The latest Principles from the Institutional Limited Partners Association offer best-practice guidelines for the industry, touching on a range of issues from waterfall calculations to GP-led secondaries transactions to ESG.
Here are nine key takeaways.
- There are references to subscription credit lines aplenty
Subscription lines of credit have their own dedicated section, but their more widespread use across the industry is addressed throughout the Principles.
For example, in recommendations on the calculation of carried interest, the Principles state “in cases where capital is drawn from a bridging or other short-term financing facility collateralised by uncalled LP capital commitments, the preferred return should be calculated from the date capital is at risk, ie, the date on which the facility is drawn, rather than the date at which the capital is ultimately called from LPs.”
LPs should be given performance information both with and without the use of a subscription line “to inform performance comparisons on a vintage year basis and relative to other funds”. Investors should also be “offered the option to opt out of a facility at the onset of the fund”.
The Principles call for a “reasonable window” of at least 10 business days in which LPs can respond to capital-call requests.
- Some of the language is stronger
At several points in the Principles, ILPA builds on and strengthens the previous iteration.
One such example relates to the calculation of carried interest, which the Principles state should be “based on net profits (not gross profits), factoring in the impact of fund-level expenses”. In version 2.0, the equivalent section stated that: “Alignment is improved when carried interest is calculated on the basis of net profits”.
- The rise in GP stake sales has not gone unnoticed
The Principles address the possibility that a GP may sell a stake in itself during a fund’s life. Managers should “proactively disclose the ownership of the management company” and “notify all LPs if the ownership of the management company changes over the life of the fund”.
This is also picked up in the section dedicated to limited partner advisory committees: “In cases where voting members of the LPAC have an interest in the GP, such as a minority ownership stake in the management company, the GP should disclose the existence of those relationships to the LPAC.”
- The LPAC should be diverse
The committee should be “comprised of a representational cross-section of investors by commitment size, type, tax status and quality of relationship with the GP”.
Jennifer Choi, ILPA’s managing director of industry affairs and lead developer of the Principles 3.0, told Private Equity International that this was currently “the exception and not the rule”.
“We recognise that’s probably a recommendation that will be a bit harder to adopt,” she said. “Frankly, it’s not unreasonable for the LPs that make the most sizeable commitments to the fund to want, and maybe even expect, an LPAC seat. But we want to think about it in terms of what is lost.”
- The plan for co-investments should be clearly articulated
GPs should disclose a clear framework for how co-investment opportunities, interests and expenses will be allocated, including whether any prioritisation will be applied. When GPs put forward a co-investment opportunity, they should give the prospective co-investors “strategic reasoning” for including the co-investment tranche rather than allocating the entire amount to the fund.
The Principles also suggest GPs consider “employing a pre-qualifying assessment or other process, during fundraising and at appropriate intervals over the investment period, to confirm LPs’ interest and ability to execute on a co-investment opportunity”.
- GPs shouldn’t stack up management fees
A GP shouldn’t be looking to collect two sets of full management fees if it reaches the end of the investment period for one vehicle and immediately begins investing its successor. The management fees should “take into account the lower levels of expenses incidental to the formation of a follow-on fund”.
- There’s advice on fees and expenses allocation
The Principles make recommendations on the allocations of particular expenses. Costs and expenses associated with “any remedial actions required as the result of a regulatory exam” should be the fund manager’s responsibility. Choi says this is not standard practice across the industry today. Technology implementation or upgrades that “solely or chiefly [benefit] the GP, and can be utilised across multiple funds over time” should also be paid for by the manager.
- LPs should seek verifiable information on ESG
A firm’s ESG policy should “identify procedures and protocols that can be verified and/or documented, rather than [simply constituting] a vague commitment of behaviour”. If a GP claims it is pursuing an impact-investment strategy, “a framework to measure, audit and report on the impacts achieved by the fund should be adopted”.
- The growing role of GP-leds is recognised
The Principles offer an abridged version of the best-practice guidance on GP-led secondaries that ILPA published in April. The Principles touch on LP engagement and the role of the LPAC, the structure of the process – including the need to give LPs sufficient time to evaluate the transaction – and who should be on the hook for advisor fees.