LPACs Are Gaining Authority, But Not Accountability

Over the last decade, continuation funds have become an important component within the private equity market. The increased use of secondary transactions has been accompanied by concerns about the role played by General Partners (GPs) in structuring these alternative vehicles. Prior research has studied the dual agency problem that arises when GPs act on both sides of the transaction. There has been some debate about the effectiveness of the Limited Partner Advisory Committees (LPACs) in reducing conflicts of interest. On the one hand, the monitoring view argues that stronger committee oversight and tighter feasibility thresholds can reduce GP opportunism. On the other hand, a nascent empirical literature suggests that concentrated LPAC representation, close continuing GP–LP relationships, and specific side letter protections may shield GPs from effective scrutiny.

In their new research, Yaron Nili and Elisabeth de Fontenay shed light on these two conflicting views by examining whether variation in LPAC composition and contractual design is associated with systematic differences in formal LPAC authority. Using a dataset of 217 fund governance documents from one large institutional investor, including 155 LPAs, the authors document that LPACs address GP–LP conflicts through consent, waiver, and approval rights. At the same time, this structure may create a second conflict between inner circle and outer circle LPs.

The evidence shows that the LPAC governance structure is influenced by GP-controlled member selection, limited individual member rights and uneven access to independent advisers, but also by widespread fiduciary duty disclaimers and extensive indemnification and exculpation. Moreover, the power index, a measure of formal authority, increases from 4.8 to 5.5 across vintage cohorts, providing support for the view of an expanded formal role for LPACs. However, the expansion of the formal authority does not seem to be associated with changes in committee representation, information access, or fiduciary accountability. This combination of evidence supports the value of introducing a set of reforms, including structured annual LPAC review of expenses, valuation practices, and continuation vehicle approvals, with the results disclosed to all LPs. 

Comments:
Theory

While identifying the implications of LP heterogeneity as an important determinant for LPAC approval, the absence of a theory or hypothesis development section leaves unspecified which dimensions of heterogeneity influence approval incentives. An agency theory perspective could help distinguish which dimensions of LP heterogeneity strengthen monitoring from those that align particular LPs with the GP. In this context, the paper’s structural claims may support several conjectures regarding how LP heterogeneity influences variation in continuation fund approvals. Potential areas for consideration are: (1) GP-mediated powers may privilege particular groups of LPs; (2) liability protection without fiduciary accountability is more problematic when LP interests diverge; and (3) intra-LP conflict concerns are most intense when LPAC approvals affect LPs differently.

Data and methodology

A second benefit of this study is the large, hand-collected sample that provides detailed contractual evidence on LPAC governance across fund vintages, strategies, and sponsors. There may also be disadvantages that result from obtaining documents from a single, large institutional investor. For example, the sample may not be representative of the private fund market, and differences across fund types may limit the ability to draw cross-sectional inferences.

As noted above, the authors also construct a composite power index across 13 domains. Following concerns raised by legal indices, it is interesting to ask whether aggregating LPAC powers that differ in legal effect can be meaningfully integrated into a single equally weighted index. Further, changes in LPAC drafting style across vintages may create the appearance of increased LPAC authority without altering the underlying allocation of power.

This study also draws on qualitative evidence from interviews with GPs, LPs, and fund counsel to capture their concerns about continuation fund transactions, factors influencing LPAC approval and the effectiveness of aligning LPAC members with the GP in response to access to co-investment and other sponsor vehicles. I wonder whether the forthcoming interviews could more directly test which factors influence investor willingness to approve continuation fund transactions. One approach would be to employ factorial vignettes using hypothetical continuation fund transactions with randomly varied features: NAV discount, rollover rate, GP rollover commitment, asset quality, and disclosure quality. Through this means, the study could attempt to answer the following question: what are the most significant factors influencing LPAC approval decisions?

This stimulating paper asks key questions about LPAC approval decisions and will have important implications for the direction of the alternative investment fund literature.

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Joseph McCahery is a professor of International Economic Law and the Financial Market Regulation at Tilburg University, and an ECGI Research Member.

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This blog is based on a paper presented at the 5th conference on The Law and Finance of Private Equity and Venture Capital, held at Goethe University Frankfurt. The conference was convened by Bocconi University, the DFG LawFin Center at Goethe University Frankfurt, LSE Law School, the Faculty of Law of the University of Oxford, and the Institute for Law & Economics at the University of Pennsylvania, together with ECGI., Visit the event page to explore more conference-related blogs.

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