Are GPs Listening? New ILPA Report Out

The Institutional Limited Partners Association (ILPA) created the ILPA Private Equity Principles in September 2009. In response to much of what happened during the past few years, these guidelines were meant to "serve as a common framework for continued discussion among and between the general partner and the limited partner communities with the goal of improving the private equity industry for the long-term benefit of all its participants".

A recent report published by industry research leader Preqin, took a look at what ILPA principles were being followed in recently formed funds. The report looked at funds primarily in North America, Europe and Asia. Here's a summary of some of their findings: 

Carry/Waterfall

In effort to achieve better alignment of interests, ILPA called for a standard-all-contributions-plus-preferred-return-back-first mode. What this means is that in terms of the sequence in which proceeds from the sale of a portfolio company are distributed, funds should not pay carry to the fund manager until all capital that has been drawn down has first been returned to the investors. The European distribution waterfall (vs. the American waterfall, which is more GP friendly) repays all drawn down capital to the LPs (cash that was called for realized and unrealized investments, management fees and other expenses of the fund), then pays a preferred return on all drawn down capital and ONLY then does the manager start to get their carry (typically 20% share) of remaining proceeds usually with a catch up.

The report found that within North America, nearly half (47%) of all recent funds (vintage 2009/2010) are still distributing proceeds on a deal-by-deal basis vs. a whole fund carry structure. Compare this to European and Asian funds where only 11% of recent funds utilize a deal-by-deal structure as the basis for distribution of fund proceeds with the majority employing the whole fund carry structure.

GP Contributions

Another area LPs have focused on in an effort to achieve a better alignment of interest between GPs and LPs is the call for the general partner to have a substantial equity interest in the fund.

The report found that 39% of recent funds have a GP contribution of 1-1.99%. 22% of funds have GP contributions  of 2-2.99%. 10% of funds have a GP contribution of 5-5.99% and 14% have a GP contribution of 10% or more.

The key here is that the GP should have sufficient "skin in the game" to demonstrate their financially aligned interests with their investors. Investors will shy away from funds that do not demonstrate this.

Other areas covered in this report included management fees post investment period, transaction and monitoring fees and a no-fault divorce clause.

So what does this all mean in terms of investors? 58% of LPs polled in this survey indicated they may not invest in a fund as a result of a GP ignoring ILPA guidelines. GPs need to be keenly aware of the changed environment and the term-conscious LP community when structuring their funds or face a very long and uphill fund raise. 

Sagar A. Dalal is the co-founder and managing principal of Beckerman’s real estate fund advisory division. The division works with real estate fund managers by advising on all aspects of the private fund placement process including fund structuring, competitive positioning and market assessment, preparation of fund-related documentation and providing expert fund communication advisory services to fund managers to ensure a productive and successful relationship is maintained with current and prospective investors. He can be reached at [email protected].