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The recently appointed head of industry affairs at the Institutional Limited Partners Association, Chris Hayes, is on a mission. Working with a team of attorneys, ILPA is trying to boil down the limited partnership agreement into a new simplified format that could save time and money for managers and investors when a new fund is formed.

Hayes believes the LPA has become unnecessarily complicated. The bespoke nature of the modern document pushes up the legal costs, the bulk of which are borne by limited partners. 

Creating standard legal documents will improve the market for everyone, providing LPs with greater clarity on fund terms and GPs with a faster track to fund closing, Hayes says.

“Our understanding is that many of these documents are increasingly complex and much of that complexity is unnecessary and leads to unnecessary cost,” he says.

Concentrating on the overlap between these areas, the subscription agreement – part of the fund documentation that sets out the basis on which a prospective investor will be admitted as a partner of the fund – was identified as the least contentious.The project kicked off in summer 2016, when ILPA conducted a survey of 30 LP counsel to establish the highest priorities for LPA simplification from an investor perspective. These findings were complemented by a survey of 57 GP counsel that identified which legal terms were the least difficult to negotiate from the fund manager’s vantage point.

“Right now we have a structure where there’s no incentive to cut some of those legal costs because ultimately LPs pay all of those costs”
Chris Hayes

In December, ILPA released its first model subscription agreement for private equity funds, which it describes as a modular, multi-jurisdictional document that provides a balanced, off-the-shelf solution, which can be easily customised to meet the needs of fund managers and their investors. It was downloaded 500 times in its first eight weeks online, Hayes says.

Attention has now turned to a model LPA, with a focus on three things: standard of care/indemnification; the distribution waterfall; and fees and expense disclosure and allocation. The plan is to put draft documentation out for consultation in the fall, and to publish a model LPA by year-end.

Hayes says: “We are trying to think outside the box about how information could be presented more effectively, and we have a variety of groups of lawyers working on specific sections to try to put something together that is thoughtful. We are hopeful that people will adopt the entire document, but if not, we hope separate sections will be helpful, whether it’s the waterfall section or the fees and expenses section.”

But lawyers across the industry, working for both LPs and GPs, say the task of simplifying the LPA is an extremely ambitious one. Ed Gander is a partner in the private equity team at Weil Gotshal & Manges in London. He says: “Standardisation in theory is a good thing, because obviously it makes things more efficient. We would rather advise on more fundraisings taking the same amount of overall time than less fundraisings taking more time.”

He sounds a notes of caution: “But you can have up to 200 investors all with different interests and concerns negotiating documentation with the manager in a single fund, using dozens of different law firms from all over the world.

“Fundraisings are global and every manager and investor has different considerations that need to be addressed in each fundraising. Combined with that, each fund has a different investment strategy, which affects things like tax structuring and jurisdiction of vehicle etc. So, when you put all the different interests and inputs together, you come out with thousands of potential nuances in the documentation.”

He says that in practice he can’t see standardisation happening in the near future.

It’s a view shared by Jonathan Blake, an investment funds lawyer at O’Melveny & Myers. He says: “From an LP perspective, standardisation may be simpler, but is it even right to think that a $10 billion mega-fund that tends to have pretty good performance and is hugely oversubscribed should play off the same documentation as a $100 million first-time fund? Everything is there for a reason, and you often need further fine tuning.”

Blake has been one of the leading lawyers working on investment funds in Europe since the 1980s, and adds: “There’s more diversity of terms today than there ever has been. It’s not that less attractive managers are having to offer cut-price terms, because broadly speaking people don’t invest in funds because the terms are better. It’s more that if your performance is superlative, you might get better than standard terms, and we’re seeing that leading to a spate of different conclusions.”

ILPA points to efforts by the International Swaps & Derivatives Association in the hedge funds industry and the National Venture Capital Association in the US venture capital space, as examples of bodies that have made similar efforts to standardise and simplify industry documents, with positive effect. 

“Is it even right to think that a $10 billion mega-fund that tends to have pretty good performance and is hugely oversubscribed should play off the same documentation as a $100 million first-time fund?”
Jonathan Blake

Hayes also notes that limited partners, via the fund, bear the bulk of the legal costs associated with the lengthy negotiations involved in LPA drafting: “Right now we have a structure where there’s no incentive to cut some of those legal costs because ultimately LPs pay all of those costs. It’s one of the few industries where investors pay to structure the entire product.”

Nick Benson is a partner in the investment funds group at Latham & Watkins, based in London. He says: “LPs are, in general, able to address their needs through a combination of getting the LPAs amended in the course of negotiations and through side letters. Also, the GP community has been pretty good at accepting LP sentiment to reflect their greater needs on things like reporting and disclosure.”

He adds, “Nobody has ever said to me that we should be trying to move towards standardised fund documentation, because the challenges involved are too difficult. You can probably contemplate trying to standardize documents in a transactional context – a good example of which is the ISDA standard documentation – but that’s totally different to a fund agreement where you have an active live relationship between a group of not just two partners, but often upwards of 50. It is effectively a multi-party joint venture going on for 10 to 15 years, with everyone having their own particular needs, structures, tax and regulatory contexts.”

Hayes says ILPA is a global organisation and hopes to put out something that can be used across jurisdictions, though it is well aware of the complexities. He says: “We are realistic about the market. We are going to provide a couple of different waterfalls that could be used, for example. We’re not going to stick to one and say everybody should use that because we know there’s flexibility in the marketplace.”

He says a schedule is also planned to deal with fees and expenses, to replace wordy paragraphs with a simple list of things that might be charged to the fund, from which both sides can select and agree.

The most hotly contested terms remain the level of the management fee and carry, according to Blake: “The exact way in which the carry works, and the exact way in which the management fee works, are always going to be top of the list in the areas that are most debated. Then there are the key-person clauses – who the key people are, and what happens if those clauses are triggered,” he says.

Another pertinent issue right now is extensions, he adds. “A lot of funds are going on for longer than their initial time, so the whole question of extension and who votes for extensions is big at the moment. Maybe you have a couple of years when the manager can extend, but after that the investors’ committee gets to opine on whether any further extension can occur. That’s become quite a common issue – plus what majority of the investors’ committee needs to agree an extension, and what would the fees be during an extension, if indeed there would be fees.”

Jason Glover is a funds expert and managing partner of the London office of law firm Simpson Thacher, with clients including Apax Partners, BC Partners, EQT and Cinven. He says standardization is difficult because of the speed of market change.

One of the areas where LPs are currently negotiating hard is on borrowing provisions, for example, where the market has shifted considerably following ILPA’s publication last year of guidance on subscription lines of credit.

“All of a sudden, investors are saying that GPs have got far too much scope and need significant changes in what can be borrowed for, how much can be borrowed, and for how long it can be borrowed,” says Glover. “ILPA would have wanted a completely different standard on borrowings two years ago to what they would look for now.”

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He also points out that investors are rarely happy to sign up to the same set of terms on successor funds that they have agreed to previously: “With a lot of the funds that we do at this point in the cycle where we have had seven or eight good years for GPs, we are coming to the market with an LPA that is basically very similar to the previous fund. So, if investors are minded to go with standard, you would think they would sign up to the same terms they signed four years ago, particularly because if anything things have only moved in GPs’ favour. But we have tried that, and we find that investors are keen to try to renegotiate nearly all of the terms again.” 

Hayes argues that ILPA is only trying to make the market run more smoothly for all concerned: “It is a challenge, but when you look at it objectively, there really is no reason why millions of dollars in legal expenses should be spent every time a bespoke agreement is created, for every single fund, when a lot of other industries have created standard agreements that have been helpful.”