Op-Ed: A Valuable Tool for Private Equity Fund Investments

Margaret Niles

Last fall, the Institutional Limited Partners Association (ILPA) released a publicly available, free to download, model limited partnership agreement (LPA) for private equity funds. In July, ILPA followed up its initial Model LPA (released in October and featuring a “whole-of-funds” distribution waterfall structure) with another version, featuring a deal-by-deal distribution waterfall structure, which might be more appealing for certain types of private equity fund managers. We were involved in drafting the new ILPA Model LPA, and were joined by a diverse group of legal counsel all working toward crafting a model agreement that ILPA believes represents a fair, equitable agreement for both investors and managers.

Won-Han Cheng

ILPA’s move enhances transparency in the private funds market. Under common practice, fund agreements have been treated as confidential and subject to non-disclosure requirements. We and the rest of the ILPA drafting team, with decades of combined experience negotiating and drafting LPAs governing the deployment of capital in private equity funds, have developed a strong sense of the range of terms that commonly appear in LPAs, as well as the challenges institutional investors face when seeking to negotiate these terms. LPAs are extremely complex and often difficult to navigate. Due to the confidential nature of these agreements, that complexity is exacerbated by a lack of available information on what terms are considered “market” in the private equity industry. Essentially, what is “market” is largely in the eye of the beholder and therefore the subject of debate.

ILPA’s publication of the ILPA Model LPAs is intended to give these documents high visibility across the private equity fund industry. As attorneys who help institutional investor clients around the globe navigate these agreements, the authors of this article believe the ILPA Model LPAs can provide valuable guidance for investors and for managers seeking to understand what is important to ILPA’s members and other investors.

First, investors can use these agreements to benchmark the terms in the governing documents of particular funds against ILPA guidance, confident in the knowledge that these agreements align with ILPA principles, reflect the preferred terms of like-minded investors, and, from ILPA’s perspective, are fair to all parties. 

Second, these agreements can be used in negotiations with established managers, providing ready examples of provisions that can be used by investors to negotiate key terms of LPAs or side letters to seek to improve transparency, governance, and alignment of interests. Each provision in the ILPA Model LPAs was developed from a precedent that we and our co-drafters have seen in recent negotiations. In many cases, the terms of a particular LPA may deviate from certain provisions in the ILPA Model LPAs for valid commercial or regulatory reasons; nevertheless, a comparison of the terms of a particular LPA against provisions in the ILPA Model LPAs can help the parties identify and discuss these differences, leading to a better understanding of the terms of the particular fund. Moreover, since many of the terms an investor would seek in a side letter are already included in the ILPA Model LPAs, all investors may be able to benefit equally from these terms. 

Finally, the ILPA Model LPAs can be useful guidance for emerging managers seeking to understand how to implement ILPA principles in their fund documents. For some managers, the ILPA Model LPAs can serve as a helpful starting point.  

Chief investment officers at institutional investor organizations are under constant pressure to improve returns without excessive risk or cost, and many are seeking to increase their allocation to private equity because of the attractive returns. Those CIOs and their investment teams that are familiar with the ILPA Model LPAs and other ILPA standards will be well-equipped to demonstrate the ways in which they would like to improve fund terms, and thereby reduce the time and expense of negotiations.

Future market dynamics may move private equity fund terms in a direction more (or less) friendly to investors—ILPA Model LPAs can serve as a road map to help investors navigate these market changes. Institutional investors and fund managers should give these documents a look—at a minimum, they may gain a better sense of terms sought by investors to improve transparency, governance, and alignment of interests in these investments.

Margaret Niles is a partner with global law firm K&L Gates LLP, where she has a domestic and international business transactions practice centering on alternative investments and joint ventures for investors. She focuses on representing public pension funds, university endowments, sovereign wealth funds, and other institutional investors in private equity funds, hedge funds, and other commingled funds of all kinds, and she has been nationally ranked in the 2019 Chambers USA publication and recognized in the Best Lawyers in America publication.

Won-Han Cheng is a partner with K&L Gates LLP, where she is a member of the Tax and Corporate practices, and she has been recognized by the 2020 USA Chambers Washington. She focuses on federal, state and international tax issues for both foreign and domestic clients, and she has worked extensively in the area of alternative investments, assisting institutional investors with tax and economic issues related to investments in commingled pooled investment funds, including private equity funds, hedge funds, venture capital funds, and real asset funds.

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Institutional Shareholder Services or its affiliates.