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LPs demanding greater clarity in fund terms

Investors want less ambiguity in their partnership agreements, leading GPs to nail down precisely what rights and obligations LPs are afforded in the fund.

Private equity investors are demanding much more specific language around key fund terms and conditions, sources have told Private Equity International in various interviews.

While it’s been widely reported LPs are winning more favourable terms, less ink has been spilled warning fund managers of a parallel trend in the demand for these terms to become more precise.

For example key man clauses, which trigger certain investor rights following the exit of a crucial GP, are now being drafted to clarify how many hours per week a key man should be working. “Whereas before a partnership agreement might say a key man has to invest a ‘substantial amount of their business time’ they may now specifically state a 40-hour work week”, said one London-based funds lawyer.

Investors want to know exactly what the consequences are if they can’t meet a payment; for instance how many days can go by until they have to start paying interest on the default

Unstable market conditions and best practice guidelines put forth by the Institutional Limited Partners Association (ILPA), a trade group for private equity investors, are two primary drivers of the trend explained Bridget Barker, a private equity partner at law firm Macfarlanes.

ILPA released updated guidelines earlier this year as way of encouraging more dialogue and negotiations between fund managers and their investors. One of the group’s primary objectives, greater fund transparency, says “GPs should provide detailed financial, risk management, operational, portfolio, and transactional information regarding fund investments”.

Default rights, which impose certain penalties should an LP fail to meet a capital call, is another area where tighter language is being used, said a separate London-based funds lawyer. “Investors want to know exactly what the consequences are if they can’t meet a payment; for instance how many days can go by until they have to start paying interest on the default, whether they lose voting rights, or if their fund interest can be sold.”

Using greater precision in fund terms can lead to more innovative agreements, said Chris Gardner, a private equity attorney at Dechert. “Take the level of spin-outs that we are seeing, for instance.  Whereas previously, key person provisions focused on one or two established individuals, LPs now acknowledge that a team will grow beyond those names, and consequently investors may want key person events to be triggered by as yet un-named individuals leaving – which leads to these types of provisions becoming more detailed and complex than had been the case in the past.”

Other areas investors are demanding clarity on revolve around a fund’s investment strategy, Gardner adds. “Instead of a GP saying we will allocate 40 percent of our capital to, say, Asia or into renewables, they are increasingly being asked to specifically state which Asian nations and which types of renewable energy they will focus on so that investors not only have the comfort that GPs are focusing on investments within their sphere of expertise, but also that investors can better manage their asset allocation programmes and risk strategies.”

It’s also worth noting certain GPs have not felt pressure to clarify fund terms post-crisis provided they’ve managed to consistently satisfy their investor base with strong returns, said Michael Suppappola of international law firm Proskauer Rose. “In a general sense, LPs who have long-standing relationships with oversubscribed, top-tier firms have not looked to substantially renegotiate the terms used in the past, although some LPs may try to negotiate certain terms where they feel there has been a significant shift in the market since the prior fund”. 

Instead it is those private fund managers perhaps raising a first time fund or who have less certain fundraising prospects that are more likely to be subject to this trend, he added.