ILPA-Private-Equity-Principles-2 0_011111

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Institutional Limited Partners Association

Private Equity Principles

VERSION 2.0l

JANUARY 2011


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Contents

ILPA Private Equity Principles 2

Alignment o Interest 4 Carry/Waterall

Management Fee and Expenses

Term o Fund

General Partner Fee Income Ofsets

General Partner Commitment

Standard or Multiple Product Firms

Governance 7 Team

Investment Strategy

Fiduciary Duty

Changes to the Fund

Responsibilities o the LPAC

Transparency 11Management and Other Fees

Capital Calls and Distribution Notices

Disclosure Related to the General Partner

Risk Management

Financial Inormation

LP Inormation

Appendix A 13

Limited Partner Advisory Committee

Appendix B 16 Carry Clawback Best Practice Considerations

Appendix C 18Financial Reporting

About the ILPA 20


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ILPA Private Equity Principles


he Institutional Limited Partners Association(ILPA) released the Private Equity Principles(the Principles) in September 2009 to encourage

discussion between Limited Partners (LPs) and

General Partners (GPs) regarding und partnerships.

Tese Principles were developed with the goal o

improving the private equity industry or the long-term

benet o all its participants by outlining a number okey principles to urther partnership between LPs and

GPs. Over the past year, ILPA has heard numerous

success stories regarding improved communication

between LPs and GPs. o that end, the Principles

are o to a great start in achieving the goals that

were originally envisioned.

In order to make ongoing improvements to the

Principles, ILPA committed to solicit additional eedbackrom both the LP and GP communities throughout

2010. Ater reecting on the extensive input rom these

discussions, the ILPA Best Practices Committee drated

a new version o the Principles. Tis release retains the

key tenets o the rst Principles release while increasing

their ocus, clarity and practicality.

We continue to believe three guiding principles orm the

essence o an eective private equity partnership:

1. Alignment o Interest

2. Governance

3. ransparency

Te three guiding principles are elaborated upon urther

in the ollowing sections to introduce the revised

preerred private equity terms and best practices or

Limited Partner Advisory Committees (LPAC).

Tese preerred private equity terms and best practices

may inorm discussions between each GP and its

respective LPs in the development o partnershipagreements and in the management o unds. ILPA

does not seek the commitment o any LP or GP to any

specic terms. Tey should not be applied as a checklist,

as each partnership should be considered separately

and holistically. We recognize that a single set o terms

cannot provide or the broad exibility o market


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circumstance and thereore we emphasize the importance

o LPs and GPs working in concert to develop the same

set o expectations when entering into any particular

partnership. We believe that careul consideration to each

o these preerred private equity terms and best practices

will result in better investment returns and a more

sustainable private equity industry.

In line with the spirit o the Principles, we encourage

all LPs to be transparent in their consideration and

application o these Principles. A list o organizations

that endorse the ILPA Private Equity Principles is posted

on the ILPA website (ilpa.org).

Te remainder o the document comprises three sections

on Alignment o Interest, Governance, and ransparency

and three appendices on LPAC Best Practices (AppendixA), Carry Clawback Best Practice Considerations

(Appendix B) and Financial Reporting (Appendix C).

Each section starts with a general discussion o the

application o the three guiding principles and

continues with detail on specic aspects or points

o emphasis. Te detail should always be seen as

subordinate to the more general principles. Te

appendices are oered as deeper dives into specic

topics o broad relevance or great complexity. Te

appendix on LPAC Best Practices is a completelyredrated version o the original Appendix A,

reecting considerable input rom GPs. Te appendix

on Carry Clawback is new, and given the complexity

o this subject, it was deemed worthy o outlining

suggestions or what we all hope will be a rare

contingency. Appendix C covers GP reporting

best practices. Standardized Reporting emplates

are being developed concurrently. Going orward,

ILPA will consider issuing urther appendices toaddress similar topics as industry best practices continue

to evolve. Suggestions or such consideration should be

submitted to the ILPA.


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Alignment o interest between LPs and GPs isbest achieved when GPs wealth creation isprimarily derived rom carried interest and returns

generated rom a substantial equity commitment to

the und, and when GPs receive a percentage o prots

ater LP return requirements are met.

GP wealth creation rom excessive management,

transaction or other ees and income sources, reducesalignment o interest. We continue to believe that a

GPs own capital at risk serves as the greatest incentive

or alignment o interests. GP equity interests in unds

primarily made through cash contributions result in

higher alignment o interest with LPs compared to those

made through the waiver o management ees.

