ILPA unveils guidelines on carry, fees, key-man

Limited partners to private equity funds should first be repaid all contributed capital plus a preferred return before general partners begin to receive carried interest, according to a newly unveiled set of terms-and-conditions best practices from the Institutional Limited Partners Association (ILPA).

The guideline on carry is just one of many recommendations that make up the new ILPA “Private Equity Principles” released Tuesday, and reviewed in advance by PrivateEquityOnline.

ILPA is the trade association for limited partners to private equity funds. Its roughly 220 members control the vast majority of commitments to private equity funds across the world – some $1 trillion of private equity assets. The association has grown steadily since 2007 when current executive director Kathy Jeramaz-Larson joined. At the time ILPA had 158 members.

ILPA members, the names of which are not disclosed, include the most influential private equity investors in the world, including major US state pensions, sovereign wealth funds, endowments and family offices.

The investment staff for the California State Public Employees' Retirement System will next week recommend endorsement of the guidelines at an investment committee meeting. “The principles and best practices promote stronger alignment of interests between limited partners and general partners, improve investment reporting and transparency to investors, and enhance partnership governance,” staff said in an advanced agenda released Wednesday. If adopted by the investment committee next week, CalPERS would notify its “private equity partners of the endorsement and begin incorporating the principles and best practices on a prospective basis”.

The guidelines come at a time when LPs worldwide have unprecedented negotiating leverage on partnership terms and conditions. ILPA’s recommended terms and principles are not currently in place in many current private equity funds. For example, many US-based private equity funds do not require a “distribution waterfall” that returns all contributed capital plus the preferred return to LPs before carry is paid. In the ILPA principles, this “recognised best practice” is given priority over the next-best term governing carry, called an “enhanced deal-by-deal model”.

Jeramaz-Larson, in an interview with PrivateEquityOnline, said the guidelines will not be “enforced” or “policed” by ILPA. They are instead meant to “promote the conversation between GPs and LPs. It is up to each LP to determine exactly how they want to implement” the guidelines.

Other highlighted best practices from the new ILPA principles stipulate that:

• No carry should be taken on current income
• Clawback amounts should be gross of taxes paid
• Management fees should “step down significantly” once a follow-on fund is formed
• Deal fees should go 100 percent toward the “benefit of the fund”
• GP cash commitments to the fund are favoured over management fee waiver schemes
• Key-man devotion to other funds is discouraged
• A cap on indemnification expenses is encouraged
• The investment period is automatically suspended when a key-man event is triggered
• Notes on carry calculation must be sent with each distribution
• A schedule detailing fund-level leverage is included with each quarterly report
• Cash-burn, debt and valuation notes for each portfolio company an included in all reports
• Contact details for all LPs are provided upon the closing of the fund
• “In camera” sessions of the LP advisory committee become an industry standard

The principles were formed by a sub-committee of ILPA in consultation with all ILPA members.

Jeramaz-Larson said her association would begin seeking endorsements from institutions who wish to be officially recognised as signatories to the principles.