Divorce, Private Equity style...
Private equity funds have long lives. Private equity limited partnership agreements (LPAs) typically provide for an initial 10-year term, plus two one-year extensions at the discretion of the general partner of the fund (GP). However, fund terms often stretch out for much longer, sometimes 15 to 18 to 20 or more years. This is truly a long-term commitment, for both the limited partners (LPs) and for the GP. For an overview of LPs, GPs and limited partnerships, please see my prior post "LP Corner: US Private Equity Fund Structure - The Limited Partnership."
Because funds stay around for a long time, things will change. Partners may leave the fund’s management company; the investment strategy might drift away from the initial strategy; the investment performance may be terrible to the point that the LPs want to stop the GP from investing; the fund or management firm may be embroiled in a scandal; or in rare cases, the GP may behave badly (not illegally or in violation of the LPA, but in ways that may place their personal interests above the best interests of the LPs). There are many other changes that can occur during the life of a fund.
To read more, please click "Read More" to the right below.
Private equity funds have long lives. Private equity limited partnership agreements (LPAs) typically provide for an initial 10-year term, plus two one-year extensions at the discretion of the general partner of the fund (GP). However, fund terms often stretch out for much longer, sometimes 15 to 18 to 20 or more years. This is truly a long-term commitment, for both the limited partners (LPs) and for the GP. For an overview of LPs, GPs and limited partnerships, please see my prior post "LP Corner: US Private Equity Fund Structure - The Limited Partnership."
Because funds stay around for a long time, things will change. Partners may leave the fund’s management company; the investment strategy might drift away from the initial strategy; the investment performance may be terrible to the point that the LPs want to stop the GP from investing; the fund or management firm may be embroiled in a scandal; or in rare cases, the GP may behave badly (not illegally or in violation of the LPA, but in ways that may place their personal interests above the best interests of the LPs). There are many other changes that can occur during the life of a fund.
To read more, please click "Read More" to the right below.
An example of a GP behaving badly but not in violation of the LPA or law might be a partner’s refusal to step off of a board of a portfolio company after it has been public for a long time. If a partner is on the board of a public portfolio company, the fund is restricted in its ability to sell its stock in that portfolio company. If the fund is 15 years old, and the portfolio company has been public for several years, in my view the partner should step off the board to allow the fund to either sell or distribute the stock to the LPs. But being on a public board is like being in an exclusive club; once in the club, you don’t want to leave. In this case, the interests of the individual partner conflict with the interests of the LPs.
A common LP protection is known as the “no fault” divorce or “no fault termination.” These rights can provide that upon a super-majority vote of the LPs (ranging from 2/3 to 80%), certain things can happen, such as: suspension or termination of the investment period, removal of the GP, or dissolution of the fund. There doesn’t have to be a specific reason or triggering event for the exercise of these rights – the dissatisfaction of the LPs is sufficient. Note that unlike stockholders in publicly-traded companies who can sell their shares instantly in the public market, LPs in private equity funds don’t have that luxury, which is why provisions like this are needed.
The Institutional Limited Partners Association (www.ilpa.org), in their Private Equity Principles version 2.0 (January 2011) (available here) outline their position:
These “no fault” provisions are rarely exercised, but it does happen. In some cases, the credible threat of exercising these provisions will be enough to effect change.
A key area of LPA negotiation is what happens when a GP is removed without cause. Key considerations include:
In a later post, we will discuss removal of the GP “for cause.”
This is a continuation of a series of posts on fund terms. Prior posts include:
© 2018 Allen J. Latta. All rights reserved.
A common LP protection is known as the “no fault” divorce or “no fault termination.” These rights can provide that upon a super-majority vote of the LPs (ranging from 2/3 to 80%), certain things can happen, such as: suspension or termination of the investment period, removal of the GP, or dissolution of the fund. There doesn’t have to be a specific reason or triggering event for the exercise of these rights – the dissatisfaction of the LPs is sufficient. Note that unlike stockholders in publicly-traded companies who can sell their shares instantly in the public market, LPs in private equity funds don’t have that luxury, which is why provisions like this are needed.
The Institutional Limited Partners Association (www.ilpa.org), in their Private Equity Principles version 2.0 (January 2011) (available here) outline their position:
- On 2/3 in interest vote of LPs, the fund’s commitment period can be suspended or terminated; and
- On 3/4 in interest vote of LPs, the GP may be removed or the fund can be terminated.
These “no fault” provisions are rarely exercised, but it does happen. In some cases, the credible threat of exercising these provisions will be enough to effect change.
A key area of LPA negotiation is what happens when a GP is removed without cause. Key considerations include:
- Whether the GP be paid some kind of termination (or "breakup") fee
- What happens to the GP's carried interest?
- What happens to the GP's commitment to the fund?
In a later post, we will discuss removal of the GP “for cause.”
This is a continuation of a series of posts on fund terms. Prior posts include:
- Management Fee
- GP Commitment
- Carried Interest Overview
- Carried Interest – Preferred Return and GP Catchup
- GP Clawback
- Management Fee Offsets
- Key Person Clauses
© 2018 Allen J. Latta. All rights reserved.
