In January 2011 the Institutional Limited Partners Association (ILPA) released an updated version of its Private Equity Principles (Principles).
The Principles were first released in 2009 and reflect ILPA’s commitment to serve institutional investors in private equity, to drive private equity industry best practices and to support long-term relationships between general partners (GPs) and limited partners (LPs). According to ILPA’s website, the original Principles were endorsed by over 140 organisations. A survey conducted during the first half of 2010 by Preqin has shown that over 70 per cent of LPs which completed the survey would view non-adherence to the Principles as a reason not to invest in a fund.
The updated Principles maintain the three guiding principles of alignment of interest, governance and transparency. The Principles have been formulated after incorporating feedback from GPs, LPs and other private equity industry participants provided during 2010 with the aim of increasing the application and adoption of the Principles within the private equity community. ILPA Chairman, Tim Recker, has identified that “moving into 2011, alignment of interest, governance and transparency will become even more important to strengthen private equity as an asset class, especially as liquidity returns to the market, investments shift towards global emerging markets where risk exposures increase and investors become more discerning about the various asset classes post-financial crisis”.
Although the original Principles were intended to balance the interests of GPs and LPs, they were widely perceived as providing LPs with additional bargaining power over GPs, particularly in the context of negotiating certain key fund terms. The updated Principles, however, seem to aim for a better balance between GP and LP interests. Amendments to the Principles include:
- the incorporation of a new appendix relating to GP clawbacks
- a recommendation that the Limited Partner Advisory Committee (LPAC) should engage with the GP in relation to the allocation of partnership expenses, replacing the more onerous recommendation that partnership expenses are to be reviewed annually by the LPAC
- the incorporation of an explicit recommendation that fund extensions (which remain restricted to one year increments) require the majority approval of the LPAC or LPs and if such approval is not provided, there is a recommendation that the GP liquidates the fund within one year of the fund’s expiry
- sharpening the recommendation that the GP should have a substantial equity interest in the fund and indicating that the whole of this interest (rather than just a high percentage of it) should be contributed in cash. ILPA also discourages GPs from co-investing in underlying deals and recommends that the whole equity interest of the GP should be via a pooled fund vehicle
- a recognition that certain amendments to a limited partnership agreement may be made without the consent of the super-majority in the interest of the LPs, depending on the nature of the amendment
- a new recommendation that any changes to key-man provisions are approved by a majority of the LPAC or LPs
- an additional recommendation that, together with all fees generated by the GP, all fees charged to the fund or any portfolio company by an affiliate of the GP should be disclosed and classified in each audited financial report
- building upon the existing transparency guidelines by inserting three new recommendations that GPs:
- provide estimates of quarterly projections on capital calls and distributions
- disclose to the LPs any material contingency or liability arising during the fund's life
- disclose to the LPs any breach of the limited partnership agreement or other fund documents, and
- new guidelines on risk management, recommending that GP annual reports should include portfolio company and fund information on material risks and an explanation of how these risks are managed.
Also released with the updated Principles was a Capital Call and Distribution Notice template, which is the first of five recommended “Standardized Reporting Templates” (Templates). The Templates were developed by ILPA working together with GPs in an effort to generate greater efficiencies, improve uniformity and transparency and reduce expenses in the administration of private equity investments. Additional Templates in relation to annual and quarterly reporting as well as financial schedules are currently under development by ILPA.
Based on industry participant feedback, ILPA plans to issue further appendices to the updated Principles, where required, in order to allow its framework of best practice to evolve and to address new topics as they arise.