Why fund performance is only part of the story
In 2026, institutional investors and family offices aren’t just underwriting strategy — they’re auditing structure. The fastest way to lose LP trust isn’t through underperformance. It’s through unclear economics.
When limited partners assess fund commitments, they look first at how profit-sharing, expenses, and governance intersect. Before a GP pitches the next great investment thesis, LPs are already reviewing the waterfall model and carry crystallization schedule.
The takeaway is simple: alignment isn’t verbal — it’s structural.
The new LP lens: economics as governance
In today’s market, LPs see economic terms as the truest expression of governance maturity. They reveal how a GP thinks about fairness, transparency, and accountability — all before capital is ever deployed.
Five signals stand out:
- Hurdle rate clarity — LPs want to see hurdle mechanics that are both transparent and defensible. Ambiguity around compounding, catch-up rates, or resets can derail trust before the first close.
- Carry crystallization — The timing and method of carried interest realization tells LPs whether incentives are short-term or enduring. Annual crystallization can trigger concern; end-of-fund or post-clawback crystallization earns confidence.
- Clawback escrow — Institutional LPs increasingly require 20–30% of carry to be held in escrow or backed by GP guarantees. This is now considered a baseline governance feature, not a negotiation point.
- GP commitment — LPs interpret the GP’s personal capital commitment as the clearest proxy for conviction. Commitments below 1% of total fund size often draw scrutiny unless offset by team tenure or prior track record.
- Expense allocation — Transparency in which costs are borne by the fund versus the manager is a defining factor in LP confidence. Vague or open-ended expense clauses are a recurring red flag.
Each of these signals tells a story about how the GP defines fairness — not just compliance.
Waterfalls: where math meets trust
The profit waterfall is where alignment becomes real. LPs now benchmark every tier — management fees, preferred return, catch-up, and carried interest — against market norms.
Key patterns LPs expect in 2026:
- Management fees that decline post-investment period.
- Preferred return (“hurdle”) set between 6–8% for private equity or 5–7% for venture strategies.
- Catch-up clauses that are capped or structured to ensure LPs receive their hurdle first.
- Carry percentages between 15–25%, adjusted for risk and fund size.
- Full-fund clawbacks rather than deal-by-deal, especially for newer managers.
Investors view these terms as a reflection of discipline and foresight. A well-structured waterfall doesn’t just allocate profits — it communicates integrity.
When small clauses create large misalignment
The most common disputes between GPs and LPs rarely stem from malice. They arise from structural vagueness.
Examples:
- “Net of fees” language that conflicts with expense definitions.
- Side letters granting bespoke hurdle adjustments.
- Inconsistent treatment of recycling or co-invest proceeds.
- Undefined “termination for cause” triggers in clawback enforcement.
Each inconsistency chips away at the credibility built elsewhere. LPs now use legal and operational due diligence not to uncover fraud, but to measure how predictable — and auditable — a manager’s structure will be.
Side letters: when alignment fragments
Side letters remain vital tools for institutional investors, but they also introduce risk.
Overbroad Most Favored Nation (MFN) clauses, poorly defined expense or reporting waivers, and inconsistent co-investment rights all undermine the uniformity that LPs expect.
In 2026, the standard of care has shifted:
- MFN clauses should specify class, vintage, and closing parameters.
- Reporting waivers are viewed skeptically and often rejected outright.
- Expense-sharing language must be traceable to the fund’s LPA.
Managers who maintain a side-letter matrix mapping all negotiated rights build confidence through transparency. Those who treat side letters as bespoke exceptions invite unnecessary complexity.
The economics-reporting link: ILPA 2.0 and beyond
Clear economics must translate into clear reporting. LPs now expect quarterly transparency packs modeled on ILPA 2.0, including:
- Fee and expense breakdowns with offsets;
- Capital account statements reflecting recycling and clawback positions;
- Distribution waterfalls by tier; and
- Certification of compliance with side-letter terms.
Even for funds that don’t adopt ILPA formats verbatim, LPs expect equivalency in clarity. The message is clear — if it can’t be explained on one page, it’s too complex.
This expectation is reinforced by the upcoming CARF (Crypto-Asset Reporting Framework) rollout, which will push global funds toward unified data and role assignment between GP, administrator, and tax adviser.
GP perspective: balancing flexibility and trust
For managers, the challenge is designing economic terms that both attract LPs and allow operational flexibility. Over-engineering for optics can slow execution; under-engineering invites distrust.
Three principles help strike that balance:
- Document clarity over novelty. LPs prefer conventional structures that are clearly drafted over innovative ones that introduce ambiguity.
- Alignment by math, not narrative. The model should make fairness self-evident without relying on explanation.
- Proactive transparency. Providing the waterfall model, side-letter matrix, and fee policy early in diligence builds momentum toward close.
The strongest fund managers communicate that alignment is not reactive — it’s embedded in design.
LP diligence trends: what investors are checking now
In 2026, LP due diligence extends beyond the LPA. Review teams now assess:
- Fee grids and offsets across related vehicles.
- Clawback funding mechanics, including escrow or insurance coverage.
- Consistency of economics across vintages and co-invests.
- Expense reimbursement policies and whether they adhere to ILPA guidance.
- Audit readiness for CARF and CRS regimes.
Managers who can provide structured responses to these points signal operational maturity. Those who rely on “customary” practices risk being screened out before the second diligence call.
When alignment is visible, fundraising accelerates
Alignment doesn’t just reduce risk — it accelerates closing.
Funds with transparent economics and governance often experience:
- Faster LP approvals during legal review;
- Lower resistance to side-letter negotiation;
- Higher re-up rates from existing investors; and
- Easier integration with institutional reporting frameworks.
In an environment where deal flow and trust compete for attention, structure is the fastest path to differentiation.
Final Thought
LPs don’t just invest in managers — they invest in how those managers think about structure.
In 2026, every fund term, from hurdle to clawback, tells a story about integrity and foresight. The best GPs use economics not as a negotiation point but as a proof point.
Alignment isn’t declared; it’s designed.
At Veritas Global, we help fund managers and family offices design fund structures that build trust, meet global reporting standards, and align with investor priorities.
Contact our team to discuss how to structure for the future.