We continue to believe that an all-contributions-plus-

preerred-return-back-rst waterall is best practice. In

situations where a deal-by-deal waterall is used, theaccompanying use o signicant carry escrow accounts

and/or eective clawback mechanisms will help ensure

LPs are ully repaid in a timely manner when the GP has

received carry it has not earned.

We recognize alignment o interests can be achieved

through many dierent combinations o the elements

stated above or indeed, through new approaches.

Alignment o interest must be evaluated in giving

consideration to each o these elements in totality.

CARRY/WAERFALL

Waterfall Structure

l A standard all-contributions-plus-preerred-

return-back-rst model must be recognized

as a best practice

l Enhance the deal-by-deal model:

Return o all realized cost or given

investment with continuous makeup o

partial impairments and write-os, and

return o all ees and expenses to date

(as opposed to pro rata or the exited deal)

For purposes o waterall, all unrealized

investments must be valued at lower o cost

or air market value

Require carry escrow accounts with signicant

reserves (30% o carry distributions or more)

and require additional reserves to cover

potential clawback liabilities

l Te preerred return should be calculated

rom the day capital is contributed to the

point o distribution

Alignment o Interest


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Calculation of Carried Interest

l Alignment is improved when carried interest

is calculated on the basis o net prots (not gross

prots) and on an ater-tax basis (i.e. oreign or

other taxes imposed on the und are not treated as

distributions to the partners)

l No carry should be taken on current income or

recapitalizations until the ull amount o invested

capital is realized on the investment

Clawback

l Clawbacks should be created so that when they

are required they are ully and timely repaid

l Te clawback period must extend beyond the

term o the und, including liquidation and

any provision or LP giveback o distributions

l Appendix B serves as a model given this is an

area o considerable complexity

MANAGEMEN FEE AND EXPENSES

Management Fee Structure

l Management ees should be based on reasonable

operating expenses and reasonable salaries, as

excessive ees create misalignment o interests

l During the ormation o a new und, the GP

should provide prospective LPs with a ee

model to be used as a guide to analyze and

set management ees

l Management ees should take into account the

lower levels o expenses generally incident to the

ormation o a ollow-on und, at the end o the

investment period, or i a unds term is extended

Expenses

l Te management ee should encompass all normal

operations o a GP to include, at a minimum,

overhead, sta compensation, travel, deal sourcing

and other general administrative items as well as

interactions with LPs

l Te economic arrangement o the GP and its

placement agents should be ully disclosed as

part o the due diligence materials provided to

prospective limited partners. Placement agent ees

are oten required by law to be an expense borne

entirely by the GP

ERM OF FUND

l Fund extensions should be permitted in 1 year

increments only and be approved by a majority

o the LPAC or LPs

l Absent LP consent, the GP must ully liquidate

the und within a one year period ollowing

expiration o the und term

GENERAL PARNER FEE INCOME OFFSES

l ransaction, monitoring, directory, advisory,

exit ees, and other consideration charged by

the GP should accrue to the benet o the und

A L I G N M E N T O F I N T E R E S T


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GENERAL PARNER COMMIMEN

l Te GP should have a substantial equity interest

in the und, and it should be contributed in cash

as opposed to being contributed through the

waiver o management ees

l GPs should be restricted rom transerring their

real or economic interest in the GP in order to

ensure continuing alignment with the LPs

l Te GP should not be allowed to co-invest in

select underlying deals but rather its whole equity

interest shall be via a pooled und vehicle

SANDARD FOR MULIPLE PRODUC FIRMS

l Key-persons should devote substantially all their

business time to the und, its predecessors and

successors within a dened strategy, and itsparallel vehicles. Te GPs must not close or act

as a general partner or a und with substantially

equivalent investment objectives and policies

until ater the investment period ends, or the und

is invested, expended, committed, or reserved or

investments and expenses

l Te GP should not invest in opportunities

that are appropriate or the und through other

investment vehicles unless such investment is

made on a pro-rata basis under pre-disclosed

co-investment agreements established prior to

the close o the und

l Fees and carried interest generated by the

GP o a und should be directed predominantlyto the proessional sta responsible or the success

o that und

l Any ees generated by an afliate o the GP,

such as an advisory or in-house consultancy,

whether charged to the Fund or an underlying

portolio company, should be reviewed and

approved by a majority o the LPAC

A L I G N M E N T O F I N T E R E S T


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he vast majority o private equity unds are basedon long-term, illiquid structures where the GPmaintains sole investment discretion. LPs agree to such

structures based on their condence in a dened set o

investment proessionals and an understanding o the

strategy and parameters or the investments.

