Earlier this 12 months the Institutional Restricted Companions Affiliation (ILPA) launched a Delaware-law primarily based Mannequin Restricted Partnership Settlement (Mannequin II LPA) to be used by personal fairness fund sponsors wishing to implement a “deal-by-deal” distribution waterfall of the sort extra widespread in america. The Mannequin II LPA is a variation on the European fashion “whole-of-fund” mannequin restricted partnership settlement ILPA revealed in October 2019. Like the sooner “whole-of-fund” mannequin, the Mannequin II LPA builds upon the ideas set forth within the third version of the ILPA Ideas (Ideas 3.0), which search to advertise the alignment of pursuits between basic companions (GPs) and restricted companions (LPs) by way of higher fund governance, the adoption of a better customary of care, and elevated transparency and enhanced disclosure. For extra info concerning the “whole-of-fund” mannequin LPA and ILPA’s Ideas 3.0, please see our Funding Administration Advisories “ILPA Publishes Mannequin Restricted Partnership Settlement Making use of Ideas 3.0” and “ILPA Ideas 3.0: Specializing in Enhancing Transparency in Personal Fairness Funds and Various Investments.”
By offering mannequin language for the restricted partnership settlement of a fund utilizing a deal-by-deal distribution waterfall, ILPA expects that the Mannequin II LPA will present a number of advantages to the business, together with (1) minimizing the complexity, time and value of negotiations between GPs and LPs and lowering the size of facet letter agreements; (2) offering GPs with better fundraising certainty; (3) reducing fund formation prices; and (4) offering LPs extra balanced and clear phrases that clearly clarify their rights and obligations. However, realizing these advantages might show troublesome in apply. It’s because, though the Mannequin II LPA was drafted with enter from attorneys within the business representing each GPs and LPs, ILPA represents the pursuits of the investor neighborhood and the Mannequin II LPA is in lots of respects a LP pleasant settlement.
The complete textual content of the Mannequin II LPA is offered right here.
Notable Provisions of the Mannequin II LPA
The Distribution Waterfall. What distinguishes the Mannequin II LPA from the sooner whole-of-fund mannequin restricted partnership settlement is, after all, how internet features realized from the sale or different disposition of all or a portion of a portfolio funding are distributed among the many companions. Within the whole-of-fund mannequin, the GP doesn’t begin to obtain its carried curiosity distributions till LPs have obtained cumulative distributions equal to their mixture capital contributions to the fund plus their most popular return (or hurdle).
In distinction, a typical deal-by-deal distribution waterfall usually permits the GP to obtain carried curiosity distributions as quickly because the LPs have obtained cumulative distributions equal to the sum of their capital contributions used to fund every realized portfolio funding and to pay bills plus the popular return on such capital contributions. Many such deal-by-deal waterfalls additionally require that LPs recoup their capital contributions used to fund portfolio investments (and associated bills) which have been written off or which have in any other case suffered a fabric impairment and been completely written down earlier than the GP receives any carried curiosity distributions.
The Mannequin II LPA provides a couple of decidedly LP-friendly variations to this extra customary mannequin which can very properly result in extra relatively than much less negotiation between GPs and LPs. Underneath the Mannequin II LPA, earlier than the GP begins to obtain its carry, not solely should every LP have obtained cumulative distributions equal to the sum of their capital contributions used to fund every realized portfolio funding and pay fund bills, but in addition an quantity equal to their professional rata portion of the fund’s “unrealized losses” (i.e., the portion of the capital contributions made by the LPs to fund unrealized portfolio investments that exceeds the worth of these unrealized portfolio investments on the date of willpower), plus the popular return on all such capital contributions.
Requiring LPs to obtain distributable proceeds equal to the mixture abnormal unrealized losses on portfolio investments that haven’t been written off or “Completely Written Down”1 by the fund isn’t a market time period and one a properly suggested basic companion would probably not settle for, notably when mixed with the interim clawback mechanism mentioned beneath. Collectively, these two provisions quantity to duplicative safety towards the danger of an over distribution of carried curiosity to the GP.
