The Institutional Limited Partners Association (“ILPA”) has recently issued a publicly available model private equity limited partnership agreement (the “Model LPA”) as part of its simplification initiative. ILPA is an international organisation that represents the limited partner community, although it also works with managers of private equity funds and other practitioners when publishing its model texts and guidelines. One of ILPA’s principal aims in publishing the Model LPA is to standardise a document that is generally negotiated on a bespoke basis.
Efficiency is a potential benefit to the Model LPA. In addition, to the extent an investor ‘friendly’ document such as this is used, it is also likely that the time spent negotiating side letters (and administering them) would also be reduced. However, before agreeing to use the Model LPA (or aspects of it), managers should be aware of the potential strategic, commercial and contractual implications of using this new template. Similarly, while it might seem counterintuitive, a focus on terms perceived to be favorable to investors can actually be harmful to investors as a whole as the manager may find its hands tied in managing a problem with an investor, to the detriment of other investors. For these reasons we would envisage that over time the Model LPA may serve more as guidance as to what investors are looking for than a precedent used by many.
While the Model LPA focuses on private equity (specifically, the Model LPA is tailored to a Delaware limited partnership for a U.S. buyout strategy), we would anticipate that investors will treat it as informative with respect to other closed-ended fund structures and across asset classes (including private debt and real estate).
The Model LPA follows a recent update to ILPA’s Principles for Fostering Transparency, Governance and Alignment of Interests for General and Limited Partners (the “Principles”) and is generally consistent with them (and other guidelines issued by ILPA).
High-Level and Strategic Concerns
The selection of the base limited partnership agreement for a fund launch will inevitably set the tone for negotiations with investors and ultimately the terms agreed. Therefore, managers should be aware of some strategic points in this respect before agreeing to use the Model LPA.
- A private fund is a long-term proposition and accordingly the right balance needs to be struck between manager and investor interests to ensure a fair and well-aligned deal over the life of the fund. It may be argued that the Model LPA is less market balanced and too skewed towards investors.
- ILPA suggests that the Model LPA may be particularly helpful to emerging managers, presumably as they will not have precedent documents, are likely to have less resources for extensive negotiations and are less likely to be able to insist on sponsor-favorable terms. However, the Model LPA is not a complete first draft and requires further input. Emerging managers should also bear in mind that, to the extent they anticipate successor funds and/or repeat investors, they are likely to be tied to the base limited partnership agreement used for their first fund for some time. There is also no optionality for seed investor language in the Model LPA and managers would need to seek specific advice to the extent this was relevant. ILPA also recommends the Model LPA as a point of reference for existing managers, although we would not anticipate established managers wishing to move to this template as this would involve surrendering terms already agreed with prior investors.
- As with the Principles, it is likely that investors looking at funds beyond the U.S. buyout market are likely to request the Model LPA or certain of its terms. However, in many instances the terms of the Model LPA are not appropriate for different asset classes or a broader array of structures. Different structures may be selected for a variety of reasons relevant to the fundraise in question (including tax, anticipated investor base, manager infrastructure, etc.) and the limited partnership agreement used will need to be adjusted for the particular structure in question. For example, even if operating as parallel funds, Delaware, Cayman Islands and Luxembourg partnerships will require different terms relevant to their respective jurisdictions. Notable examples include specific Luxembourg requirements with respect to the treatment of defaulting investors and the scope of powers of attorney.
- While the Model LPA contemplates parallel fund structures, in reality, it is not appropriate for the sophisticated structuring that most large fundraises demand today. In particular, the Model LPA is unlikely to be appropriate for managers who manage (or anticipate managing) multiple accounts (including separately managed accounts and co-investment structures) or cover multiple strategies. The Model LPA could not be used for umbrella structures with multiple sub-funds (which are often used in Europe). Commonly requested features such as the ability to apply leverage to the underlying investments and the ability to allow investment through different currencies are also not fully provided for.
- While relatively comprehensive, the Model LPA still needs specialist assistance with respect to the regulatory and tax aspects. Although some language is unlikely to change significantly between funds, these should always be checked with regard to the investment strategy, the manager’s specific circumstances and other factors. For example, with respect to ERISA issues, the Model LPA assumes that the “venture capital operating company” (“VCOC”) exemption will be used if there is significant investment from Benefit Plan Investors – bespoke advice should be sought with respect to this technical area of law, particularly as this specific route is not available for a number of strategies. Similarly, European funds would need to take into account the provisions of the EU Alternative Investment Fund Managers Directive (“AIFMD”) and other EU legislation but would not necessarily be concerned by some of the U.S. regulation cited in the Model LPA (for example the provisions relating to the U.S. Federal Communications Commission’s rules may not be applicable to non-U.S.-focused investment strategies). Other specialist advice should also be sought to the extent a capital call or leverage facility is envisaged or certain types of investors are targeted (such as German regulated investors). With respect to the carried interest, the Model LPA also assumes that the recipient will be the general partner, which is frequently not the case, especially outside of the United States. As a general matter, carried interest structuring is likely to require further specialist input given that the structuring will be bespoke to the manager’s concerns, particularly if the firm spans multiple jurisdictions or the founders have complex personal affairs.
Fund Terms and Other Commercial Points
Disenfranchising the Manager Under the Model LPA, investors have a variety of options to disenfranchise the manager. Importantly, the general partner may be removed and the commitment period can be terminated in a no-fault situation. Combined with a lack of manager protections within them (such as so-called ‘honeymoon’ periods, during which a provision cannot be invoked), these provisions put the manager at risk of a loss of revenue or losing ‘control’ of the fund without cause.
