyond what the LPA provides, including secondary transfer pre-approval mechanics.
• Regulatory accommodations, such as ERISA-related representations, FOIA carve-outs for public pension investors, or tax-related structuring commitments for non-U.S. or tax-exempt investors.
• Co-investment priority or guaranteed allocation for specific deal sizes.
Not every request should be granted. Managers need to evaluate each ask against two questions. First, does this concession create an obligation the fund cannot operationally deliver on? Enhanced reporting sounds easy to agree to until you are running four different reporting formats for four different LPs every quarter. Second, does this concession change the economic deal for other LPs, and if so, does your MFN provision require you to extend it to the full investor base?
The strongest position is to maintain a standardized set of side letter terms that you offer to all institutional LPs, with limited deviations for genuinely unique regulatory or structural needs. This reduces negotiation cycles across closings and limits MFN exposure.
7. MFN Provisions: How One Side Letter Can Reshape Your Fund
Most favored nation provisions give LPs the right to elect any term that the fund has granted to another LP in a side letter, subject to certain carve-outs. In practice, the MFN clause is the mechanism that turns every individual side letter negotiation into a fund-wide issue.
Here is where managers get into trouble:
• Granting a fee discount to an early anchor LP, then watching every subsequent LP elect that same discount through the MFN. If the discount was priced as a one-off incentive to get the anchor in, the manager just gave away economics across the entire fund.
• Granting co-investment priority to one LP in a side letter, then having five other LPs elect the same right. Now you have six LPs with "priority" co-invest rights and no clear allocation framework.
• Granting excuse rights to one LP on the basis of a genuine regulatory restriction, then having other LPs elect the same right opportunistically, which effectively gives them a free option to cherry-pick deals.
The fix is structural. Your MFN clause should include carefully drafted carve-outs for:
• Terms that are specific to an LP’s legal, regulatory, or tax status and are not available to LPs that do not share that status.
• Terms that are tied to commitment size thresholds (for example, fee discounts available only to LPs committing above a specified amount).
• Terms relating to the LP’s role as an anchor or seed investor, where the economic concession is consideration for accepting early-close risk or a longer lock-up.
Managers should also build in a process around MFN elections. Set a window after each closing for existing LPs to review newly granted side letter terms and make their elections. This keeps the process orderly and prevents the MFN from being exercised retroactively months or years later.
Above all, think about MFN exposure before you sign the first side letter, not after. Every concession you make should be stress-tested against the question: what happens if every LP in the fund elects this term?
Conclusion
GP/LP negotiations are not just about getting to a signed LPA. They are about building a set of terms that you can live with across the full fund life, that will survive LP counsel scrutiny at every subsequent closing, and that will not unravel through side letters and MFN elections.
The managers who approach this process with a clear view of what they will and will not give up, a well-structured MFN framework, and a consistent side letter posture across closings will close their funds faster and with fewer concessions than those who treat each LP negotiation as a standalone event.
For advice on your LPA negotiations, side letter strategy, or fund terms, contact us. Learn more about our Fund Formation practice here.
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