Back in October, the British Private Equity & Venture Capital Association (BVCA) unveiled its latest set of standardized deal documents for early stage venture capital investors. GPs and their legal advisors could capture a number of benefits if the standard takes off, chiefly a reduction in the time and expense needed when drafting transaction documents.
The end goal for the BVCA is for these templates to become so widely used throughout the industry that fund managers and lawyers are immediately familiar with common commercial terms under negotiation. No more wasting time on reviewing standard legal terms written in clumsy (or overly clever) language.
It’s worth noting that the BVCA’s European counterpart, the European Private Equity & Venture Capital Association (EVCA), sees value in the project as well. The EVCA will be discussing a similar initiative in its member committees, but as yet it remains undecided on producing such documents at a European level.
The million-dollar question though is: will GPs use them? On first blush, it’s hard to think of a reason why they wouldn’t, considering the benefits standardization here offers.
“Whether these initiatives succeed will depend on whether enough market participants are willing to accept and use the templates,” a client memo from law firm King & Wood Mallesons said when the template was released. But it went on to add: “No doubt some will feel wedded to their own tried and tested documents.”
Legal advisors speaking to pfm echo the latter sentiment and say that most of the industry will likely continue writing their own custom legal terms. That may not be surprising to hear, considering lawyers may lose billing hours if standardization happens; but it’s also industry lawyers who are sitting on industry trade body technical committees to push this agenda forward. The win for them is a marketing opportunity. It’s easier to win business from new clients and emerging market managers who use the documents as a starting point and seek counsel on more sophisticated negotiations from there. The trump card though may be that GPs themselves tell us they have limited interest in standardization, for reasons discussed below.
Indeed, most people seem to agree that standardization could only realistically be achieved, at least for now, at the smaller end of the market – which sources peg as GPs with less than or around $500 million in assets under management (AUM).
The BVCA however “looks after a very large number of fund managers who do lots of different things,” says Kiran Sharma, corporate partner at law firm Ropes & Gray. That makes it difficult to appeal to all firm sizes at once.
At the lower end of the market, there appears to be greater hope that standardization will one day be a reality, and maybe even eventually work its way up the food chain. Smaller firms are more cost-sensitive meaning there’s less appetite for heavily negotiated legal documents that can rack up lawyer fees, sources mention.
“The more valuable the transaction or the fund, the less likely it is to be standardized because people are going to be concerned that their particular point of view is reflected,” elaborates one fund formation lawyer. “That is the problem you find in relation to standardization: everybody would probably agree that it is a good idea, but only if the standard reflects their views.”
Larger managers also care less about cost savings because they often charge such legal expenses to the fund, says Anand Damodaran, a funds partner at Ropes.
“Many private fund managers believe that the primary disadvantage of standardization – which is a lack of flexibility to cater for the unique traits of their organizations – considerably outweighs its principal advantages,” says Damodaran, who says that the main advantage is the reduction in time and cost during negotiations, particularly when fund establishment costs are (up to a pre-agreed cap) typically borne by the funds themselves.
History on your side
Age (and some psychology) also appears to be a factor in the debate for standardization. Older fund managers use legal documents built upon years of negotiation and evolution, meaning a new standard would wipe all that history and hard work away. The firm’s administrative team may also be perturbed at having to work off two different sets of documents, says one UK-based private equity CFO. They too have a certain kind of history with the firm’s tried and true legal documents, meaning any new standard would come with a learning curve.
Sources point to confidentiality agreements as a prime example of where standardization seems possible until certain, hidden snags appear. In August, the BVCA put out a standard confidentiality agreement for consideration, one that provided buyers and sellers a “middle ground” starting point with scope for tailoring, the group said. But not everyone agreed on how useful they were in practice.
“For a lot of those sophisticated funds the deals can be very complex, for instance a take-private. In that instance your confidentiality agreement is going to look completely different to the BVCA template,” said one UK-based corporate lawyer. “We do confidentiality documents; and again we see clients with their own specific preferred agreement terms and wording.”
First time managers seem more open to standardization. For one, because they aren’t turning the clock back on entrenched practices; but also because a standard has marketing advantages with investors, according to sources. By using a template, investors know in advance what to expect.
There does, however, seem to be a thirst amongst all manager types, of all sizes, for standardized documents that don’t typically undergo much negotiation.
“Because of the many different ways corporate transactions can be structured, there are not many opportunities to simply pull a form off the shelf and use without some substantial tailoring,” says Sharma. “[But] a due diligence checklist is one example of a document which can be used in a pretty standardized way.”
Documents that are being thrown up due to regulatory change are also ripe for standardization, says Damodaran. “Increasingly prescriptive legislation in the private funds space – such as the AIFMD and its depository requirements – may over time result in fairly similar looking ancillary service provider agreements.”
Taken together, market sources say the work of industry trade bodies on standardization is important, and that wins are to be had at the smaller end of the market. Moreover, standardization for certain regulatory forms, and documents that require little negotiation are important starting points. Less certain is their pick-up at the larger end of the market, where GPs are less persuaded by cost concerns and demand tailored legal treatment. But each time their lawyers spend unnecessary hours debating the minutia of terms in a fairly typical confidentiality agreement, expect this crowd too to consider more the appeal of greater standardization here.