Proskauer’s Nigel van Zyl explains the key commercial, legal and investor relationship issues GPs need to consider before amending the agreement’s provisions or restructure funds in this excerpt from The LPA Anatomised.
It is inevitable that the terms of a document designed to govern and regulate the complex relationship between a general partner and its investors over a 10- to 12-year period may need to be revisited and renegotiated from time to time.
This is often the case in the years immediately following upheavals or disruptions in the financial markets, such as between 2001 and 2004 after the collapse of the dot.com bubble and following the global credit crisis.
This chapter examines some of the common fund terms that have been renegotiated over the last few years, the circumstances that typically trigger renegotiations and the issues GPs need to consider when approaching their investors to discuss revising fund terms.
The circumstances in which limited partnership agreements have had to be renegotiated generally can be divided into the following three broad categories:
- Renegotiations at the initiative of the GP. These include:
- extensions to a fund’s investment period and to the duration of the fund term,
- enhancing the ability to retain or recycle investment proceeds,
- amending or revising a fund’s investment strategy or investment restrictions,
- dealing with succession planning,
- obtaining waivers to raise top-up funds or other similar products,
- increasing the size of a fund and planned changes of control in GPs due to spin-outs, financial institutions disposing of their private equity businesses, sales of stakes to strategic investors and the listing of management companies; and
- GP-led fund restructurings of older vintage
- Renegotiations due to disruptive or unplanned events. This could be triggered by the death or departure of key executives, or strategic or significant investors defaulting, or threatening to default, on their commitments to a fund.
- Renegotiations driven by investor activism. This is where investors threaten to, or do, invoke the provisions of the LPA that allow them to suspend investment activity, terminate the fund or replace the GP. Typically, this would be in situations where the investors are very unsatisfied with the performance or conduct of the GP. This is less common.
There are many key commercial, legal and investor relationship points that GPs need to consider when deciding to approach their investors to amend the LPA provisions or restructure funds. These are listed below.
- It is important that there is a clear rationale demonstrating that the proposed amendments are in the best interests of the fund and are designed to deliver enhanced value to the investors, or designed to preserve or protect the value of the fund’s portfolio, and this is clearly communicated to investors.
- In a number of circumstances, when approaching their investors to amend key provisions, a GP’s past performance and track record, and the current position of the unrealised portfolio, influence how investors respond to requests from
- GPs should go to great lengths to demonstrate that the amendments they are proposing are not simply attempts to extend or enhance management fees. To the extent the effect of the amendments does result in enhanced management fees, GPs need to communicate very clearly why it is in investors’ interests to continue paying management fees at particular levels or, indeed, to pay management fees at all beyond what investors contractually agreed to when committing to the
- In circumstances where the amendments could give rise to conflicts between investors and the GP, or between the relevant fund and another investment vehicle (for example, a top-up fund or co-investment fund or a fund restructuring), the GP needs to set out how these conflicts of interest will be managed and resolved so that the investors are not prejudiced, and be cogniscant of the fiduciary duties a GP owes to the fund and its investors.
- Communicating early with members of the LP Advisory Committee (LPAC) and other key strategic investors to obtain their views and input on any proposed amendments or fund restructure is strategically important. GPs must know, before formally approaching the entire investor base in their funds, that they have the support of a majority of the investors on their LPAC and the support of other large, strategic or influential investors.
- GPs need to understand their limited partner (LP) base and have a sense of the macro- issues, possibly entirely unrelated to their own funds or the approvals they are seeking, that may influence their investors’ attitudes towards proposed amendments. GPs should attempt to anticipate these issues in any proposals that they place before their investors.
- Understanding what the LPA provides about amendments to terms, how these amendments need to be approved by investors and what level of consent is required from investors is also important. Certain types of amendments, extensions or waivers may not have been expressly contemplated when the LPA was drafted and, therefore, must be dealt with under the general amendment and variation clauses within the agreement. Depending on how these clauses are drafted and what protections investors negotiated at the time the funds were raised, certain amendments, waivers or extensions may require all investors to approve the It is important that GPs receive clear and commercial legal advice on their positions.
- In situations where a single investor (or a minority of investors) indicates that it is not going to consent to an amendment, extension or waiver, GPs should be prepared to provide solutions and alternatives to those investors. Solutions could include:
- offers to facilitate secondary sales of their stakes in the fund to other investors or indeed the GP itself,
- structuring the relevant amendment, extension or waiver so that the fund can be bifurcated and continue to operate both for investors that have objected to the proposals and for investors that are supportive of the proposals, and
- in respect of fund restructurings, ensure the restructure allows investors to participate in the restructure in a manner that maintains the ‘status quo’ for them.
- These situations could result in conflicts of interest arising between different groups of investors. Therefore, it is important to have a clear strategy and governance process for how these conflicts would be managed.
GPs need to be aware of the risk that when they are seeking to renegotiate terms, investors may seek discussions on other unconnected fund terms. This is especially the case with funds raised at the top of the market with terms that investors now consider to be over generous to the GP.We can see how these principles are applied in practice in situations such as renegotiating extensions of investment periods and fund terms, succession planning and change of control, which are, among other terms, discussed further below.
Nigel van Zyl is a partner and head of the European Private Investment Funds Group at Proskauer. He advises private equity fund managers, institutional investors and investment advisors on a broad range of issues, including fund formation, secondaries transactions, fund investments, spin-outs and restructurings.