On January 11, 2011, the Institutional Limited Partners Association (“ILPA”),1 a not-for-profit private equity industry association, released a revised version of its Private Equity Principles (the “ILPA Principles”), suggested best practices and preferred private equity terms intended to inform discussions among fund sponsors (“General Partners”) and investors (“Limited Partners”). The original version of the ILPA Principles was first published in September 2009 and received endorsement from 140 industry organizations. The updated ILPA Principles retain the three stated goals of the first version: (i) alignment of interests between General Partners and Limited Partners; (ii) enhanced fund governance and (iii) greater transparency to Limited Partners. However, the new version also reflects the feedback received from General Partners, as evidenced by a number of General Partner-favorable changes. To view the updated ILPA Private Equity Principles, please see http://ilpa.org/principles-version-2-0/.
Together with the release of the revised ILPA Principles, ILPA revealed its new standardized reporting initiative, aimed at promoting industry efficiencies and improving transparency. To this end, ILPA launched a Capital Call and Distribution Notice Template, one of five standardized reporting templates ILPA is developing in consultation with General Partners. An instruction guide comes along with the template and includes sample cover letters and notices with respect to capital calls and distributions.2
In addition to the introduction of the standardized reporting template, some of the more notable changes to the ILPA Principles include the following:
Clawback of Carried Interest
The revised ILPA Principles include a new appendix outlining carry clawback best practices, emphasizing that General Partners should have in place mechanisms to ensure clawback obligations are satisfied (e.g., joint and several liability of General Partner members/escrow accounts/parent company or personal guarantees) and that the governing documents should clearly provide the legal structure for requiring clawback payments. Unlike the prior version of the ILPA Principles, in which the recommendation was that the General Partners would be responsible for the full clawback amount (gross of taxes), the updated version recommends the implementation of mechanisms whereby a General Partner is neither improperly benefitting from its ability to receive tax advances, nor responsible for repaying more than its after-tax carry received. ILPA also moved away from the suggestion that clawback liabilities should be disclosed at the end of every reporting period, instead recommending disclosure on an annual basis as part of the audited financial statements. Although ILPA still backs an “all-contributions-plus-preferred return-back-first” waterfall model, the revised ILPA Principles set forth best practice suggestions for General Partners receiving deal-by-deal carry, including a net asset value coverage test and interim clawbacks.
Management Fees and Partnership Expenses
Although there were no significant changes to ILPA’s recommendations regarding management fees and partnership expenses, the revised ILPA Principles concede that general partner insurance coverage should be a partnership expense to be borne by the fund. In addition, unlike the prior version of the ILPA Principles, which specified a 100% offset for transaction and other fees received by the General Partner, the current ILPA Principles do not specify a percentage amount to be offset, perhaps signaling an acknowledgement by ILPA that 80/20 or other offset arrangements are prevalent in the market and may be appropriate.
General Partner Commitment
The updated ILPA Principles make clear that in furtherance of the alignment of interests, the General Partner should not be allowed to co-invest in select underlying deals (i.e., to “cherry pick”).
General Partner-Related Fees
The ILPA Principles also clarify that where the General Partner is a part of a large multiple product institution, the General Partner may appropriately charge third-party-like fees to the fund or portfolio company for services provided by an affiliate of the General Partner. However, ILPA recommends that any such fees should be reviewed and approved by a majority of the Limited Partner advisory committee.
Limited Partner Opt Outs
The revised ILPA Principles recognize that the General Partner should accommodate investment restrictions imposed by certain Limited Partners, but caution that allowing such opt outs may require increased focus on concentration limits for remaining Limited Partners.
Limited Partner Clawback
The ILPA Principles now specify suggested limits on the Limited Partner clawback to fund indemnification expenses: a reasonable percentage of committed capital (but no more than 25%) and a reasonable time period (e.g., two years after the date of distribution).
Changes to the Fund — Amendments and No Fault Rights
General Partner-favorable revisions were made to approval and voting thresholds for amendments to the limited partnership agreement (“LPA”) and no fault rights. LPA amendments generally should require a majority in interest of Limited Partners, instead of the previously-suggested supermajority. A 66-2/3% vote of Limited Partners (in lieu of a majority) should be able to suspend or terminate the investment period without cause, and a 75% vote of Limited Partners (in lieu of 66-2/3%), should be able to remove the General Partner or terminate the fund without cause.
Key-Man and For Cause Provisions
Previously, the ILPA Principles recommended a 66-2/3% vote of Limited Partners to reinstate the investment period after a key-man or cause event. However, the revised ILPA Principles suggest only a “defined super-majority” vote of Limited Partners, which presumably allows for a higher percentage requirement, such as 75% or 80%. Additionally, in stating that a majority of Limited Partners must be able to remove the General Partner or terminate the fund for cause, the revised ILPA Principles seem to be implicitly accepting the notion that such a removal or termination, rather than being an automatic occurrence, may require a Limited Partner vote. Nevertheless, the ILPA Principles advise that mechanisms for removing the General Partner should allow Limited Partners to act before the fund has suffered irreparable harm.
ILPA has stated that it may issue additional appendices to the ILPA Principles, in response to evolving industry best practices, and that standardized templates for annual and quarterly reporting as well as portfolio metrics are in development.