Investors are demanding increased oversight over fund affairs and the remit on which the limited partner advisory committee is asked to comment is expanding. While this may give comfort that more robust checks and balances are in place to temper GP activity, it does also raise issues of investor involvement and liability. Recent examples of dysfunctional LPAC relationships have raised questions regarding what protections investors should be seeking prior to accepting LPAC seats.
Here are three points of contention and some practical steps to ensure effective LPAC operations.
Historically, LPAC oversight was limited to the approval of conflicts of interest (for example, in the case of a GP-led secondary), but this is now moving towards a wider remit – for example the LPAC’s role now often includes the general right to review the performance of the fund’s assets, something which active investors are exercising more frequently.
This expanded role has a clear knock-on effect on the time commitment and skill set required of LPAC members. As the LPAC moves from a conflict clearance tool to a committee with broad range of scrutiny and approval rights, its members are expected to devote more time to fund affairs. Investors do well to seek indemnification from liability under the fund’s partnership agreement as well as written confirmation that their remit does not erode their limited liability status.
The rise in GP-led secondary sales and end-of-life liquidity offers has created an increased set of conflict scenarios. With this rise in potentially adversarial discussions between GPs and investors, the ability for the LPAC to appoint independent counsel – at the cost of the fund – is essential.
Without these protections, investors must ask whether they are comfortable accepting seats on LPACs which may, in extremis, be asked to act under complex conditions.
Critics are quick to flag that given the GP appoints the LPAC, it is rarely an accurate representation of the fund’s investor base.
It is a testament to the prestige of the LPAC itself that GPs reserve appointments for the largest investors or key relationships of the vehicle. Examples of GPs padding LPACs with ‘safe’ relationships abound but are hard to prevent in practice; seeking disclosure of existing LPAC members and the rationale for their inclusion as part of investment due diligence is essential. The danger is that difficult decisions are waved through by a sympathetic LPAC. To guard against such questions of bias, investors – including those not being offered seats – do well to negotiate the LPAC’s operative provisions to ensure independence and transparency of decision-making.
The LPAC should be able to call its own meetings, excluding the GP if necessary and to call members of the deal teams and/or the fund auditors to provide further information. It is not unheard of for investors to request to meet with the board of portfolio companies – although in practice this is rare.
Where the LPAC has real concerns around a particular decision they could also seek the right to put the matter back to a wider investor consent.
Constituted correctly, the LPAC is more agile in its decision-making than the full investor-base, while representing a critical mass of overall votes. It serves neither GP nor investor to effectively re-constitute the investor base by over-allocating LPAC seats.
It is here that the competing interests of a GP in ‘marketing’ mode – incentivising investors to make commitments, and a GP in ‘fund management’ mode – having to deal with the loss of efficiency which an oversized LPAC creates, can be seen.
Having witnessed the inefficiency of LPACs approaching 20 members, we would strongly advise all parties to limit the number of appointments made, or to grant observer seats as an alternative class of LPAC right. Likewise, investors should demand operative provisions which streamline decision making (for example, telephone meetings and voting by a simple majority of those participating).
Where the LPAC comes into its own is where it can act quickly to resolve an issue; if the operative provisions make the timescale and decision making process akin to a full investor vote, one queries the real benefit to either the GP or investors.
In calm waters it is clear why an organised and engaged LPAC is a benefit to both GPs and investors alike, allowing contentious issues to be resolved efficiently.
GPs benefit from working closely with their investors and can strengthen key relationships outside of a fundraising cycle. Investors get access to fund operations and deal teams and are able to look under the hood of the vehicle’s assets.
However, care must be taken to carefully frame the LPAC’s remit and protections so that investors are able to properly perform their LPAC duties in difficult and potentially adversarial scenarios without fear of reprisal or increased liability.
Gabriel Boghossian is a partner and Sarah de Ste Croix is senior counsel at law firm Stephenson Harwood, based in London.