It’s an investor’s market now. Model LPAs give new managers an edge

Todd Boudreau argues that ILPA’s model LPAs can give emerging managers an edge in a highly competitive market, helping to attract new relationships and reduce the costs and complexities of negotiation.

Speculation that we were overdue for an economic downturn began to reach a fever pitch in recent years, but no one could have predicted the global pandemic now roiling markets.

The World Bank is forecasting a 5.2 percent contraction in GDP globally this year – the greatest decline since World War II. With so much uncertainty, managers raising a private equity fund for the first or second time face a dilemma: attracting investor capital is proving to be more challenging than ever, while the time to do so has never been better. Emerging managers face a particular set of challenges in this climate, but attracting LP interest and securing capital is not impossible.

Market challenges for new fund managers

In recent years, increasing demand has often given managers the upper hand in negotiations, but it’s looking more and more like an investor’s market now.

The economic impact of the covid-19 pandemic is having a clear impact on private equity. Preqin, in its most recent quarterly private equity update, reported that fundraising slowed in Q2 to the lowest quarterly total since 2018, while the number of funds closed in Q2 was at its lowest level in the years that Preqin analysed (2015-20). These figures underscore the quick shifts in private equity activity in reaction to market volatility, given that we previously saw an acceleration of fund closings in March 2020 by long-time, successful fund managers – likely as an effort to get ahead of the turmoil caused by covid-19.

Despite a slowdown in fundraising, Preqin reports that the number of funds in the market increased 6.5 percent between January and June 2020, suggesting that there’s significant appetite to capitalise on the opportunities that the economic fallout presents.

With investors scaling back the size of their commitments due to limited partner liquidity uncertainty and the challenges of fundraising remotely – and with many LPs now opting to primarily invest with existing relationships – how can emerging general partners still successfully participate in this increasingly competitive environment?

For starters, emerging managers can (and should) continue to develop LP interest and improve their fundraising chances by being persistent and keeping the conversations going. Most importantly, it’s imperative that they give LPs certainty around the terms and process of their fund.

A tool for new and young fund managers

One option that emerging managers now have for providing certainty around the terms and process of their funds is to use either the “whole-of-fund” or “deal-by-deal” model limited partnership agreements that have been produced by the Institutional Limited Partners Association.

Both LPAs were created by a group of lawyers representing both the GP and LP community in the fund formation process, and together they represent the first-ever complementary legal templates for the private equity industry, helping to effectively streamline fund negotiations on both sides of the deal.

I’m an advocate for efficiency and simplification of the review process for emerging managers, who will benefit most from these model agreements, as they should reduce the complexity, cost and resources required to negotiate the terms of an investment. Additionally, it’s important that new managers develop their relationships with LPs, and using one of the model LPAs is an easy way to build trust. They represent a foundational component of an LP-friendly fundraise and conform to ILPA Principles 3.0, the key features of which are alignment of interest, governance and transparency.

Understanding that one size doesn’t fit all, the model LPAs provide room for flexibility by including bracketed language that can be tailored to fit a particular strategy and approach to best suit the needs of either party. Best yet, they provide a starting point for new and inexperienced managers that helps demonstrate how others have modified the partnership agreements to conform to their own processes and procedures for governance and management.

While there are critics of any effort to standardise agreements across an industry (I’m sure the National Venture Capital Association heard similar concerns when it proposed its models), using well-backed templates that investors are familiar with will help advance the GP-LP conversation and has the potential to streamline the investment process altogether.

Starting from a shared foundation is advantageous for the private equity industry as a whole, but it is even more beneficial for emerging managers who are looking for efficiencies to improve a rather cumbersome and complex process.

The takeaway

The current market is rife with opportunities for emerging managers looking to raise a fund, but they need LPs to invest and invest quickly. That will require starting their new LP relationships with a set of documents that LPs are familiar with and can act upon. In my view, emerging managers should take the opportunity to review and adopt many of ILPA’s standards, and that should start with serious consideration of the model LPAs.

Based in Boston, Todd Boudreau is a partner in global law firm Morrison & Foerster’s Private Equity Investments + Buyouts Practice. He serves on various committees of the Institutional Limited Partners Association and was a member of the group of lawyers representing LPs and GPs who helped ILPA develop its Model Limited Partnership Agreement for the private equity industry.