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Institutional Limited Partners Association Publishes New Private Equity Fund Guidelines

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Written by Michael Wu

Earlier this month, the Institutional Limited Partners Association (“ILPA”) published Version 2.0 of its Private Equity Principles (the “Principles”).  The Principles set forth the ILPA’s take on the best practices in establishing private equity partnerships between limited partners (“LPs”) and the general partner (“GP”).  The Principles focus on three guiding tenets for developing effective partnership agreements: Alignment of Interest Between LPs and GP, Fund Governance and Transparency to Investors.  The revised version of the Principles incorporate feedback from GPs, LPs and third parties in the industry to increase “focus, clarity and practicality.”

The following are the key changes from the prior version of the Principles under each of the three guiding tenets:

Alignment of Interest Between LPs and GP

  • GP cash contributions are preferred to fee waivers
  • European-style waterfalls (i.e., all contributions plus preferred returns are paid before the GP receives any carry) is preferred to American-style waterfalls (i.e., deal-by-deal), though with certain safeguards, such as carry escrows of 30% or more, 125% NAV tests and interim clawbacks, the American-style waterfall could be acceptable
  • GP clawbacks should be net of taxes, “fully and timely repaid” and should extend beyond the term of the fund
  • Joint and several liability of the GP’s members is preferred, but a joint and several guaranty from a substantial parent company or individual GP member may be acceptable, and LPs should be able to enforce the GP clawback guaranty
  • Lower management fees should be charged at the end of the investment period, the formation of a successor fund and if the term of the fund is extended
  • Deal sourcing fees should be a GP expense
  • LP clawbacks for indemnification should be capped at 25% of the capital commitments and should not apply after two years from the date of distribution
  • Term of the fund may only be increased in one-year increments and only with the consent of a majority of the Advisory Committee or the LPs, and if such consent is not obtained, the fund should be fully liquidated within one year of the end of the fund’s term
  • GP should not co-invest with the fund (i.e., GP’s entire interest should be through the fund)
  • Advisory Committee should review and approve any fees generated by an affiliate of the GP, whether charged to the fund or a portfolio company

Fund Governance

  • GP may be removed for “cause” and the fund terminated for “cause” upon a majority vote of the LPs
  • A 2/3 in interest of the LPs may terminate/suspend the commitment period without fault and a 3/4 in interest of the LPs may remove GP and dissolve the fund without fault
  • GP should accommodate LP investment policies and provide applicable excuse rights
  • A majority in interest of the LPs may make general amendments; a super-majority in interest of the LPs may make “certain amendments” (e.g., investor-specific provisions) and amendments affecting the fund’s investment strategy and the fund’s economics; and amendments negatively affecting any LP’s economics, require the consent of such LP
  • Where the interest of the LPs and the GP is not aligned, a reasonable minority of the members of the Advisory Committee may engage independent counsel at the expense of the fund

Transparency to Investors

  • Annual reports should be delivered within 90 days of the end of the year
  • Annual and quarterly reports should be provided to LPs regarding a portfolio company’s debt
  • Funds should use the ILPA’s standardized form of capital call and distribution notice template

Finally, the ILPA’s release also set forth best practices for Advisory Committees.  More information about the Principles can be found here.