The Institutional Limited Partners Association has released new best practices guidance covering a variety of topics in the private equity space.
One topic is management fees, which the association said should be based on reasonable expenses that are normal operating costs of the fund. And, it noted, when new funds are formed, general partners should provide limited partners with a fee model for how fees will be calculated over the life of the fund.
Overhead costs, salaries of GP employees and other relevant advisors or affiliates, travel and other costs related to the manager’s investment activities should come from the management fee and not be allocated to the fund, according to the guidance.
It also walked through what should be considered in the basis for management fees and delved into fee income beyond management fees, including fee offsets related to co-investments. As well, it provided an overview of reasonable organization and partnership expenses, highlighting these should be disclosed regularly to LPs.
Historically, it was assumed that certain costs were being borne by the management under the management fee, says Jennifer Choi, managing director of industry affairs at the ILPA. “And overtime, whether it’s because of enhanced disclosure or because of an actual cost-shifting practice, we’re beginning to see a lot more itemization around the expenses being charged to the partnership — to the fund — and not being paid for by the GP. And . . . we wanted to just go on record to say that it has to pass the reasonableness and fairness test. And there’s no singular answer for every set of circumstances, every fund strategy, but there is a general framework around which you can have a conversation about reasonability.”
The guidance also outlined that LP agreements should reinforce the GP’s fiduciary duty.
“This is the first time we’ve made some of these statements, really hoping that GPs, LPs and their advisors will begin to embrace that managers do owe a duty to their LPs — and I think the majority of managers would recognize that,” says Choi. “And so we need to make sure that the documents mirror that as well.”
The ILPA’s guidance also addressed LP advisory committees, outlining how an LPAC’s role can be more formally institutionalized. One way is to include a clearly disclosed mandate that covers topics including reviewing valuation methodologies, the use of leverage and evaluating conflicts of interest.
“I do think that we spent quite a lot of time thinking about governance and the role of the LPAC . . . and it’s a really nuanced and complex topic that deserves more time,” says Choi. “It deserves more attention and more air time because there’s a real broad spectrum of views about how large the LPAC should be, about what the LPAC’s duty really is or what its mandate and responsibility should be. We tried to start that conversation within the context of the document, but I would say there’s a lot of interest across the industry in examining, what is the optimal governance model for a private equity fund? And how can we optimize the LPAC if, in fact, that is the best model?”
Currently, how LPACs are modeled varies from fund to fund. “There are lots of different models and that’s why I don’t think we can say there’s one way to do it,” Choi notes. “But I do think that given the amount of interest that topic generates with pretty much every stakeholder group we raise it with, it suggests that it’s a topic worthy of further consideration.”
The ILPA doesn’t expect people will adopt the entire document, adds Choi. “But we do think it’s something that people will be coming back to and/or it will be in the backdrop as they consider, what are our priorities when it comes to either the fund terms themselves, the negotiation or our diligence of a manager?”
The guidance is an update on previous principles published in 2011 and captures various topics that have been addressed in other formats since that date.