Given that a Limited Partnership Agreement (LPA)

cannot make advance provision or all circumstancesand outcomes, LPs need to ensure that the appropriate

mechanisms are in place to work through unoreseen

conicts as well as changes to the investment team or

other und parameters. An eective LPAC enables LPs to

ulll their duties dened in the partnership agreement

and to provide advice to the GP as appropriate during

the lie o the partnership. Te role o the LPAC is

discussed urther in Appendix A.

EAM

Te investment team is a critical consideration in making

a commitment to a und. Accordingly, any signicant

change in that team should allow LPs to reconsider and

reafrm positively their decision to commit, through the

operation o the key-man provisions:

lAutomatic suspension o investment period,

which will become permanent unless a dened

super-majority o LPs in interest vote to re-instate

within 180 days, when a key-man event istriggered or or cause (e.g. raud, material breach

o duciary duties, material breach o agreement,

bad aith, gross negligence, etc.)

l Situations impacting a principals ability to meet

the specied time and attention standard should

be disclosed to all LPs and discussed with, at a

minimum, the LPAC

l LPs should be notied o any changes to

personnel and immediately notied when

key-man provisions are tripped

l Changes to key-man provisions should be

approved by a majority o the LPAC or LPs

INVESMEN SRAEGY

Te stated investment strategy is an important

dimension that LPs rely on when making a decision

to commit to a und. Most LPs commit to PE unds

within the context o a broad portolio o investments

alternative and otherwise and select each und or

the specic strategy and value proposition it presents.

Te unds strategy must thereore be well dened and

consistent:

lTe investment purpose clause should clearly

and narrowly outline the investment strategy

lAny authority to invest in debt instruments,

publicly traded securities, and pooled investment

vehicles should be explicitly included in the agreed

strategy or the und

l Funds should have appropriate limitations on

investment and industry concentration and

may consider investment pace limitations,

i appropriate

l Te GP should accommodate a LPs exclusions policy,

which may proscribe the use o its capital in certain

sectors and/or jurisdictions. However, consideration

o increased concentration eects on remaining

LPs and transparency o process and policies must

be requisite in the event o a non-ratable allocation

Governance


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FIDUCIARY DUY

Given the GPs high level o discretion regarding

operation o the partnership, any provisions that allow

the GP to reduce or escape its duciary duties in any way

must be avoided:

l GPs should present all conicts to the LPAC or

review and seek prior approval or any conicts

and/or non arms length interactions or

transactions. As materiality is a subjective

criterion, it is best to consult the LPAC in all

instances. No GP should clear its own conicts

l Te high standard o duciary duty applicable to

the GP should preclude provisions that allow or

them to be exculpated in advance or indemnied

or conduct constituting a material breach o the

partnership agreement, breach o duciary duties,

or other or cause events

l A majority o LPs must be able to remove the

GP or terminate the und or cause

l Conditions precedent and other removal

mechanisms should be constructed so that LPs

can act beore there is irreparable damage to their

interests. o the extent that there are mitigating

actors, LPs will take these into consideration in

evaluating their response to the or cause event

l o the extent that an all-partner clawback is

appropriate in order or the und to indemniy the

GP, this should be limited to a reasonable

proportion o the committed capital but in no

case more than 25% and limited to a reasonable

period, such as two years ollowing the date o

distribution

o assist in monitoring the GP in the perormance o

its duciary and other duties to the und, LPs rely upon

independent auditors and may need, in certain instances,

other support rom third parties. Independent auditors

are engaged on behal o the und and should alert theLPAC to any known conicts o interest in relation to

perorming such duties.

l Te auditor should present their view on valuations

and other relevant matters annually to the LPAC

and be available to answer questions at the annual

meeting o the und. A list o the members o the

LPAC should be provided to the auditors

l

LPs should be notied o any change in theindependent external auditor o the und

l Te auditors should review the capital accounts

with specic attention to management ee,

other partnership expenses, and carried interest

calculations to provide independent verication o

distributions to the GP and LP

l When considering important matters o und

governance or other matters where the GPs

interests may not be entirely aligned with the

LPs, a reasonable minority o the LPAC may

engage independent counsel at the unds expense

G O V E R N A N C E


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CHANGES O HE FUND

Given the long-term nature o the PE partnership,

the unds terms and governance must be well dened

upront but also be exible enough to adapt to changing

circumstances. With appropriate protections or the

interests o the GP, LPs should have the option to

suspend or terminate the und.

