ILPA Principles: broad-brush solution to a complex issue?

Julian Longhurst
09 July 2010

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In a buyerтs market it is hardly surprising that there has been a real focus on re-aligning various terms & conditions of private equity funds to favour LP investors. But are attempts to drive and perhaps formalise this process wide of the mark? Julian Longhurst investigates.

It's a sign of the times: the investor relations partner of a well respected European mid-cap investor is nervous of his group's upcoming fundraising programme. Despite having multiple previous funds under its belt and an innate confidence in the firm's tried and tested investment strategy, the current conditions make it hard to predict how the fundraising process will pan out.

Of course, while there may have been a short window of fundraising activity in the first four or five months of the year, macro economic demons have once again made the situation worse for any GPs doing the fundraising rounds. But there are other issues making the process more onerous: the significantly more thorough LP due diligence process is one thing, along wih a strong push from the buy-side to secure more LP-friendly terms and conditions.

In this regard, LPs have had some help from the Institutional Limited Partner Association (ILPA), a US organisation with some 220 members in 10 countries. ILPA has built a set of principles aimed at serving as "a basis for continued discussion between the general partner and limited partner". The principles have certainly lent some weight to LPs' calls for changes in areas such as; management fees, transaction fees, GP fund contributions, key-man and no-fault clauses, and transparency, especially in carry distribution.

While the general shift in power has certainly precipitated some notable concessions in Ts&Cs (note Apollo and Blackstone as cases in point), there are those that suggest the principles are a knee jerk reaction to issues endemic at the top end of the scale and represent too simplistic a solution for the industry as a whole.

A good example of this, according to the mid-market specialist is the practice of GPs taking a large slice of the transaction fees they earn, rather than passing it all to the fund: "Larger funds will never get away with this again - it is such a conflict of interest. But, the issue is nowhere near as clear for much smaller funds, whose operational costs are disproportionately high in comparison to their management fee income. For them, the ability to supplement income via transaction fees can be important in some cases".

It is not just GPs who think it so, and research emerging recently suggests only one in eight LPs will insist on the full implementation of the principles, suggesting that the one size fits all approach really doesn't work.

Whatever the rights or wrongs of the ILPA principles, between now and the end of 2012, virtually every private equity group that currently invests from an external fund will have to have gone out to the market to raise new money, so we are possibly some way from knowing exactly how far the pendulum will swing towards the LPs.

A more detailed look at the fund raising environment will be covered in the upcoming issue of Private Equity Europe.