In June 2019, the Institutional Limited Partners Association (ILPA), the industry body for limited partners (LPs), released its "Principles 3.0". This is the third in a series of guidelines designed to set best practice on fund terms and documentation.
In recent years the private equity industry has increased in size and complexity with a variety of strategies and products. In that context ILPA notes that the Principles should be used as a framework, rather than a checklist, around which general partners of funds (GPs) and investors can manage expectations when entering into the fundraising process.
The Principles focus on the theme of stewardship and the fiduciary role of the GP. ILPA describes private equity firms as having the "solemn responsibility" of managing the savings and capital of investors. In that vein, the Principles provide significant detail on best practice with regards to governance terms.
ILPA suggests that fund documentation includes an affirmative statement by the GP of the standard of care owed to the fund and should avoid language allowing for the disclaiming of its fiduciary duty (to the extent allowable by law).
The Limited Partner Advisory Committee (LPAC) membership should be representative of all fund LPs (by type, commitment size, quality of relationship with the GP) so that it is well placed to serve its key function of advising the GP on conflicts. The LPAC should play a key role in GP-led secondary transactions as GPs should engage with the LPAC as soon as possible around the objectives and rationale of the deal and also on conflicts (this repeats its guidance on these transactions released earlier this year).
On economic terms, the ILPA continues to recommend that a "whole of fund" model (all contributions plus preferred return-back first) represents best practice when it comes to constructing a waterfall structure. This mitigates the need to rely on carried-interest clawback mechanisms, and aligns with standard market practice in European private funds.
The Principles also reiterate ILPA's 2017 guidance on subscription lines (read our update on that) which state that these should be used to manage working capital and not to enhance the IRR. In practice, we still see the preferred return accruing as from the date that the capital is drawn and not from the date that investor capital is at risk (in other words, when the subscription facility is drawn), contrary to these recommendations by ILPA.
Osborne Clarke comment
The Principles will be a useful tool for industry practitioners, particularly for LPs and their advisers. Although they go into a lot of detail (and some of the points will only be familiar to the most seasoned of practitioners), it is clear that there is no one-size-fits-all approach and they are to be applied on a case-by-case basis. We expect to see the Principles forming a central part in most private fund negotiations over the next few years.