Managers should also be aware of the definition of ‘Removal Conduct’ in the Model LPA, which is particularly relevant in the context of the general partner removal provision. This is expansive and, again, does not build in customary manager protections. In particular, there is no requirement for a final court decision with respect to any removal conduct leading to a potential removal for cause notice, leaving the point open to debate. The removal conduct circumstances also apply to the fund’s key persons and in some instances a wider scope of removal conduct is applied to these individuals (all of which should be carefully reviewed).
Other Accounts The Model LPA limits a manager’s activities with respect to other accounts it manages (or intends to manage). For instance, a successor fund is broadly defined, limiting a manager’s ability to launch similar accounts (including separately managed accounts and, potentially, co-investment vehicles) without the consent of the majority of investors. A better approach may be to include a covenant in the governing documentation to allocate deals in accordance with the manager’s established allocation practices (which would be consistent with the requirements that many managers, specifically those registered with the U.S Securities and Exchange Commission (“SEC”), are already subject to).
Economics The Model LPA includes a whole of fund waterfall, rather than a deal-by-deal waterfall which can be more beneficial to managers. While this point may be more controversial in the U.S. buyout market, many funds, particularly those with European sponsors, already adopt this approach. In any event, ILPA have confirmed that they intend to release a version of the Model LPA that uses a deal-by-deal waterfall in due course.
Consistent with the Principles and other guidance issued by ILPA, a footnote to the Model LPA notes that, to the extent the fund utilises a subscription line of credit, the preferred return should be calculated from the date on which the facility was drawn (on the basis that capital is at risk from this date). However, many sponsors do not consider this appropriate, and it is not the market position.
In terms of expenses, the list of expenses borne by the fund could be more expansive and should be scrutinised by managers before agreeing to them. Being clear on fund expenses is beneficial to both the manager and investors and is also a focus of regulators such as the SEC.
Investor ‘Friendly’ Provisions As a general matter (and unsurprisingly), the Model LPA includes a number of starting provisions that are more favorable to investors than we would otherwise expect to see in the market. In this vein, the Model LPA integrates a number of provisions that investors might typically request in side letter negotiations.
Managers (and investors) should also note that investor ‘friendly’ provisions may not be beneficial to the investor body as a whole. Similarly, over-defined processes and an over-reliance on consent procedures could cause practical issues in running the fund.
ILPA cite the reduction of the time and costs associated with side letters as a benefit of the Model LPA applicable for both investors and managers. Whilst there is some merit in this, there are a few points for managers to keep in mind. Firstly, by permitting terms that would otherwise be applicable only to investors with the relevant side letter provision (or the appropriate most favored nations (“MFN”) rights) to go into the fund’s limited partnership agreement, the manager is accepting that the provision will now apply to all investors. Secondly, the Model LPA follows the (albeit not uncommon) practice of including an MFN provision in the limited partnership agreement, rather than deferring to an individual investor to negotiate this on their own behalf. In doing so, this provision is also applicable to all investors, widening its effect. Clearly some investors will have bespoke concerns that will not be applicable to other investors, such as the need for certain U.S. government-related investors requiring specific sovereign immunity clauses. The scope of the MFN provision is also increased by two significant factors – the application of the MFN is not affected by the size of an investor’s commitment (commonly investors only benefit from provisions agreed with investors with an equal or smaller commitment to them; this is not included in the Model LPA) and, while there are some carve outs to the MFN (such as confirmation of an advisory committee seat), a number of common carve-outs are missing from the provision. In addition, since any more favorable side letter rights automatically apply (there is no election process), any manager that does choose to adopt the Model LPA should be particularly disciplined in what they grant to investors. For example, a confirmation that an investor would be offered a defined portion of co-investments would not work if the Model LPA is used.
Finally, while the Model LPA does include some square brackets and footnotes to accommodate an element of tailoring, it does present a number of terms as a ‘done deal’, when in reality these mechanics can be achieved quite differently in the market. The terms of the management fee in the Model LPA (including the basis of its calculation and the period of time during which it applies) is one such example. Similarly, the reinvestment provisions may need to be adapted to suit the relevant strategy (and other fund terms) and the key person/manager time and attention requirements will need to be adapted to the manager’s circumstances.
This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.
Gus Black is a partner in Dechert’s London office. He is global co-chair of Dechert's financial services group and a member of the Policy Committee, and focuses his practice on investment funds (emphasising private equity, debt and hedge funds), establishing and restructuring international asset management businesses, corporate and commercial transactions in the asset management sector and general UK financial services regulation.
Russel G. Perkins is a partner in Dechert’s London office. He focuses his practice on the private funds industry. He advises fund sponsors, asset managers and institutional investors on a wide variety of fund formation, governance and compliance issues relating to real estate funds, private equity funds, hedge funds, funds of funds, secondaries funds, co-investments and other alternative asset classes.
Omoz Osayimwese is a partner in Dechert’s New York office. He focuses his practice on matters relating to the formation and operation of private equity funds, other closed-end investment funds and alternative asset management businesses.
Nathalie Sadler is an associate in Dechert’s London office. She advises on the structuring, establishment, management, marketing and restructuring of private funds in a range of onshore and offshore jurisdictions.
Dechert is a leading global law firm with 26 offices around the world. We advise on matters and transactions of the greatest complexity, bringing energy, creativity and efficient management of legal issues to deliver commercial and practical advice for clients. For more information, please visit www.dechert.com.