ILPA updates influential guidance for investors in private funds

The third edition of the Private Equity Principles (44-page /399KB PDF), produced by the US-based Institutional Limited Partners Association (ILPA), updates and expands the 2011 version. The aim of the document is to provide best practice guidance on a range of topics relevant to private equity investment, with a view to creating a standard set of terms for use by institutional investors when negotiating with fund managers.

ILPA was set up to represent the institutional investors who act as limited partners of private equity funds. These include public and corporate pension funds, insurers, hedge funds and others. Over 500 institutions are members of ILPA, representing over $2 trillion worth of private equity assets under management.

"Private equity has evolved considerably over the last decade and it was important for the ideals and practices that enable a vibrant industry to keep pace with market change," said Steve Nelson, chief executive of ILPA. "The purpose of the Principles programme is to foster a stronger private equity ecosystem through shared expectations, and for those shared expectations to become the industry standard."

The new edition of the principles is more granular than the previous editions, and covers a wider variety of topics. Among the topics covered more fully or for the first time are GP-led secondaries, fee and expense reporting; scope of the fund audit; subscription lines of credit; co-investment allocations and notifications and disclosure, including around ESG and impact investing.

Investment funds expert Oliver Crowley of Pinsent Masons, the law firm behind Out-Law, said: "There are a number of existing principles which have been strengthened from an LP [limited partner] perspective and GPs will need to consider this carefully when going to market. There is also guidance on new topics, including ESG and impact investing, which is in line with the ever growing focus on this area."

The principles are structured around the 'three guiding principles' which, in ILPA's view, form the essence of an effective private equity partnership: alignment of interests; partnership governance; and reporting transparency. Broadly, ILPA expects the general partner of the fund to make decisions taking into account the benefit to the partnership as a whole; to provide timely, clear and not misleading disclosures to investors; and to charge reasonable fees.

ILPA continues to state that profits be distributed on a 'whole-of-fund', rather than transaction by transaction, basis, as best practice. It has for the first time given guidance on subscription lines, which it states should not be used to enhance internal rates of return (IRR), and returns should be calculated from the date the facility is drawn rather than when capital is called from individual limited partners.

"This deviates from general current market practice albeit we are aware of a number of large investors who are all requiring such terms," said Crowley.

On carried interest ('carry'), IPLA states that clawback should be gross of taxes. This deviates from the previous version of the guidelines, ILPA 2.0, and will receive close attention from GPs, according to Crowley

Guidance on what 'management fees' and 'partnership expenses' should cover is set out in far greater detail, as are the requirements for offsets. The principles are particularly strict around travel expenses, third party administration charges and hosting costs attributable to annual general meetings.

ILPA has also for the first time given guidance on GP-led secondaries, including on the structure of the process, the role of the LPAC and information to be provided to investors. 

Provisions in the principles relating to ESG investment factors and impact investment have been greatly expanded, in line with developments in the industry and more generally. General partners should consider maintaining and periodically updating an ESG policy, which is to be supplied to investors on request. The guidelines list several recognised industry frameworks as examples of rules with which a general partner could comply.

If the general partner markets the fund as pursuing an impact investing strategy, it should put in place a framework to measure, audit and report on the impacts achieved, according to ILPA.

"Measuring impact is very topical and many sectors are still trying to find a consistent approach on this," said Crowley

ILPA said that it did not intend to seek official endorsements for the latest version of the principles. Instead, it is encouraging industry-wide adoption through supporting guidelines, templates and model documents. It is also encouraging investors in asset classes other than private equity to consider the adoption of relevant sections of the document.

Funds expert Ian Warner of Pinsent Masons said: "GPs have always had to consider ILPA principles in the past and the level of detail included in these new guidelines will only increase the scrutiny on GPs that are looking to deviate from what ILPA sees as best practice.  First-time fund managers in particular should be able to save time and expense if they base their terms around what ILPA is suggesting."