The latest Principles from the Institutional Limited Partners Association offer a set of best-practice guidelines for the industry, touching on a wide range of issues from waterfall calculations to GP-led secondaries transactions to ESG.
Here are nine things you need to know.
- There are references to subscription credit lines aplenty
Subscription credit lines have their own dedicated section but their more widespread use across the industry of subscription lines of credit 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 provided 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”, and investors should be “offered the option to opt out of a facility at the onset of the fund”.
“There should be a reasonable window of at least 10 business days for LPs to 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: “Carried interest should be calculated based on net profits (not gross profits), factoring in the impact of fund-level expenses”. In version 2.0, this section read: “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 new Principles address the possibility that a GP may sell a stake in itself during a fund’s life, stating that 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 committee best practices: “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 limited partner advisory committee should be “comprised of a representational cross-section of investors by commitment size, type, tax status and quality of relationship with the GP”.
Today, this is “the exception and not the rule”, Jennifer Choi, managing director of industry affairs and lead developer of the Principles 3.0 guidance told Private Equity International.
“We recognise that’s probably a recommendation that will be a bit harder to adopt because 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,” she said. “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 to a clear framework for how co-investment opportunities, interests and expenses will be allocated, including whether any prioritisation will be applied. When presenting a co-investment opportunity, co-investors should be given “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”.
- Managers 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 some recommendations on the allocations of particular expenses. Costs and expenses associated with “any remedial actions required as the result of a regulatory exam”? The manager’s responsibility, which is not standard practice across the industry today, according to Choi. Technology implementation or upgrades that “solely or chiefly benefits the GP, and can be utilised across multiple funds over time”? Also should be paid by the GP.
- LPs should seek verifiable information on ESG
The Principles recommend that a firm’s ESG policy should “identify procedures and protocols that can be verified and/or documented, rather than a vague commitment of behaviour”. If a GP is claiming to pursue an impact investing 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 practices guidance on GP-led secondaries ILPA put out in April, touching 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.