ILPA's Private Equity Principles

Simon Witney, Partner, SJ Berwin LLP

In late 2009 the Institutional Limited Partners Association (ILPA), a predominantly US-led association of private equity investors, published its Private Equity Principles. ILPA says that these principles aim to enhance partnership governance, strengthen alignment of interest between GPs and LPs, and improve investor reporting and transparency. ILPA says that the document - which includes a long list of "best practice" fund terms - was written following a comprehensive survey of ILPA's 215 members, and a number of roundtable discussions.

ILPA acknowledges that the private equity industry has a history of alignment of interest: it argues that the combination of carried interest - which means that LPs share a "substantial portion" of the fund's profits with managers - and "meaningful" investment by fund executives in their own funds created "a business culture . where most private equity firms were able to maintain a single-minded determination to maximise returns on the underlying investments". ILPA says that the principles aim to "restore and strengthen" that basic proposition.

One way in which ILPA seeks to do that is by arguing for a cautious approach to payment of carried interest, with no carry becoming payable until all contributions and a preferred return have been paid - which is already the usual (although not universal) practice in European funds. There are also calls for adequate clawback and escrow mechanisms to protect investors in case there is an overpayment of carry.

Other suggested terms (most of which are already normal market practice) include:

  • a requirement for the general partner to have a "substantial" equity interest in the fund, paid out predominantly in cash (and not through waiver of the management fee);
  • for carry to be held "predominantly" by the "professional staff";
  • a call for levels of management fees that only cover the normal operating costs of the firm and its principals, based on a disclosed "fee model";
  • for transaction and other fees to be fully credited to the fund;
  • a reinforced general partners' duty of care;
  • a requirement (under the heading "Style Drift") that investments should be consistent with the initial investment strategy described when the fund was raised, and that the strategy should be narrowly drafted;
  • no-fault divorce clauses - including a provision permitting a simple majority to suspend or end the investment period, which is not currently standard in Europe;
  • "key person" and "for cause" events which result in an automatic suspension of the investment period;
  • independent auditors (which do not perform other services for the general partner and its affiliates) focused on the best interests of the partnership and its limited partners;
  • transparent fee and carried interest calculations, certified by an independent auditor; and
  • quarterly detailed updates on the valuation and financial information of portfolio companies.

To ensure that funds operate transparently, ILPA also says that it is best practice for the general partner to disclose a number of details about the operation of the fund, including details of all fees, capital calls and distributions, details of the general partner itself, details of the activities of the general partner's management company (including the formation of publicly listed vehicles and any other fund offers), and financial information on the fund and each portfolio company.

The principles also include an appendix dealing with Limited Partner Advisory Committees ("LPACs"). Among other things, ILPA suggests that LPACs should review expenses, budgets, fees and carry; oversee conflicts of interest; discuss personnel and strategy; approve non-arm's length transactions; and review valuations. To assist them, the principles propose that LPAC members are given access to legal and other advisers at the fund's expense.

The executive director of ILPA stated, in an interview with PrivateEquityOnline, that it will not "enforce" or "police" the principles - they are intended to "promote the conversation between GPs and LPs". Additionally, the principles themselves emphasise their purpose as an "educational medium". But it remains to be seen whether ILPA's principles will have an impact on the terms of European funds, which in many respects already have more conservative terms than their American counterparts.

Simon Witney, Partner,

Simon is a Partner with SJ Berwin, a leading pan-European law firm, where he is a member of the private equity team. He is a member of the British Private Equity and Venture Capital Association's Legal and Technical Committee and the European Private Equity and Venture Capital Association's Tax and Legal Committee and regularly works with them on issues which are of critical importance to the European private equity and business community. In October 2006, Simon was named as one of the "30 most influential lawyers in global private equity" by the highly regarded industry journal Private Equity International, and, in January 2008, he was recognized as one of the Hot 100 lawyers by The Lawyer.

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