Some Thoughts on Limited Partner Advisory Committees
Ask A CIO #59
It is so cold in New York. Cold enough that we’re asking ourselves if it’s possible that the Hudson River might actually freeze over.
If you’ve never lived in New York, you probably haven’t experienced the city in a snowstorm. And you probably also haven’t experienced the state of New York sidewalks following these snowstorms.
For however long it takes for the snow to melt away, New Yorkers are stuck awkwardly dancing around each other on narrow sidewalk paths and crosswalks. There’s maybe enough room to allow a single file line of pedestrians walking in each direction, if that.
And then at the end of each block, there are just these comically large snow mountains. Snow has been plowed off the streets and sidewalks (sorta), but there’s no place to move the snow. So into random, giant piles they go!
This week’s question has nothing to do with snow, or winter. I’m just ready for this cold spell to end!
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How do you think about LPAC member responsibility before you decide to not re-up? Are you supposed to raise issues? Why or why not? Is there a different standard of feedback that applies to LPAC members versus just LPs?
I love this question. My mind immediately goes to a bunch of different places, so I’ll try to organize my thoughts in a useful order. In a fortuitous bit of timing, I also recently had the benefit of joining a closed door discussion on LPAC best practices. I’ll incorporate some of the more universally shared perspectives here too.
But before we start, let me first describe LPACs for those readers that may be less familiar with the concept. LPAC stands for Limited Partner Advisory Committee. These committees are formed from a subset of LPs as part of the governance structure for (most typically) closed-end private equity funds. LPACs don’t get involved in investment decision making, that’s the purview of a fund’s General Partners (GPs). LPACs are called upon to weigh in on things like industry wide best practices, valuation policies, legal or compliance matters, etc.
Buried somewhere in the hundred plus pages of a Limited Partnership Agreement, the legal document that governs every buyout, growth equity, and venture capital fund, there is a section describing the LPAC and its role. And while there is some variation in the influence of LPACs across funds and firms, LPACs are tasked with representing the interests of all the LPs of those funds in those moments when LP interests need to be represented (more on this later).
The natural next question might be – well, who gets to be on these LPACs? As is so often the case, the answer is – it depends. Some GPs have a dollar threshold. If an investor commits a minimum dollar amount or above, that investor automatically has a seat on the LPAC.1 For many more GPs, it’s a blend of the GP courting specific LPs and/or LPs negotiating for that LPAC spot, if they’re so inclined.
In fact, the question of whether to sit on an LPAC at all can be a topic of debate in some investment offices. I’ve always felt strongly that having an LPAC seat is preferable, whenever possible. Some in the LP community hold less favorable views of serving on LPACs, most frequently citing the time commitment required from LPs versus the potential benefit of participation. Fair enough. I’ve also heard LPs mention the greater difficulty of not re-upping in a manager’s follow-on fund while serving on an existing fund’s LPAC. This concern touches directly on your question, and I am admittedly far more skeptical of this argument (more on this later too).
Ok, we’ve covered what an LPAC is and who sits on an LPAC. So why do LPACs exist and how do they work? Or perhaps more accurately, how might they ideally work?
Going back to my earlier comment, LPACs exist to represent the interests of all the LPs in those funds in those moments when LP interests need to be represented. These are moments when GPs take, or are about to take, actions that pose potential conflicts of interest. To be clear, in these moments, it doesn’t mean GPs are behaving badly, just that GP and LP interests may not be fully aligned. Common examples might include: fund to fund transactions, changes in key person provisions, fund amendments, or fund extensions. When these events pop up, the GP generally needs some threshold of LPAC member votes in favor of the proposal to take that action.2
Aside from these one-off situations, an LPAC typically meets once per year during a GP’s annual meeting. The LPAC basics described above are approximately similar across firms and funds.
But, and it’s a big but, how well LPACs operate as advisory committees for GPs and how effectively LPACs can advocate for LP interests vary enormously. And here, I’m going to share some thoughts that you didn’t ask for, but that I want to put out there.
Pulling from that recent LPAC discussion, some basic suggestions:
LPACs are most effective when GPs provide consistent and transparent fund and firm information. Information and LPAC meeting material should be shared well ahead of the annual meeting to give the LPAC ample time to prepare.
In camera sessions where LPAC members are given the opportunity to talk amongst themselves and coordinate feedback are highly valuable.
Smaller LPACs may be preferable. Experienced LPAC members are necessary.
In keeping with transparency, LPAC members should be provided with a full list of members along with their organizations and contact information.
All of the above assumes that a GP wants an effective LPAC. If we’re being totally blunt, that isn’t always the case. And whether intentionally or not, some LPACs can feel not particularly impactful. Hence the viewpoint from some corners that LPACs aren’t worth the time or effort.
Having already shared my broader perspective on LPACs, you might have a sense of where I’m going with this when it comes to your specific questions.
First, an LPAC member’s responsibility doesn’t change based on a decision to re-up or not in a GP’s follow-on fund. The LPAC member continues to have a duty to represent LP interests for the duration of that fund’s term. And since these are closed-end funds we’re talking about, that LPAC member’s own exposure to the existing fund doesn’t change, so the LPAC member is certainly incentivized to do a good job.3
Second, I’m of the belief that an LPAC member’s decision to re-up or not in a GP’s follow on fund should be made independent of that LPAC role. Compared to other LPs, LPAC members, to some extent or other, have more visibility into the operational and strategic decisions made GPs. They may also have closer lines of communications with the GP. To the extent that an LPAC member doesn’t re-up, it’s important to convey that decision while maintaining an ongoing constructive partnership.
Lastly, to your questions about LPAC members raising issues and standards of feedback. If an LPAC is operating effectively, there should be multiple opportunities, both formal and informal, for LPAC members to raise issues and concerns throughout the life of the fund. From the LP perspective, of course LPAC members have a greater duty for feedback. They serve as representatives and are the collective voice on behalf of the entire LP base.
That said, I think you may be asking from a GP perspective, so let me conclude by turning the question back to you. As the GP, how do you want to engage your LPAC members? Ideally, you’re building a partnership where LPAC members can share views and disagreements without turning adversarial. And if that’s the case, then I would expect that you’re putting yourself in a good position to receive useful feedback on a consistent basis, not just when LPs are deciding whether or not to re-up.
Thanks for the great question! As always, reach out at askacio@ivyinvest.co.
See you in two weeks,
Wendy
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This selection mechanism tends to show up more in the mega funds as compared to smaller or middle market private funds. In these cases, the thresholds for LPAC inclusion are high, for example $100 million commitment or greater.
Depending on a given fund’s Limited Partnership Agreement terms, the full LP base may also need to provide some threshold of votes in favor of approval.
Assuming no LP secondary transactions here. If the LP sells its position, that’s a whole other discussion.