There is no single “off-the-shelf” package of documents for a private equity fund. Instead, every fund manager (with the help of its lawyers) develops and negotiates the fund’s limited partnership agreement (LPA) with its investors (and their lawyers). The practice of negotiating side letters with specific investors, generally to confer privileges or accommodate special requests, adds a further layer of complexity, even if side letter concessions are subsequently offered to some or all of the other investors.
While some LPA provisions become “market standard” because they are widely adopted, there is nonetheless considerable variance in terms from fund to fund, particularly in key areas like distribution waterfalls, GP removal, key man protection, indemnification and carry clawback. This variance gives investors an eclectic choice, but makes it tricky to compare funds, even within the same country, let alone internationally.
Some in the industry see the introduction of standardised documentation as a way to improve comparability. The Institutional Limited Partners Association (ILPA) led the way in early 2016 when it released a comprehensive template for the reporting of private equity fees, expenses, carried interest, called capital and clawback.
It is not mandatory, but surveys suggest that roughly half the market has adopted the template, either wholesale or partially with modifications. Other GPs in the market continue to develop their own customised forms of report; they say that they need flexibility to cater to investors who have their own tailored data requests, processing systems and reporting timeframes (e.g., quarterly, six-monthly or annual).
Pleased with the impact of the reporting template on the market, ILPA followed up in December 2017 by releasing a model subscription agreement (MSA), with the stated goals of streamlining fundraising and improving the efficiency of capital formation. The MSA is drafted to be multi-jurisdictional; its modular structure makes it customisable to a degree, to suit the particular structure of a fund.
ILPA is now working on a model LPA. (MJ Hudson is one of the international group of law firms helping ILPA to draw up the model LPA.) ILPA says that it hopes that GPs and LPs will adopt the model LPA as a complete document, but it will also be open to them to choose which sections to adopt, if any. The model LPA will aim to accommodate some of the existing variance in the market, for instance by including two or more different models of distribution waterfall.
Getting managers and investors to switch to standardised fund documentation will directly reduce variance, and thus increase comparability. That doesn’t imply that private funds would be commodified; at a minimum, they would still be able to tailor their investment strategy, structure and level of fees and carry.
However, to become the market standard, a model LPA would have to be suitable for use by first-time domestic small-cap funds, multi-billion-dollar international mega-funds, and everyone else in between. While it may make a serviceable starting point for a new fund manager, well-established GPs who have raised a number of funds may well be reluctant to junk their intensively negotiated, long-trusted suite of documents; in this situation, familiarity breeds content. There is also the added cost and effort of managing legacy funds and successor funds side by side when they are operating on quite different documentation.
A mega-cap fund can expect to attract dozens of institutional investors worldwide, and will therefore have to balance a huge range of competing interests, special considerations and technical nuances in its fund documents. Bespoke LPAs represent a constantly evolving compromise between these factors. The parties can also adapt the LPA terms quickly in response to market developments. For instance, LPAs for new funds tend to include much more detail on the allocation and disclosure of fees and expenses, in response to pressure from institutional investors and a number of high-profile SEC investigations in the last few years.
While LPAs have been getting longer in recent years, that is partly driven by the need to accommodate the host of new regulatory and tax obligations imposed on the alternative investment industry in recent years, such as those brought in by AIFMD and FATCA. This will not be reduced by standardisation.
The ISDA Master Agreement is sometimes held up as an example of how standardisation can work to the benefit of the market as a whole. The Master Agreement is the standard contract for OTC derivatives. But it is essentially a transactional document, whereas a private equity fund is a joint venture-like relationship; the LPA needs to function more like a “living constitution” for a period of 10 years or more. The Master Agreement is also not quite as absolute as the name suggests; although the terms in the Master Agreement remain fixed, the parties can and do customise it via the (negotiated) Schedule, which contains a detailed suite of elections and amendments to the Master Agreement.
Fund reporting seems to be moving in the direction of standardisation, but there is no industry consensus as yet on whether the same will work for the fund’s core legal documents. After all, the LPA is only one among several factors that influence an investor’s decision to apply for a commitment; others include the GP’s track record and the fund’s basic economics, such as fee levels and carry structure.
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