As well as, beneath the Mannequin II LPA, the calculation of the popular return takes into consideration not solely the capital contributions used to fund realized investments and pay bills, but in addition the portion of capital contributions used to fund nonetheless unrealized portfolio investments that exceeds the worth of these unrealized investments on the date of willpower. This characteristic additionally isn’t at present a market customary time period.
Closing and Interim Clawback. When the ultimate liquidating distribution is to be made to the companions, the Mannequin II LPA, like the sooner whole-of-fund restricted partnership settlement, requires the GP to find out if it has obtained cumulative distributions of carried curiosity over the lifetime of the fund that exceed what it ought to have obtained, considering within the mixture all capital contributions and all distributions through the lifetime of the fund. Any such extra is to be returned to the fund for distribution to the LPs.
As a result of the deal-by-deal distribution waterfall permits carried curiosity distributions to be made to the GP earlier than the LPs have been returned their mixture capital contributions plus the popular return, the danger of the GP receiving extra carried curiosity distributions over the lifetime of the fund is bigger as a result of distributed income from every realized funding could also be offset by losses from future tendencies of portfolio investments. The Mannequin II LPA seeks to mitigate this threat by introducing an interim clawback provision.
On varied measurement dates starting on the primary anniversary of the top of the dedication interval, if the GP has obtained any distributions of carried curiosity, the GP should calculate what it might owe the LPs if the fund had made a hypothetical remaining liquidating distribution of its belongings at their worth on the date the interim clawback is being calculated. If an interim clawback obligation exists, the GP should present the LPs with its calculation and contribute the interim clawback quantity to the fund (which quantity shall not exceed the sum of the cumulative carried curiosity distributions made to the GP decreased by any taxes paid or payable by the GP with respect thereto). The interim clawback quantity is distributed to the LPs and is handled as an “advance” that might be offset towards any future distributions owed to the LPs.
To allay additional LP considerations concerning the fee of carried curiosity to a GP earlier than the ultimate place of a fund is understood, the Mannequin II LPA additionally requires the GP to deposit 30 % of all distributions of carried curiosity into an escrow account to safe its potential clawback obligation.
Administration Charge. In the course of the Dedication Interval, the administration payment is a proportion of the Capital Commitments. Thereafter, it’s a proportion of the Capital Contributions used to fund the acquisition price of portfolio investments (apart from non permanent investments) much less the acquisition price of portfolio investments which have been realized, written off or Completely Written Down.
Governance, Normal of Care, Exculpation and Indemnity. The Mannequin II LPA incorporates the provisions included within the whole-of-fund mannequin restricted partnership settlement, which was up to date earlier this 12 months, regarding fund governance, the GP’s customary of care and fiduciary responsibility, the exculpation and indemnity of the GP and its associates and their respective companions, members, staff, administrators, officers and key individuals, fund termination and GP removing. Please see our Funding Administration Advisory, “ILPA Publishes Mannequin Restricted Partnership Settlement Making use of Ideas 3.0,” for a dialogue of these provisions.
The Mannequin II LPA is the newest element of ILPA’s broader LPA Simplification Initiative. ILPA acknowledges that the Mannequin II LPA is probably not applicable for each fund, and as now we have indicated above, its LP pleasant phrases are probably not going to be acceptable to most GPs and are usually not but market customary. That mentioned, as famous above, sure points of the Mannequin II LPA are per and replicate the elevated bargaining energy of LPs. Moreover, much like the sooner whole-of-fund mannequin restricted partnership settlement, the Mannequin II LPA supplies a sensible utility of Ideas 3.Zero and might function a place to begin for focusing negotiations between GPs and LPs, which can cut back authorized prices and organizational bills.
1 Underneath the Mannequin II LPA, a portfolio funding is “Completely Written Down” when it has been written all the way down to beneath 50 % of its unique acquisition price.
Allison Yacker additionally contributed to this text.