An explanation of Limited Partnership Agreement (LPA) in Private Equity

Thought some of you would be interested in the typical key terms in a Limited Partnership Agreement (LPA). Some of these technical aspects may help for those of you who are considering joining / staying / moving around in a Private Equity role.

For context: LPs (pension funds, endowments, family offices, SWFs etc) invest in PE funds managed by a GP. The key document that captures this relationship is the LPA. Other important documents are a subscription deed and in most cases a side letter. 

A couple of caveats:

1. I have purposely tried to simplify the language (I am not a lawyer) and these terms will be defined very specifically.

2. The LPA is a long document and I have focused on the terms that are likely to be more relevant.

Key LPA terms

• GP Commit %. This is how much of the fundraise the GP is contributing. E.g. for a $100m fund, if the GP commit is 2% then the GP (ie you and your team) will contribute $2m. There are several ways this can be funded but LPs generally prefer this to be cash. Implication for PE professional is as you become more senior, a large portion of those fat carry stacks will be re-invested to meet the GP commit for the next fund.
• Term. Typically 10 year fund life for buyout, with 5 years for the investment period and 5 years to divest. Extensions can be agreed. Most funds are deploying at a faster rate than 5 years (3-4 years) so there isn't much to worry about here for the typical buyout fund. Where there can be issues is for say distressed debt funds that raised capital specifically to take advantage of a potential economic downturn, they can get to the end of the agreed (often shorter) period not being fully deployed. The issue with not being fully deployed is that the j curve will be steeper / gross to net spread wider.
• Closing date. From first close to final close is usually 12 months. If the fund is struggling to raise then will require approval by LPs that did close to keep fundraising. On the flip side, successful funds can raise quickly (first and final close within 3 months) and spend most of their time investing.
• Investment restrictions. Defines what investments must be approved by the LPAC. For example, there is usually a single asset concentration limit of 10-20% for buyout, not able to hold public securities etc. If you are involved in sourcing deals then know what the limits are can be helpful. E.g. will the follow on investments if fully executed breach the fund concentration limit? 
• Carry. Typically 20%, most you would know how carry works at a high level but preferred return and distribution waterfall are defined in an LPA. Essentially, the LP gets 100% of the proceeds from the fund until a) aggregate capital contributions and  b) preferred return (e.g. 8% p.a.). After this depending on the catch up (50% or 100% typically), the GP receives distributions until the GP has caught up then LP gets 80% and GP 20%. This is how a 'whole of fund' waterfall works. The alternative is a deal by deal waterfall. You should find out what type of waterfall your fund is on. For whole of fund waterfall, the preferred rate and catch up regime (if not 100%) mean that carry is later than you would think. It also means the first carry check is usually also the fattest. Carry payments are also subject to clawback in the event the GP falls back out of carry. The clawback is usually on a post-tax basis so the only issue is if you spend all the carry and have to give back a portion.
• Management fees. A typical 2% management is calculated on committed capital during the investment period and then on invested capital remaining. For a $100m fund, the management fees is $2m. Note that these costs are typically for salaries, office cost etc. Deal related expenses, fund administration are paid for separately by the fund LPs. So you should be able to calculate the revenue line of the GP management company with a high degree of accuracy. 
• Key Person Event. If one or more of a list of key people in the fund no longer spending their time on the fund (e.g. they leave, fall sick) then the investment period is suspended. Knowing how this clause works is pretty important, if you are in a LMM fund then it is likely 1-2 people and even 1 of the 2 leaving can create suspension event. For megafunds which are institutionalized this is less of an issue.
• Removal of General Partner. The GP can be removed for cause and non-cause events. It helps to think of the 3 types of entities involved - LP investing capital, the fund holding the assets and the GP finding and managing the assets. The GP can be replaced by another GP to manage the assets. The main implication here is that future carry is typically forfeited in 'for cause' events and at a reduced rate in 'without cause' events.
• Advisory Committee. Aka LPAC, usually the largest LPs make up the LPAC. There are certain items that need to go to the advisory committee for approval (e.g. increasing concentration limit in a single asset beyond the specified amount) or for advice (e.g. conflict of interest and how the GP is dealing with it). Knowing who sits on the LPAC can help you understand who the most important or influential LPs are. While senior members of your fund would interact with them regularly, more junior or mid level staff have less of an opportunity. 

Happy to try and answer any questions. Interested in any thoughts people have to share on the topic.