4.7 Typical terms of a limited partnership agreement

standard practice in the PCF industry and is also recommended to SWFs by GAPP 18.2 of the Santiago Principles.47 For PCFs set up as GP/LP structures, the agreement is commonly known as a limited partnership agreement (LPA). This section refers primarily to LPAs, because GP/LP structures are the most common among funds that invest in unlisted securities (see table 4.7).

LPAs must comply with the jurisdiction in which the partnership is formed and are often heavily negotiated. Table 4.7 lays out the typical terms of an LPA. An investor’s negotiating power is influenced by the size of its capital commitment. Likewise, public sponsors that are large capital providers to a SIF may have greater leverage during negotiation. Some investors—institutional ones in particular—may have detailed requirements on certain LPA terms. Some LPA clauses may reflect generally accepted market standards, from which reputable managers may be disinclined to deviate. Commercial investors in a mixed capital SIF may also prefer to adhere to market standards.

TABLE 4.7 Typical terms of a limited partnership agreement

TERM DESCRIPTION

Investment strategy SIFs can opt to refer to the strategy detailed in the private placement memorandum, or also include detailed investment criteria in the LPA.

Investment restrictions The LPA includes express limits to the investments the fund may make, mirroring or expanding on those contained in the private placement memorandum. In addition to the limits (discussed in chapter 5 in the sections on risk management), the LPA may expressly forbid, for example, hostile transactions, investments in other funds (unless the SIF operates as a fund of funds), borrowing above certain thresholds, foreign investments, investments in portfolio companies affiliated to fund executives, and investments in industries deemed unethical.

Closing dates These are dates by which the fund may accept additional investors (usually limited to one to two years after the initial capital injection, to allow the manager to subsequently focus on investing rather than fundraising). Term The term is the life span of the fund and allowance for (typically limited) extensions. Early termination The LPA may include events that trigger the early termination of the fund (or the curtailment of new investment), by decision of investors that own a specified proportion of the fund commitments. These can include the failure of named key principals (key persons) to remain involved in the fund’s management or the material breach of the LPA by the manager. Some funds also permit a no-fault divorce, subject to a prescribed financial settlement with the management team, if approved by a high proportion of the limited partners. Noncompetition The LPA may include a prohibition on the formation of similar competitor funds until the expiry of the investment period or investment of a high portion (for example, 75% of the capital commitments).

Indemnity The LPA may indemnify or limit the liability of the general partner, the limited partners, the manager, the advisory committee, and each of their respective officers, employees, and agents. Exceptions are made in the case of a person who has acted in gross negligence or bad faith.

Transfers and withdrawals

The LPA may include restrictions to the transfer of limited partnership interests or withdrawals by limited partners. Reporting The LPA may include provisions on reporting of periodic financial, tax, and other information to investors. Capital contributions The LPA may specify size and timing of capital commitments to the fund, and provisions related to the drawdown of such commitments as the fund makes investments.

Distributions The LPA may specify the timing and process through which a fund makes distributions to its investors and manager. So-called waterfall provisions discipline the sequencing of distributions to the limited partners and the fund management team, who are usually entitled to receive a share of the fund’s profits (so-called carried interest) above a stipulated threshold. Management fees The fund manager will usually be paid a management fee periodically (for example, quarterly in arrears), in addition to the payment of carried interest. The LPA will set the management fee as a percentage of capital committed (in private equity funds, the typical range is 1.5%–2.5%). Other fees may be envisaged, for instance, for the reimbursement of deal-specific expenses incurred by the manager.

Source: Wylie and Marrs 2018. Note: LPA = limited partnership agreement; SIF = strategic investment fund.

SIF public sponsors will want to ensure compliance with the SIF’s policy mandate and may negotiate specific requirements through side letters. The SIF public sponsor must pay particular attention to the LPA provisions related to the fund’s strategy, which must be consistent with the strategy laid out in the private placement memorandum and ensure compliance with the SIF’s policy mandate, in addition to financial return requirements. The manager may also agree to side letters with some of the SIF’s investors containing tailored arrangements not included in the LPA. Such side letters could reflect, for instance, specific environmental, social, and governance requirements or investment exclusion lists of certain public investors in the SIF. Marguerite’s second fund (Marguerite II), for instance, complies with general investment eligibility criteria listed in the LPA to ensure adherence to the public sponsors’ policy goals, and also signed side letters with some sponsors to ensure compliance with their specific environmental, social, and governance requirements. Side letters could also discipline, for instance, the ability of a public sponsor to publicly disclose information on the fund and its investments.

Monitoring the external fund manager The primary means of monitoring the activity of the fund manager is the participation, by some of the SIF’s investors, in an advisory committee or advisory board (as discussed earlier under the subsection on oversight). Such committees are common in most private equity funds. The committee discusses and provides advice to the manager on multiple issues, especially related to conflicts of interest or valuation, as set out in fund documentation (Wylie and Marrs 2018). The advisory committee, however, does not interfere with investment decisions, which are the sole responsibility of the manager’s investment committee (Invest Europe 2018). The role and composition of the advisory committee should be articulated in fund documentation. Individual representatives on the committee should have enough fund investing experience to provide a meaningful contribution to discussions. Ideally, the advisory committee meets at least once a year (Invest Europe 2018).

In addition, the manager should keep investors duly informed through regular reporting of its investment activities. Specific regulatory requirements may apply in the SIF’s jurisdiction (see discussion in chapter 7). PCF industry organizations have also published guidelines and reporting templates that a SIF could use. ILPA (2016), for instance, has published comprehensive quarterly reporting standards for private equity funds, (refer to chapter 7 for a detailed discussion on SIF disclosure).

Regular meetings between the sponsor (and other SIF investors) and the external manager are also advisable. By remaining in contact with the manager, investors can get a sense of how the pipeline is being executed, the performance of portfolio companies, the manager’s success in adding value to portfolio companies, and other topics such as environmental, social, and governance compliance.

Finally, as described in table 4.7, the LPA will discipline the scenarios under which the fund can be terminated early.Early termination is determined, according to the LPA, by investors representing at least a specified portion of the fund’s capital commitments. It usually applies if the manager triggers a material breach of the LPA or key executives fail to remain involved in the fund’s management. Some funds also permit early termination outside of these circumstances (no-fault divorce), although in practice this faculty is rarely exercised and may require a financial settlement with the management team.