Version 2.0 of ILPA Private Equity Principles Reflects Change in Approach

Bruce I. Ettelson, Chris P. Kallos and William C. Brashares of Kirkland & Ellis LLP


On Earlier this year, the Institutional Limited Partners Association ("ILPA") released Version 2.0 of its Private Equity Principles ("Version 2.0"), updating the original principles issued in September of 2009 (discussed in our earlier KirklandPEN). Version 2.0 represents evolution rather than revolution, preserving the thematic structure of the earlier document and leaving much of the original language intact. However, unlike the original principles, which ILPA said were based on input from institutional private equity limited partners ("LPs") and their senior investment officers, Version 2.0 purports to reflect feedback from both LPs and general partners ("GPs").

Version 2.0 expands upon the same three themes as the earlier principles-Alignment of Interest, Governance and Transparency, and adds three related appendices- a list of Carry Clawback Best Practice Considerations, a set of proposed best practices for an LP advisory committee ("LPAC") and a table of Financial Reporting proposals.[1] The following highlights some of the significant provisions and noteworthy changes in Version 2.0.

Alignment of Interest

Waterfall. Version 2.0 continues to recommend a "European-style" waterfall (full return of all contributions plus hurdle prior to payment of any carried interest). Recognizing that not all funds will adopt this structure, Version 2.0 proposes several recommendations for deal-by-deal waterfall structures, most of which remain unchanged from the earlier principles. These include:

  • Investment proceeds from a given investment should be first used to return all capital invested in such investment, as well as any partial impairments or write-offs of other investments.
  • Carried interest distributions should be delayed until all capital contributed for fees and expenses to date (as opposed to the portion attributed to realized deals) has been returned.
  • No distributions of carried interest from current income or recapitalization proceeds should be made until all the capital invested in the applicable investment has been returned.
  • Carry escrow accounts with significant reserves (30% of carry distributions or more) should be imposed.
  • NAV coverage tests (generally at least 125% of unreturned invested capital) are recommended to ensure sufficient "margin of error" on valuations.

    Clawbacks. The new clawback discussion proposes several new LP-protective features and modifications to provisions in the prior principles criticized as impractical. For example:

    • Rather than demanding that all clawback amounts be returned gross of taxes, as in the prior principles, Version 2.0 suggests a nuanced approach intended to result in a GP member returning an amount equal to the lesser of (a) the excess carry paid and (b) the total amount of carry paid less the amount of tax actually paid by the GP member, taking into account, e.g., his or her actual tax rate, loss carryforwards and carrybacks, the character of the fund income, and deductions for state tax payments.
    • In lieu of joint and several liability among all GP members for clawback obligations, Version 2.0 would permit a several obligation together with a creditworthy guarantee from a substantial parent company, an individual GP member or some subset of GP members.
    • Version 2.0 now recommends interim clawbacks at the end of the commitment period and upon the occurrence of certain triggering events (e.g., keyman departure or insufficient NAV coverage).

      Fees and Expenses. Version 2.0 generally follows the earlier version's positions on management fees, fund expenses and fee income offsets, [2] but often uses a milder tone. For instance, where the previous version provided that the management fee "should step down significantly" at the end of the commitment period or commencement of a successor fund, Version 2.0 suggests that upon such events the fee "should take into account the lower levels of expenses" that follow.


      Version 2.0's governance prescriptions remain similar to the earlier version, emphasizing investment team stability, consistent strategy and fiduciary duties. However, several provisions in Version 2.0 appear to take into account the GPs' interests as well as the differing interests among the LPs themselves. For example, Version 2.0 provides the following:

      • A majority in interest of the LPs should be permitted to remove the GP for cause, but not simply "upon preliminary determination" of bad acts (as in the original principles); rather, a provision for GP removal for cause should employ mechanisms "constructed so that the LPs can act before there is irreparable damage to their interests."
      • A 2/3 in interest LP vote, rather than the simple majority vote prescribed by the earlier version, should be required to suspend or terminate the commitment period without cause.
      • A 3/4 in interest LP vote, rather than the 2/3 in interest vote prescribed by the earlier version, should be required to remove the GP or dissolve the fund without cause.
      • An all-partner giveback is contemplated, but apparently only for GP indemnification requirements, subject to an aggregate cap equal to 25% of commitments and a time limit of two years after the applicable distribution. The previous version did not contemplate an all-partner giveback and proposed that all indemnification obligations be capped at a percentage of total commitments.
      • Only a simple majority in interest of LPs should be required for most amendments to the partnership agreement, with supermajorities (or individual consents) for special cases, rather than a supermajority vote on any amendment (as in the earlier version).


