A two-year extension looks like a formality. Priced against the NAV still in the fund, with carry on any further gain, it sets the return the last assets have to earn.
An extension costs the LPs the management fee and fund expenses charged in the extra years, measured against the NAV still in the fund. On an illustrative fund with 120 of NAV and 100 of invested cost left at the end of year 10, two one-year extensions at 1.5 per cent on cost plus 0.5 a year of expenses cost 4.00, or 3.33 per cent of the remaining NAV. To leave the LPs with a 10 per cent return after those costs and 20 per cent carry, the last assets have to grow 13.83 per cent a year.
Worked in full in How to Read a Limited Partnership Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Almost every private equity LPA allows the term to be extended, usually by one or two one-year periods. The clause is often read for who decides. It should be read just as hard for what the fee is during the extension, because on a fund with a small tail the fee is no longer small relative to what is left.
| Input | Value |
|---|---|
| Commitments | 500 |
| Remaining NAV | 120 |
| Invested cost of remaining holdings | 100 |
| Extension | 2 × one year |
| Fee during extension, on invested cost | 1.5% |
| Fund expenses a year | 0.5 |
| Carry (fund already past its catch-up) | 20% |
| LPs' required return on capital left in | 10% |
Extension cost = (fee rate × fee base + expenses) × years
= (1.5% × 100 + 0.5) × 2 = 2.00 × 2 = 4.00
That is 1.67 per cent of NAV a year and 3.33 per cent over two years. Against commitments it is only 0.80 per cent, which is how it gets presented, and why it gets waved through.
The first hurdle is plain break-even: the assets must grow enough to pay for the extra years before they earn anything. (120 + 4.00) ÷ 120, spread over two years, is 1.65 per cent a year. Below that, every month of extension leaves the LPs with less than a sale at NAV today would have.
Break-even is the wrong benchmark, because the LPs' money has a cost and the GP takes carry on any further gain. Work backwards from what the LPs need.
LP target = 120 × 1.102 = 145.20, a gain of 25.20
Gross gain needed = 25.20 ÷ (1 − 20%) = 31.50 after fees and expenses
Exit value needed = 120 + 4.00 + 31.50 = 155.50
Required growth = (155.50 ÷ 120)1/2 − 1 = 13.83 per cent a year
In Excel, with NAV in B1, cost of the extension in B2, carry in B3, the LP rate in B4 and years in B5: =((B1+B2+(B1*(1+B4)^B5-B1)/(1-B3))/B1)^(1/B5)-1.
Without any fee or expense, the same target needs 151.50 and 12.36 per cent a year. The extension's costs add 1.47 points to the growth hurdle of assets that, by definition, are the ones the manager could not sell on schedule.
The clause is negotiable, and the base matters as much as the rate. Same fund, same two years, same expenses:
| Fee during extension | Annual fee | Two-year cost | % of NAV | Break-even growth | Growth for LP 10% |
|---|---|---|---|---|---|
| 1.5% on invested cost | 1.50 | 4.00 | 3.33% | 1.65% | 13.83% |
| 1.0% on invested cost | 1.00 | 3.00 | 2.50% | 1.24% | 13.47% |
| 0.75% on invested cost (fee halved) | 0.75 | 2.50 | 2.08% | 1.04% | 13.28% |
| 1.5% on NAV | 1.80 | 4.60 | 3.83% | 1.90% | 14.05% |
| No fee (expenses only) | 0.00 | 1.00 | 0.83% | 0.42% | 12.73% |
| 1.5% on commitments (silent clause) | 7.50 | 16.00 | 13.33% | 6.46% | 18.15% |
The last row is the drafting trap. If the extension clause does not set its own fee and the fee clause falls back to commitments, 1.5 per cent of 500 is charged on a fund with 120 left: 16.00 over two years, 13.33 per cent of NAV. Check that the post-investment-period base, worked in how the management fee is calculated after the investment period, explicitly survives into any extension.
Price an extension as fees and expenses over the extra years, divided by the NAV that is left, then solve for the growth the LPs need after carry. Here two years cost 4.00, 3.33 per cent of NAV, and set a 13.83 per cent growth hurdle; a silent fee clause can make it 18.15. How to Read a Limited Partnership Agreement works the fee clause line by line through the fund's life, and the free workbook for this case computes the fee total from your own rates, bases and step-down.
It depends on the LPA, which is the point of reading the clause. Common outcomes are the post-investment-period fee continuing on invested cost, a reduced rate, or no fee. On 100 of invested cost, 1.5 per cent costs 1.50 a year, 1.0 per cent costs 1.00, and a clause that is silent and falls back to commitments of 500 can cost 7.50 a year.
The LPA decides. Typical drafting lets the GP extend once or twice by one year at its discretion, then requires consent of the advisory committee or a majority in interest of LPs. Investors should read the consent level together with the fee clause: a GP-discretion extension at a full fee of 1.5 per cent on cost costs 3.33 per cent of a 120 NAV over two years.
Enough to pay the extension's fees and expenses, the GP's carry on the gain, and the LP's own required return. With 120 of NAV, 4.00 of costs over two years, 20 per cent carry and a 10 per cent LP target, the assets must reach 155.50, or grow 13.83 per cent a year, against 12.36 per cent with no fees or expenses.
This article is one calculation from How to Read a Limited Partnership Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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