l Any amendment to the LPA should require the

approval o a majority in interest o the LPs, and

certain amendments should require a super-majority

approval. Amendments that negatively aect the

economics o a particular LP should require that

LPs consent

l No ault rights upon two-thirds in interest vote o

LPs or the ollowing:

Suspension o commitment period

ermination o commitment period

l No ault rights upon three-quarters in interest

vote o LPs or the ollowing:

Removal o the GP

Dissolution o the Fund

RESPONSIBILIIES OF HE LPAC

Te role o the LPAC has been evolving in recent

years in response to (i) the requirement or increased

transparency into the operations o the GP and the und

(driven by increasing emphasis on LPs duciary duties);

(ii) the increasing complexity brought by multi-product

rms; and (iii) most recently, the strains o the nancial

crisis. Te LPAC has no broad governance role in a PE

limited partnership. Its ormal responsibilities are dened

by the LPA and are generally limited to reviewing and

approving:

l ransactions that pose conicts o interest,

such as cross-und investments and relatedparty transactions

l Te methodology used or portolio company

valuations (and in some cases, approving the

valuations themselves)

l Certain other consents or approvals pre-dened

in the LPA

Te LPAC should engage with the GP on discussions opartnership operations, including but not limited to:

l Auditors

l Compliance (including CSR/ESG/PRI)

l Allocation o partnership expenses

l Conicts

l eam developments

l New business initiatives o the rm

G O V E R N A N C E


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However, as indicated, the LPAC is not intended to serve

as a representative or proxy or the broader base o LPs

and should not replace requent, open communications

between the GP and all LPs.

Additionally, an eective LPAC depends on a high

degree o trust and commitment among the various

parties. LPs serving on the LPAC and receiving sensitive

inormation must keep such inormation condential.LPAC members should support the GP in taking

appropriate sanctions against any LP that breaches this

condentiality.

LPs that accept a seat on the LPAC should commit

the necessary time and attention to the und. LPAC

members should participate in all LPAC meetings, be

G O V E R N A N C E

properly prepared, and responsibly ulll the duties o

their role. LPAC members should be able to take into

account their own interest in voting on the LPAC and

should be appropriately indemnied.

Additionally, GPs should disclose the identity o

certain LPs which they believe may have conicts

o interest with other LPs in a und. Te GP is in a

position to determine i LP-LP conicts may arise inselected situations, including but not limited to, (i) LPs

participating in an investment related to the und, such

as a separate managed account which invests alongside

the und or a co-investment in one o the unds

portolio companies, (ii) i an LP has an ownership

in the GP or one o its afliates, or vice-versa or

(iii) i a LP has received preerential economic terms.


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GPs should provide detailed nancial, riskmanagement, operational, portolio, andtransactional inormation regarding und investments.

Tis enables LPs to eectively ulll their duciary

duties as well as to act on proposed amendments or

consents. LPs acknowledge the important responsibility

they bear with higher transparency in the orm o

condentiality.

MANAGEMEN AND OHER FEES

l All ees (i.e., transaction, nancing, monitoring,

management, redemption, etc.) generated by

the GP should be periodically and individually

disclosed and classied in each audited nancial

report and with each capital call and distribution

notice

l All ees charged to the und or any portolio

company by an afliate o the GP should also

be disclosed and classied in each audited

nancial report

CAPIAL CALLS AND

DISRIBUION NOICES

l Capital calls and distributions should provide

inormation consistent with the ILPA Standardized

Reporting Format

l Te GP should also provide estimates o quarterly

projections on capital calls and distributions

DISCLOSURE RELAED O

HE GENERAL PARNER

Te ollowing should be immediately disclosed to LPs

upon occurrence:

l Any inquiries by legal or regulatory bodies

in any jurisdiction

l Any material contingency or liability arising

during the unds lie

l Any breach o a provision o the LPA or other

und documents

Other activities related to changes in the actual or

benecial economic ownership, voting control o the

GP, or changes or transers to legal entities who are a

party to any related document o the und should be

disclosed in writing to LPs. Such activities include but

are not limited to:

l Formation o public listed vehicles

l Sale o ownership in the management company

to other parties

l Public oering o shares in the management

l Formation o other investment vehicles

ransparency


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RISK MANAGEMEN

GP annual reports should include portolio

company and und inormation on material risks and

how they are managed. Tese should include:

l Concentration risk at und level

l Foreign exchange risk at und level

l Leverage risk at und and portolio company levels

l Realization risk (i.e. change in exit environment)

at und and portolio company levels

l Strategy risk (i.e. change in, or divergence rom,

investment strategy) at portolio company level

l Reputation risk at portolio company level

l Extra-nancial risks, including environmental,

social and corporate governance risks, at und

and portolio company level

l More immediate reporting may be required

or material events

FINANCIAL INFORMAION

lAnnual Reports - Funds should provide

inormation consistent with the ILPA

Standardized Reporting1or Portolio Companies

and Fund inormation at the end o each year

(within 90 days o year-end) to investors

l Quarterly Reports - Funds should provide

inormation consistent with the ILPA

Standardized Reporting or portolio companies

and und inormation at the end o each

quarter (within 45 days o the end o the quarter)

to investors

LP INFORMAION

l A list o LPs, including contact inormation,

excluding those LPs that specically request to be

excluded rom the list

l Closing documents or the und, including the

nal version o the partnership agreement and

side letters

l LPs receiving sensitive inormation as described

above must keep such inormation condential.

Agreements should clearly state that LPs

may discuss the und and its activities amongst

themselves. LPs should support the generalpartner in taking appropriate sanctions against

any LP that breaches this condentiality

T R A N S P A R E N C Y

1 Appendix C outlines current reporting best practices, however, as standardized reporting templates

(available on ilpa.org) continue to evolve, they are intended to encompass all reporting best practices


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Tese best practices are oered to provide a model or

LPAC duties, its role in the partnership, and meeting

protocol. We recognize the diering constituencies

o individual partnerships and acknowledge that one

standard may not t every situation. We believe that

LPs and GPs should explicitly establish the duties o the

LPAC through the LPA and mutually adopt preerred

meeting protocol upon establishment o the LPAC. Te

role o the LPAC is not to directly govern, nor to audit,but to provide a sounding board or guidance to the GP

and a voice or LPs when appropriate.

Common objectives in relation to every board should

include:

l Facilitating the perormance o the responsibilities

o the advisory board (as dened in the LPA or

by mutual agreement), without undue burden to

the general partner

l Creating an open orum or discussion o matters

o interest and concern to the partnership while

preserving condentiality and trust

l Providing sufcient inormation to LPs so that

they can ulll these responsibilities

We note that the role o the advisory board may

evolve during the term o the und, depending on the

environment, the specic situation o the und, and

other considerations. Te ocus should clearly be on

substance over orm and efciency over ormalistic

mechanisms. o this end, there are two points o

emphasis in this revised protocol:

l Te LPAC should operate as a committee,

not as a collection o individual members; to this

end, GPs should seek to centralize important

discussions within the advisory board context,

and not on a bilateral basis

l Regular provisions or an in camera session should

be made so that LPs can speak, when appropriate,

with a unied voice

LPAC Formation

During the ormation o the LPAC, the GP should

generally adhere to the ollowing protocol:

l Te GP should issue a ormal invitation to those

LPs it has agreed to invite to serve on the LPAC.

Such invitations should provide:

Inormation about the meeting schedule

Expense reimbursement procedures

An outline o the LPACs responsibilities

under the partnership agreement

A statement o indemnication

l Simultaneously with each closing, the GP

should compile a list o LPAC members andtheir contact inormation and circulate this list to

all LPs, providing an updated list i and when any

inormation is changed

Appendix A: Limited Partner Advisory Committee


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LPAC Meeting Suggested Best Practices

Te GP and LPAC members in each und will determine

the best way to conduct the operations o the LPAC.

Te ollowing best practices are suggested to aid in

developing a joint approach in line with the objectives

outlined above:

Convening a Meeting:

l LPAC meetings should be held in person

at least twice a year with an option to dial-in

telephonically

l Te GP is encouraged to convene the LPAC

more requently to discuss time-sensitive matters

o importance (e.g. conicts); in these cases,

LPAC members should be exible and responsive.

