- GPs try to control the message, especially in negative situations
- Confidentiality provisions have become overly broad
- Some LPs talk regardless of contract provisions
Imagine this: You’re a limited partner in a 10-year-old private equity fund. The fund has not performed well and still has six remaining portfolio companies with no exit in sight.
The general partner has gone quiet, barely responding to your information requests. The GP owes you money for early profits he collected when the fund was young — profits that were wiped away by subsequent busted deals.
With little other choice, the LP advisory committee decides it’s time to remove and replace the GP. Around this time, you receive a strongly worded letter from one of the partners reminding you of your obligations under the fund’s confidentiality provisions.
This gives you pause because under the contract provisions, you are essentially barred from speaking with anyone other than your organization’s attorney about fund business.
Would deliberating with other LPs in the fund violate the provision? And if so, would the GP enforce it?
In that fund, here is what the LP is facing:
“If you’re a GP and you have a no-fault removal provision at 75 percent [LP approval], if you have a confidentiality provision that doesn’t allow LPs to talk to each other and you have aggressive lawyers that threaten breach claims, and LPs can’t use that info to the detriment of the general partner, how do they get to the point where they can get to 75 percent?” said an attorney who works with LPs. “They can’t or it’s difficult to do that. It gives the GP better control of the outcome.”
This is the sort of scenario some LPs find themselves in. Several LPs told Buyouts that GPs are getting more aggressive about LP communications, strictly regulating the kind of information LPs can share.
Confidentiality provisions are nothing new, but more recently they have gotten overly broad, barring LPs from talking to almost anyone in existence save their service providers like attorneys about fund business, according to LPs and other sources who’ve spoken with Buyouts in recent weeks. This enabled GPs in tough situations, like GP replacements or contentious fund restructurings, to try to limit fund investors’ ability to talk to each other, in an attempt to control the message.
“GPs, for better or worse, are trying to manage what LPs can and cannot discuss; you really have restrictions on information flow,” according to Svetlana Loshakov, managing director at family office Moreland Management Co. “And because some people are overly cautious, they don’t want to discuss anything. We’re sensitive to these issues, but maybe our communications with other LPs are required for us to execute our fiduciary duty.”
Another LP at a public pension described the environment as “Communist China” in terms of GPs’ efforts to suppress discussion among LPs.
The issue of communications has become concerning enough to LPs that the industry trade group Institutional Limited Partners Association held a recent webinar on the topic of communications.
“ILPA believes that communications among partners in the fund is a critical element to effective fund governance,” said Jennifer Choi, managing director of industry affairs with ILPA.
ILPA’s Private Equity Principles, a list of best practices, recommends that LPs should agree to keep sensitive information confidential, but that limited partner agreements should clearly state that LPs can discuss the fund and its activities among themselves.
Why this issue has come to the fore now isn’t entirely clear. Confidentiality provisions are not new. Part of it is the broader language about confidentiality in fund documents. Some sources say simply that more LPs are paying attention. The industry has cycled through SEC enforcement around improper disclosure of fees and expenses, and this is the next issue on the table, sources said.
There is nuance here. Several LPs who spoke to Buyouts had not felt any pressure from GPs not to talk with other LPs in the same fund. Some, including longtime LPs, said they’d never had a problem like this.
According to several sources, it’s only when a fund gets into a bad situation that a GP will start pointing to confidentiality provisions to try to control the message. But the point is that the provisions are in the fund contract, so LPs are bound to them even when something goes bad, sources said.
Andrew Ahern, a partner and fund-formation attorney with Debevoise & Plimpton, says confidentiality language in fund contracts has become fairly broad, but he stressed that no GP would actually expect LPs to not talk to each other. In fact, GPs organize annual meetings to bring fund investors together in one place.
Confidentiality provisions are designed to help protect trade information like impending deals and bid prices — information that a firm’s competitors could use to undercut the GP, Ahern said.
Access to information and confidentiality can also differ depending on the LP. Some fund investors, like public pensions, are subject to open-records laws and may have customized provisions limiting their access to information to ensure that certain data doesn’t become public.
Other investors may have unique reporting requirements and have special access to information not available to other LPs, another fund-formation attorney said. In these cases, the GPs would want to make sure the information flow is tightly controlled.
Part of what some LPs see as an overall move by GPs to silence their fund investors is the disappearance of the LP roster. This is a list of all the LPs in a fund with their contact information, a document that used to be routinely included along with the LPA.
In its best-practices list of private equity principles, ILPA recommends that GPs provide a list of LPs, including contact information but excluding LPs who specifically request to be excluded.
These days, LP rosters are much harder to get. And when they are available, they are usually filled with anonymous LPs, sources told Buyouts.
For some LPs, this is just another step in their inability to talk with the peers in a fund. Not only are they subject to broad confidentiality provisions, but they can’t even identify other investors in a fund.
The story here goes two ways, however. While LPs said this is another GP tactic to suppress communications, all in the name of controlling the message, other LPs and Ahern said that anonymizing the LP roster falls more on the LP side. Many fund investors today, especially those newer to the asset class like family offices and sovereign-wealth funds, request anonymity.
With more LPs scrutinizing the issue of LP communications, the broad language currently dominating fund contracts could get more specific. This would better inform LPs with whom they can share fund information.
Ultimately, LPs want to allocate to the asset class, and in the strong fundraising environment they need to pick and choose their fights. Many LPs have to take terms that make them uncomfortable and hope for the best 10 years down the line. And if something bad does happen, it’s likely they’ll be talking with their fellow investors anyway, confidentiality or no.
Action Item: Check out ILPA’s PE principles here: http://bit.ly/2yYfv0O
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