        In addition to many of the same information and disclosure obligations contemplated in the original principles, Version 2.0 suggests the use of ILPA's Standardized Reporting Templates (the Capital Call and Distribution Template is the only one currently available (at Version 2.0 also calls for enhanced risk management disclosure in annual reports regarding, among other things, concentration risk, foreign exchange risk, leverage risk and reputational risk.

        Limited Partner Advisory Committee

        Version 2.0 strikes a more flexible tone from the original principles regarding LPACs. Where the previous version urged standardization of LPAC practices in order to rectify the "inconsistency" and "lack of uniformity" among private equity funds, Version 2.0's LPAC proposals are intended "to provide a model" recognizing "the differing constituencies of individual partnerships" and acknowledging "that one standard might not fit every situation."

        For example, while Version 2.0, like its predecessor, lists a variety of specific instances where the LPAC should be consulted, it also casts the committee's functions and duties in broader and more flexible terms, calling for "an open forum for discussion of matters of interest and concern to the partnership" while allowing that the functions "may evolve" and that "the focus should clearly be on substance rather than form."

        Additionally, Version 2.0 appears to recognize that the interests of a fund may not be perfectly aligned with the interests of its LPAC, cautioning about conflicts within the LPAC: it "should operate as a committee, not as a collection of individual members" and each member should "consider whether they have any potential conflict of interest" and disclose actual conflicts to other LPAC members.


        Version 2.0 of the ILPA Private Equity Principles represents an incremental shift toward a more flexible, practical and bilateral approach to private equity fund terms and procedures. As a result, while the ILPA principles likely will remain more of a measuring stick used by LPs in evaluating funds than a strict set of requirements, Version 2.0 is likely to play a continuing role in fund formation negotiations.

        Bruce I. Ettelson, P.C., Partner,

        Bruce I. Ettelson leads Kirkland's Private Funds Group. His practice focuses on structuring and forming premier private equity funds and their management companies, including billion dollar plus funds for firms such as AEA, American Capital Strategies, Bear Stearns, Energy Capital Partners, Golden Gate Capital, Madison Dearborn Partners, Nautic Partners, Paul Capital Partners, Summit Partners and Vestar Capital Partners. Mr. Ettelson has represented over 75 private equity firms in the formation of more than 200 private equity funds. He is also involved in the structuring and formation of private equity funds associated with commercial and investment banks; representing investors in making and monitoring investments in private equity funds; representing buyers, sellers, management teams and fund sponsors in their investments in the secondary market; and acting for private equity clients in general corporate counseling.

        Full Bio

        Chris P. Kallos, P.C., Partner,

        Chris Kallos is a senior partner in the Private Funds Group, where his practice primarily focuses on advising leading and emerging private equity fund sponsors in connection with forming and operating their funds and management companies.

        Mr. Kallos has formed or is in the process of forming over $45 billion of funds for private equity firm sponsors, ranging in size from under $100 million to over $6.5 billion. Additionally, he advises select limited partner investors in making and monitoring substantial private equity fund investments.

        Mr. Kallos also represents private equity executives in connection with joining and spinning out of established firms.

        Full Bio

        William C. Brashares, Partner,

        William C. ("Beau") Brashares is a partner in the Private Funds Group, where he concentrates his practice on representing fund sponsors in the formation and management of private investment funds, including buyout, venture, mezzanine, senior debt, industry-specific, and funds-of-funds, as well as the structuring, operation and regulatory compliance of their management companies. He also advises clients in the formation and management of hedge funds, "hybrid" funds and other private investment vehicles. In addition, Mr. Brashares counsels funds-of-funds and prominent institutional investors in connection with their investments in leading private equity, venture, real estate, and hedge funds.

        Full Bio

        Kirkland & Ellis LLP

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        [1] These include a Capital Call and Distribution Template, the first of several recommended Standardized Reporting Templates that ILPA has under development.

        [2] Version 2.0 provides that management fees should be based upon reasonable operating expenses and salaries, and should not create GP wealth; all transaction, monitoring and similar fees should benefit the fund; and the GP should (at a minimum) bear the cost of overhead, staff compensation, travel, deal sourcing, interactions with LPs and other general administrative expenses.

        Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances. For legal advice, please consult your personal lawyer or other appropriate professional. Reprinted with permission from Kirkland & Ellis LLP.