With the consent o the LPAC, certain matters

may be handled by written consent

l Ater initially consulting the GP, a minority o

three or more members using reasonable judgment

and discretion should have the right to call or a

LPAC meeting

l Te LPAC should be made up o a small number

o voting representatives o LPs, with larger unds

having as many as a dozen members, representing

a diversied group o investors

l Upon initial constitution o the LPAC, any

replacements o LPAC members should be

determined by the GP with any additional or

eliminated seats to be approved by mutual consento a majority o the LPAC and general partner

l A standing LPAC meeting agenda should be

developed and a calendar established as ar in

advance as possible. Te meeting agenda and

calendar should be available to all LPs

l Clear voting thresholds and protocols should be

established, including requiring a quorum o

50% o LPAC members when votes are taken

l LPAC members should receive no remuneration,

but the partnership should reimburse their

reasonable expenses in serving on the LPAC

A P P E N D I X A


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A P P E N D I X A

Agenda:

l Any member o the LPAC may add an

agenda item to the LPAC meeting agenda

subject to a reasonable notice requirement

to the GP

l With any request or consent or approval by

a unds LPAC, the GP will use best eorts tosend each LPAC member background inormation

on the matter at least 10 days in advance o

the meeting

l A portion o each LPAC meeting will be set a

side or an in camera session with only the LPs

present. LPs may elect one or more members o

the LPAC to lead the discussion and report back

to the GP

l Te LPAC should have in camera access to

partnership auditors to discuss valuations.

A representative rom the audit rm should

attend each year-end LPAC meeting or

annual meeting

Voting:

l Any meeting requiring a vote o the LPAC

should be held with only the members othat specic unds LPAC in attendance.

For convenience, LPAC meetings and/or members

o other related unds may be pooled when general

topics are discussed

l Te partnership should indemniy members o

the LPAC

l Each LPAC member should consider whether

they have any potential conicts o interest priorto voting in all circumstances. LPAC members

should disclose actual conicts to other LPAC

members during discussions at LPAC meetings

Records:

l Te GP should take minutes at all LPAC

meetings. LPAC meeting minutes should be

circulated to LPAC members within 30 days and

submitted or approval at the next LPAC meeting.Once approved, LPAC minutes should be

available upon request to all LPs within a

reasonable time period

l Te GP should record all votes taken during

conerence calls or at meetings and maintain a

copy o consents obtained in writing, by acsimile,

or by email. Detailed voting records should

promptly be made available by the GP to any

LPAC member upon request


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While ortunately rare, carry clawback situations

represent one o the greatest challenges to the GP/LP

relationship. Appropriate processes and remedies should

thereore be dened at the start o the und, as alignment

between GP and LP will usually be at a low point when

they occur. Te ollowing building blocks should be

considered with regard to clawbacks:

Seek to Avoid Clawback Situations

l Best approach is all capital back wateralls

(European style) as this will minimize excess

carry distributions

l I deal-by-deal carry, then

NAV coverage test (generally at least 125%) to

ensure sufcient margin o error on valuations

Interim clawbacks should apply, triggered both

at dened intervals and upon specic events

(e.g., key-man, insufcient NAV coverage)

Ensure GPs Backstop Temselves

ILPA strongly recommends joint and several liability o

individual GP members as a best practice as LPs contract

with the GP as a whole rather than individual members.

In cases where joint and several liability is not provided,

a potential substitution would be a creditworthy

guarantee o the entire clawback repayment by any o:

l a substantial parent company; OR

l an individual GP member; OR

l a subset o GP members

However, in general, repayment obligations should

directly track the carry distributions. An escrow account

(generally o at least 30%) may also provide an eective

mechanism or clawback guarantee.

LPs should have robust enorcement powers, including

direct ability to enorce the clawback against individual

GPs. Actual and potential GP clawback liabilities should

be disclosed to all LPs annually along with a plan to

address as additional disclosure in the audited nancial

statements.

Appendix B: Carry Clawback Best PracticeConsiderations


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Ensure Fair reatment of ax Burden

GPs receive tax distributions rom the und in order

to pay their tax liabilities on carry (capital gains tax

treatment). o the extent that the GP either does not

receive (or must return) carry, there is a loss o the tax

paid since there are limitations on the GPs ability to

carry back losses to oset the gains on which tax was

previously paid. Historically, LPs have absorbed this loss

on behal o GPs. Te initial release o Principles stated

that all carry clawbacks should be gross o tax, but ater

extensive discussions with GPs, we believe that it would

be impractical to ask them to bear the cost.

