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Overall approach

·         Are we getting the transparency we need?

·         What do we need to be proactive about?

·         Are there adjustments to be made with new commitments?

·         What have we learned through the COVID experience?

Do we have confidence GP's are using the following tools in the best interests of LPs?

Current Tools at GP’s Disposal:

·         Sub Lines

·         Additional Borrowing Outside of Sub Lines

·         Recycling Capital

·         Relaxing Limitations on follow on investments

·         Greater use of Affiliate service providers - are GPs using these providers more

·         Fund mergers

·         GP led restructurings

·         Cross fund investments

·         These are occurring although not widespread

·         Term extensions

Most popular tools used: sub lines, other borrowings, and recycling of capital

Subscription Lines

·         Some lenders are increasing the cost of facilities

·         Often times sub facilities can be converted into an asset-based facilities

·         Need to be mindful of requests to extend sub facility term

Risks with Subscription Lines

·         Can see portfolio concentration risk

o   What is the calculation of the test? Does it include use of sub facility?

o   Test may use just equity investment without incorporating leverage investments

·         Increases LP giveback risk

·         Most LPAs now provide ability to force LP to return distributions not just for indemnification but for any fund liability

·         Mindful of return of distribution to back sub facility liability

·         Cross-collateralization Risk

o   If there is a problem, all portfolio companies can be a source to repay

Other Fund Leverage Concerns 

·         Does the LPA allow fund leverage or guarantees of portfolio company obligations?

o   Understand how these limits work

·         Should borrowing be permitted to pay management fees?

o   Many conversations on this

o   Saw this in 2009 GFC, make GP defer fees

Recycling

·         Cheap and easy for the sponsor

·         Quick capital

·         Consider raising limits only for new investments, not for expenses

·         LPs should be cynical when GP downplays recycling amendment

o   Example – amendment changed “return of capital” to “return of proceeds”

o   Added 2.5x ability to recall funds

·         Ask what they want to do with recycling

·         Check consent and amendment rights as an LP

o   Check required majority or if LPAC can approve

·         Because it changes fund's exposure to liabilities, a change may require supermajority approval

Affiliated Service Providers

·         Even if pricing offsets the management fees, it still results in current income being paid

·         Get full transparency

·         If LPA provide flexibility to use affiliated providers, monitor how they are using them

o   Used to offset revenue decline

Fund Mergers

·         GP tries to solve issues by using capital to support other funds

·         Look at valuation issues - how do you value something with little revenue in today’s environment?

·         Under certain statues may be able to merge without supermajority consent or without complying with LPA

·         Under Delaware law, if 2 funds merge you comply with the surviving entity LPA; the LPA of fund going away disappears

o   Understand which fund is surviving

GP led restructuring

·         Will see big increases

Cross Fund Investments - Rescue Finance

·         Role of LPAC – be cautious because approval here can absolve GP of conflicts

·         LPAC needs access to financial and legal advisors

·         Do you have clear information?

Term Extensions

·         GP unilateral extension right

Current Fund Considerations

·         Valuations

o   Watch for changes in valuation process

o   Any outliers

o   Focus on what your LPA and Side Letters provide for information access

o   GP wants to control content and discussion

·         Port Construction

o   Will concentration increase if new deals slow?

o   Will GP deploy capital simply to build fee base?

o   Will GP use COVID-19 as an excuse for performance and start to focus on the next fund?

o   LPAC Role

o   Conflicts are high and LPA terms give GP ability to create value for themselves at the possible expense of LPs

·         Clawbacks

o   Many GP are over distributed

o   GP are incentivized to not mark down assets

o   Increased LP Giveback risk

o   With use of sub facility, if assets stand behind obligation to repay (if uncalled capital is not sufficient), there is a greater likelihood of distributions being recalled

o   Greater giveback risk with leverage portfolio companies that distributed distributions

What should LPs be asking for when GP requests modifications/amendments?

Management Fees

·         Focus on:

o   Fee terminates after extension

o   Exclude new capital for recycling from management fee - why pay for giving GP flexibility

·         Ask for but less critical:

o   Make sure fee base is determined just on equity invested

o   Possible GP deferment of fees if liquidity is stretched

LP Giveback

·         Focus on:

o   GP must participate with LP

o   Adjust so net of tax construct is removed or only applies if giveback exceeds tax carry

§  You net on a global basis; many funds fail to cover this term

o   Ensure recycled amounts are no longer considered distributions that can be required to return

·         Ask for but less critical:

o   Deferred carry should not be considered a fund liability

GP Led Merger/Secondaries

·         Focus on:

o   Require high vote threshold - 75-80%, not just majority

o   Have LPAC get financial advisor

o   Try to get LPAC approval first before going to all LPs

Increased Clawback protection

·         Ensure that when you run it that you protect for the preferred return

·         Revisit clawback guarantee and collateral behind it

·         Be aware that GP guarantee that will fall away upon fund dissolution, but LP liability extends far beyond fund life

Distribution Limitations

·         Prohibit borrowing to make distributions

·         Make it subject to LPAC consent; make GP explain why it's in LP interest to do this

New Fund Considerations:

·         Haven't seen major changes in terms for new funds

·         See an evolutionary, not revolutionary change in agreement terms

o   More 1st close discounts coming back

Advice

·         Ensure strong no-fault protection

·         Be wary of deemed voting provisions (abstentions, non-response)

·         Make sure you can access list of fellow LPs

·         LPAC - have in camera meetings

·         Expenses - push back on GP shifting overhead to fund

·         GP Capital Funding - make GP fund pro rata share as they raise capital, not just at final close

·         Transfer provisions

o   Cap on fees for transfers