Unplanned or disruptive events may require GPs to renegotiate fund terms with their investors. The departure of one or more key executives is the most common example of this. Other situations may include defaults, or threats of default, by strategic investors on their obligation to advance capital to a fund.
Most LPAs include provisions that suspend (or in some cases provide investors with the ability to vote to suspend) a fund’s investment period and the ability to make new investments if a certain number of specified key executives cease to devote their time to the affairs of the fund. In some cases, these suspensions have been triggered by the death, retirement or departure of a single key executive. In other cases, the suspension is triggered by the departure of a group of key executives or a team of executives from a specific geography or sector.
Investors’ responses to these key-executive events, and to requests from a GP for them to vote to lift the suspension on new investment activity, has varied depending on the:
• Circumstances surrounding the event giving rise to the suspension.
• Broader macroeconomic environment.
• Performance and behavior of the GP before the events.
• Performance of the fund and the current value of the remaining unrealized portfolio.
In some situations, investors have quickly agreed to lift the suspension based on the fund’s ability to continue making new investments, often without the GP having to make any concessions or even proposing replacements for the key executives who have left. In other situations, discussions between investors and the GP have been protracted, adversarial, often publicized and with the GP having to make concessions.
GPs often make significant concessions — such as reducing the size of the fund or limiting the fund’s investment strategy or geographical focus — to investors to obtain a favorable vote to continue investing the fund. There are situations where GPs have not been able to convince investors to lift the suspension on new investment activity and others where GPs have decided that, strategically, they would be better placed not to ask investors to vote to lift the suspension. In the latter case, the fund’s investment period terminates and the GP is tasked with preserving and maximizing the value of the existing portfolio in order to dispose of it.
Clear and early communication with investors is of key importance to managing the consequences of a key-person event. GPs should consult widely with their investor base and convince their investors that it is in their interests for the fund to continue to make new investments. The GP needs to provide evidence on how it will function and perform without the key executives who have left, and must deal with any macroeconomic issues that may influence how investors respond. This could require the GP to present solutions to investors that require some concessions on its part.
Nigel van Zyl is a partner at Proskauer.
This is an excerpt from The LPA Anatomised (2018), published by Private Equity International, and available for purchase here.