The limited partnership serves as the most common legal structure for private equity funds. Under the agreement the providers of capital, referred to as the LPs, have limited liability for the investing decisions made by the fund. Instead, that responsibility falls to the general partner (GP), which maintains responsibility for allocating the capital in the fund.
LPs, which must be designated as “accredited investors,” are typically pension funds, endowments, sovereign wealth funds, high-net-worth individual and other entities with large pools of capital. The sole role of the LP is to provide capital for the fund, with all of the other responsibilities falling to the GP. In order to prove they have “skin in the game,” executives from the GP often provide a proportion of the fund’s capital as well.
The GP oversees every aspect of the partnership—from procuring investments from LPs and handling legal documentation, to investing the fund’s assets and managing the portfolio companies. In order to pay for the day-to-day operations of the fund, the GP charges the limited partners a management fee. Management fees vary depending on the specific contract, but typically range from 1% to 4% of committed capital.
LPs are beginning to demand more favorable terms and closer alignment of incentives in their private equity contracts.
Changing Dynamics
One of the hottest current private equity topics is the changing relationship between GPs and LPs. The GPs have held the power in the relationship since the inception of the industry, but the balance of control has begun to shift following the boom years in the middle 2000s. LPs are beginning to demand more favorable terms and closer alignment of incentives in their private equity contracts. Significant reductions in management fees have been one of the primary changes. Additionally, LPs are now demanding a large proportion, if not all, of the monitoring fee that GPs charge their portfolio companies.
In recent years, LPs have taken steps to formalize best practices for private equity investing through collaboration within the Institutional Limited Partners Association (ILPA). In 2009, the organization produced its first set of Private Equity Principles, with the cornerstones being: alignment of interest, governance and transparency. Since then, LPs have placed increased scrutiny on GPs, demanding more openness with financial statements and improved contract conditions.
