The strength of private equity funds lies in their ability to invest in illiquid opportunities that take years to mature and yield returns. At an initial take, however, this can sound very dangerous to investors. But the way private equity fund managers were able to raise record amounts of capital to manage despite this seemingly long horizon and lack of liquidity is through giving investors comfort in the fund terms, and developing practices that align investor interests with fund manager interests over the life cycle of the fund.
Amongst such developed practices is the establishment of fund advisory boards and limited partners’ advisory committees. This article discusses the roles each of these bodies plays within a private equity fund.
Advisory Boards and Limited Partner Advisory Committees in General
It is important to note that private equity funds are not mandated by law, considering the commonly used fund jurisdictions, to have advisory boards or committees. Yet, it is best market practice to include both because each can serve an important purpose for the management of the fund.
Advisory boards provide advice and market insight to the fund manager (referred to as General Partner or (“GP”). Their advice assists with sourcing transactions, and the advisory board’s existence lends credibility to the fund. With this in mind, advisory boards should be composed of industry experts or service providers in the area of the fund’s focus. Common candidates for advisory boards are established private equity fund managers (assuming there is no direct competition), economic experts, and service providers to the private equity industry.
Limited Partner Advisory Committees
Limited Partner Advisory Committees (“LPAC”) differ from advisory boards. While an advisory board consists of industry and financial experts who can advise the GP, an LPAC is composed of a representative (3 to 5) group of investors (referred to as limited partners or “LPs”) that are appointed by the GP. Rather than providing high-level guidance to the GP, an LPAC helps handle more sensitive matters that the GP faces to ensure that they are managed to the comfort of the investors. These include:
- Conflicts of interest. An LPAC allows a smaller, focused group to make decisions about conflicts of interest between LPs and GPs. Common conflicts of interest include investments in affiliated funds, purchases from or sales to affiliates of the GP, service contracts with GP affiliates, and review of valuations prepared by the GP. The LPAC has the power to approve or disapprove conflict-of-interest transactions.
- Waivers of LPA restrictions. The Limited Partnership Agreement or fund terms and conditions (referred to as an “LPA”) may include restrictions on the fund or the GP, including the partnership term, caps on investments, industry restrictions, restrictions on investment in foreign companies, investment period, and change of control restrictions. The LPA may provide that the LPAC can take action to waive certain restrictions or approve certain decisions.
- General oversight. Depending on how the LPAC is structured, the committee may have the power to provide additional oversight and transparency to the fund. The LPAC could receive additional financial and other data including access to fund auditors and approval of accounting variances. If granted this power, the LPAC acts as a balance to the GPs power over the fund.
In order to have a highly effective LPAC, it is advisable that it is composed of knowledgeable LPs that are not affiliated with the GP. Any duties or powers allocated to the LPAC should be clearly detailed in the LPA, and each member should be aware of the scope of their responsibility. Members of an LPAC are likely to be concerned about their own liability based on the fund’s actions, so you will need to consider insurance and indemnification provisions.
Make Smart Decisions
If you are considering establishing or investing in a private equity fund, it pays to focus on the details of the fund’s structure. Take some time to determine whether the fund would benefit from an advisory board or an LPAC. Then spend the time to make sure either or both bodies are effectively staffed and that all details are included in a well-drafted LPA or fund Terms and Conditions.
The GP Series
The GP Series is a series of practical guidance notes prepared by Hammad & Al-Mehdar’s PE and VC team that are designed to guide GPs and practitioners on best practices relating to private equity fund management.
The attorneys at Hammad & Al-Mehdar represent over 35 years of experience in providing legal services in Saudi Arabia and the UAE at international standards. Contact us today to discuss how we are able to support the legal demands of your private equity fund.