The percentage is what gets negotiated; the definition of invested underneath it moves the date by more than a year.
It depends on what the agreement counts as "invested". On an illustrative 500 fund with a 75 per cent successor fund test, counting only closed investments lets the manager raise its next fund after 4.00 years, when 80.0 per cent is invested. Counting fees, follow-on reserves and signed deals as well moves that date to 2.75 years, when only 51.0 per cent is actually invested and 212.0 of the investors' commitments is neither invested nor spent on fees. Same fund, same pace of deals, fifteen months apart.
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 →
Most limited partnership agreements stop the manager from raising a successor fund until the current one is substantially invested, usually expressed as a percentage of commitments, or until the investment period ends. The clause exists to keep the team's attention, and its deal flow, on the investors who are already committed. The percentage is what gets negotiated. The definition underneath it does more of the work.
| Input | Value |
|---|---|
| Commitments | 500 |
| Successor fund test | 75% of commitments = 375 |
| Investment period | 5 years, 20 quarters |
| Management fee | 2.0% of commitments, 2.50 a quarter |
| Fund expenses | 0.5 a quarter |
| New deals | 15 to 45 each, in 14 of the 20 quarters, 470 in all |
| Follow-on reserve | 20% of cost invested |
| Signing to closing | one quarter |
Four common drafts, each adding one item to the measure the clause compares with 375:
Measure = invested cost [+ fees and expenses paid] [+ reserves for follow-ons] [+ amounts committed under signed agreements]
At quarter 11, for example: 255.0 invested, 33.0 of fees and expenses, 51.0 of reserves and 40.0 signed for the deal closing next quarter. The narrow measure is 255.0; the broadest is 379.0, which clears the 375 bar.
In Excel, keep one cumulative column per item and test each draft with =MATCH(TRUE,INDEX(Measure>=0.75*Commitments,0),0) to return the first quarter that passes.
| Quarter | Invested | + Fees and expenses | + Reserves | + Signed |
|---|---|---|---|---|
| 8 | 185.0 | 209.0 | 246.0 | 246.0 |
| 10 | 225.0 | 255.0 | 300.0 | 330.0 |
| 11 | 255.0 | 288.0 | 339.0 | 379.0 |
| 12 | 295.0 | 331.0 | 390.0 | 390.0 |
| 14 | 335.0 | 377.0 | 444.0 | 474.0 |
| 16 | 400.0 | 448.0 | 528.0 | 528.0 |
| 20 | 470.0 | 530.0 | 624.0 | 624.0 |
| Definition of "invested" | Passes in quarter | Year | Actually invested | Still to invest or spend on fees |
|---|---|---|---|---|
| Closed investments only | 16 | 4.00 | 80.0% | 52.0 |
| + fees and expenses | 14 | 3.50 | 67.0% | 123.0 |
| + follow-on reserves | 12 | 3.00 | 59.0% | 169.0 |
| + signed, not yet closed | 11 | 2.75 | 51.0% | 212.0 |
Under the broadest draft the manager can launch its next fund with 42.4 per cent of this fund's commitments still to be deployed, and spend the remaining two and a quarter years of the investment period investing them while marketing to new investors. Under the narrow draft it waits until only 52.0, 10.4 per cent, is left.
Each addition has a defensible logic. Fees are spent commitments. Reserves are money the fund will need for companies it already owns. A signed deal is as good as done. But the reserves line has no natural ceiling: at 20 per cent of cost it reaches 94.0 by the end of the period, and an uncapped reserve lets the measure exceed commitments altogether, as the 624.0 in the last row shows. If reserves count, they should be capped and evidenced company by company.
| Threshold | Invested only | + Fees | + Reserves | + Signed |
|---|---|---|---|---|
| 70% (350) | 15 | 14 | 12 | 11 |
| 75% (375) | 16 | 14 | 12 | 11 |
| 80% (400) | 16 | 15 | 14 | 13 |
Winning the threshold from 70 to 80 per cent buys investors at most two quarters on any one draft. Moving the definition from the broadest to the narrowest buys five. An investor with one point to spend in this clause should spend it on the definition.
What the test does not catch. A successor fund clause controls when the manager may hold a first close, not when it may start marketing. Check whether the agreement also restricts pre-marketing, and whether the advisory committee can waive the test, because a waiver at 60 per cent is a common request.
Reading "75 per cent invested" as 75 per cent in companies. Under a broad draft that includes fees, reserves and committed amounts, that reading overstates deployment by 24.8 points at the moment the test is passed. The fee side of the same arithmetic is in how much a 2 per cent management fee costs over a fund's life, and the cost of the term running long in how much a fund term extension costs the LPs.
A successor fund test is a definition with a number attached. Here the same 75 per cent test passes after 4.00 years on invested capital and after 2.75 years with fees, reserves and signed deals counted, when half the fund is still to be invested. The working documents for the book include the map of the agreement's dates and numbers, which is where this test belongs alongside the investment period and the term.
A clause that stops the manager holding a first close of a new fund until the current one is substantially invested, often 70 to 80 per cent of commitments, or its investment period ends. On an illustrative 500 fund, a 75 per cent test means a measure of 375, and when it is reached depends on what the measure counts.
Only if the agreement says so, and if they do they should be capped. In the illustrative case counting a 20 per cent reserve moves the pass date from quarter 14 to quarter 12, and by the end of the investment period an uncapped reserve takes the measure to 624.0 against commitments of 500.
The definition. On the illustrative fund, moving the threshold from 70 to 80 per cent delays the pass date by at most two quarters on any one draft, while moving from the broadest definition to closed investments only delays it by five, from quarter 11 to quarter 16.
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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