The downside to American private equity-style 'interim' bonus payments at investment funds is being graphically demonstrated in a hushed-up case involving London-based real estate company, Tristan Capital Partners. It might even make professionals question signing such performance-related contracts.
A group of as many as 20 people including past employees of Tristan and AEW Europe are being pursued by Tristan for repayment of bonuses they received more than 10 years ago for successful transactions on behalf of a fund co-managed by the two firms called European Property Investors Special Opportunities (EPISO) fund.
Sources indicate that the 20 people started to receive the demand at the end of the 2023 and the start of 2024. The size of 'clawbacks' of bonuses already paid out range from very significant amounts of money to as little as €1,700. Some people have paid up, while others are said to be resisting, with the issue set to proceed to a group arbitration court hearing in the US.
EPISO was an opportunistic real estate fund raised in 2008. Investors backed it with €788 mln of equity seeking to make profits from attractively priced real estate in dislocated European markets with a 'buy it, fix it, sell it' strategy.
The fund started out making successful investments by buying cheap. Records also show divestments started quickly from 2010 onwards. However, it seems early wins did not translate to the successful performance of the 10-year fund in terms of hitting the hurdle rate upon final liquidation, hence the clawbacks.
Historically, the 'deal-by-deal waterfall' bonus payment model has been known in the market as the 'US waterfall'. In contrast, the European approach has typically been to follow what is known as the 'whole fund' waterfall model in which bonus payments are only paid once the whole fund is liquidated.
That said, some European private equity real estate firms such as Tristan Capital opted in the past for the American-style model in order to motivate and incentivise staff to the maximum.
Interim bonus agreements between a general partner (the fund manager) and senior staff on a fund will set out several important factors such as hurdle rates that investments need to clear in order to trigger a bonus to be paid out. The legal documents will also provide for what happens should ultimately the whole fund miss its return target. In such a situation, investors in the fund need to be 'made whole' and this can be done by the use of clawbacks – literally taking back payments already made to people.
Such a model will also typically use escrow accounts. This means the person may receive into their personal bank account only a portion of their interim bonus. The other portion will be held in escrow only to be released once the fund is fully liquidated, provided no clawback is necessary. If limited partners in the fund are to be made whole, escrow accounts will be used in the first place to recompense them, and if still not enough, then direct demands will be made of people that received money into their own account.
Tristan declined to comment on the matter, but it has been suggested it stopped offering staff asset-by-asset remuneration agreements on its funds around 10 years ago. A firm in its position would argue it has the fiduciary duty to recover money from those who signed agreements, no matter how small the sum might seem or how long ago the person left the company.
The Tristan case is notable because of its status as a well-known European private equity real estate firm.
In 2008 when EPISO was raised, Tristan Capital had not yet been formed. Back then it was known as Curzon Global Partners, a company led by Ric Lewis, and an affiliate of Paris-based AEW Europe. Senior Europe professionals working for AEW Europe as co-manager of EPISO were given the opportunity to sign the interim bonus agreements, which is why former AEW staff are being pursued for money today.
Tristan Capital spun out as an independent firm in 2010 co-founded by Lewis, and Ian Laming (who now has day-to-day management of the company). It is thought that one reason why Lewis wished to create a new firm was to end the relationship with AEW because the two firms did not always see eye-to-eye on investment strategy.
No-one would comment to PropertyEU, however some well-known figures in the real estate industry would almost certainly be on the hook for the clawback.
Clawbacks are being sought even from those who have retired from the real estate industry altogether.
As an independent firm, Tristan has raised many more funds in the EPISO series, and they have grown in size as investors wrote larger cheques while new limited partners also committed. The latest, EPISO 6, raised €2 bn in January 2023 – more than twice the size subject to clawbacks.
Those who are resisting the clawback demands are thought to have sought accounting evidence for the whole fund performance, including the use of escrow accounts to prove why the company has to reach back to cash distributions made to ex-employees in 2012 and 2013.
Assuming the case does proceed to arbitration, it is assumed that such detail must be disclosed.
Exactly what ultimately happened with EPISO is not publicly known. It is said to have bought well in the early years and exited successfully. An early example of a quick buy, improvement, and sell strategy was an office in Wimbledon, London, sold for £58 mln in June 2010 well ahead of business plans.
Another early example was a UK logistics centre developed by Prologis that Tristan sold for £80 mln to Malaysia Employees Provident Fund. In total, the fund made 17 investments.
In 2018, Tristan Capital put together a corporate document in which it stated all of its funds along with performance data. It listed EPISO as a €760 mln fund with 65% gearing that made 17 investments and had a projected double net Internal Rate of Return of 10%, and projected triple net IRR of 9.5% and a projected equity multiple of 1.6x and 115% equity returned. Yet by 2023 and 2024 it needed to claw back bonuses paid out a decade earlier. Experts noted that a fund can still have made an overall return, yet clawbacks can be exercised where hurdle rates were not met.
However, one person familiar with the matter said: ‘People are trying to say, “prove it to me” how these funds have failed so miserably that there needs to be a claw back.’
New York Life Investments Company took a 40% stake in Tristan in 2018 and subsequently increased its stake to 80% in 2023. However, experts suggested any liability from clawbacks would have been relatively small compared to the overall investment.
Tristan declined to comment on all questions put to it regarding the questions raised in this article.
The wider point is over the use of interim bonus payments especially at a time when several private equity real estate firms are 'out of the money' when it comes to carried interest from current funds.
This has led to a significant number of people contemplating switching firms. Head-hunters have been kept busy fielding inquiries from those seeking to join another firm.
According to law firm Macfarlanes - which was not invited by PropertyEU to comment on any individual firm – numerous incentive and profit-sharing models continue to be used across the real estate funds market in Europe.
It said deal-by-deal performance fee models were seen most commonly in less established managers seeking to incentivise their teams earlier for good performance or working with a smaller number of investors to build up a track record.
Alternatively, if the real estate fund is focused on current income returns rather than capital, it may have two separate waterfalls paying earlier carried interest for the income returns (albeit both of these are typically a whole fund rather than deal by deal model).
Interim clawbacks
Interim clawbacks rather than just a clawback at the end of the life of the fund will help to ensure any overpayment of profit to the manager is rectified early on, the law firm reflected.
But the pitfalls are that should an early payment of carried interest be made, it means management may become less incentivised following early profit payment in maximising returns for the investor, albeit the lookback clawback helps protect against this. Also, there is a risk that if there is a clawback, the clawback will not be met, albeit the escrow helps protect against this as well.