However, current practice in some cases does not take

into account the GPs ability to reduce the tax burden

through carrying losses orward, osetting a gain

against a loss, or living in a avorable tax jurisdiction.

GPs clearly should not make a prot rom the LPs

willingness to bear their tax payments in clawback

situations. Accordingly, instead o assuming the highest

hypothetical marginal tax rate in a designated location,

the rate should be based on the actual tax situation o the

individual GP member and should take into account:

l Loss carryorwards and carrybacks

l Te character o the und income and deductions

attributable to state tax payments

l Any ordinary deduction or loss as a result

o any clawback contribution or related capital

account shit

l Any change in taxation between the date o the

LPA and the clawback

Any tax advances made to the GP should be returned

immediately i in excess o the actual tax liability.

Fix the Clawback Formula

In essence, the clawback amount should be the lesser o

excess carry or total carry paid, net o actually paid taxes.

However, there are oten errors in the stipulated ormulas

which have a material impact on und cash ows:

l Te tax amount should not simply be subtracted

rom the amount owed under the clawback

l Te clawback ormula should take the preerred

return into account

A P P E N D I X B


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lAnnual Reports - Funds should provide the

ollowing inormation at the end o each year

(within 90 days o year-end) to investors:

Audited nancial statements (including a clean

opinion letter rom auditors and a statement rom

the auditor detailing other work perormed or

the und);

Internal Rate o Return (IRR) calculations

prepared by the und manager (that clearly

set orth the methodology or determining

the IRR);

Schedule o aggregate carried interest received;

Breakdown o ees received by the manager

as management ees, rom portolio companies

or otherwise;

Breakdown o partnership expenses;

Certication by an auditor that allocations,

distributions and ees were eected consistent

with the governing documentation o the und;

Summary o all capital calls and distribution notices;

Schedule o und-level leverage, includingcommitments and outstanding balances on

subscription nancing lines or any other

credit acilities o the und;

Management letter describing the activities o

the und directed to the LPAC but distributed

to all investors;

Political contributions made by placement agents,

the manager or any associated individuals to trustees

or elected ofcials on investor boards.

lQuarterly Reports - Funds should providethe ollowing inormation at the end o each

quarter (within 45 days o the end o the quarter)

to investors:

Unaudited quarterly prot and loss statements

also showing year-to-date results;

Schedule showing changes rom the prior quarter;

Schedule o und-level leverage, includingcommitments and outstanding balances on

subscription nancing lines or any other credit

acilities o the und;

Inormation on material changes in investments

and expenses;

Management comments about changes during

the quarter;

I valuations have changed quarter-to-quarter,

an explanation o such changes;

A schedule o expenses o the general partner

Appendix C: Financial Reporting


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lPortfolio Company Reports - A und should

provide quarterly a report on each portolio

company with the ollowing inormation:

Amount initially invested in the portolio company

(including loans and guarantees);

Any amounts invested in the portolio company

in ollow-on transactions;

A discussion by the und manager o recent key

events in respect o the portolio company;

Selected nancial inormation (quarterly and

annually) regarding the portolio company

including:

Valuation (along with a discussion o the

methodology o valuation;

Revenue (Debt terms and maturity);

EBIDA;

Prot and loss;

Cash position;

Cash burn rate;

lCapital Call and Distribution Notices

A standardized reporting template has been developed

by ILPA and is available at ilpa.org

Under development standardized reporting

templates to cover annual and quarterly reporting

as well as supporting nancial schedules

A P P E N D I X C


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About the ILPA

he Institutional Limited Partners Association (ILPA) is a member-led not-or-protassociation committed to serving limited partner investors in the global private equity

industry. ILPAs mission is to provide a orum or acilitating value-added communication,

enhancing education in the asset class and promoting research and standards in the private

equity industry.

ILPA has grown substantially since its inception in the early 1990s to include more

than 240 member organizations rom around the globe. While membership is comprised

exclusively o limited partners, the variety o member institutions makes the ILPA a

dynamic organization representing a diverse range o interests.

Te ILPA membership is united by a common goal: to enhance the proessional interests o

its afliates, and ultimately, to enable them to achieve strong portolio perormance. ILPA

member organizations collectively manage approximately $1 trillion o private equity assets.


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For more information on the ILPA

visit ilpa.org or call (416) 941-9393

ILPA-Private-Equity-Principles-2 0_011111

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