Alignment of General and Limited Partner Interests in PE Funds

Editor’s Note: The following post comes to us from Martin Steindl, former Senior Corporate Governance Officer for the International Finance Corporation (IFC) based in Cairo and Mumbai and now a Senior Corporate Governance Officer for the Netherlands Development Finance Company (FMO) based in Hague. The author would like to thank Gordon I. Myers, Chief Counsel in IFC’s Technology and Private Equity Legal Department, Tom Rotherham, Associate Director for Hermes Equity Ownership Services, and Meera Narayanaswamy, Senior Investment Officer in IFC’s Private Equity Funds Department, for their comments, guidance, and valuable input throughout the drafting process. The views expressed in this post are those of Mr. Steindl and do not reflect those of FMO, IFC, or Hermes Equity Ownership Services.

There are arguably two broad objectives to the governance of any entity including private equity (PE) funds: i) effective and accountable decision-making and ii) aligning interests of different stakeholders. This article focuses on the second of these objectives describing in more detail the difficulties in aligning interests between a general partner (GP) and a limited partner (LP) in a PE fund.

The governance of PE funds is increasingly coming into the spotlight. The Institutional Limited Partners Association (ILPA) revised its Private Equity Principles in 2011 to establish a set of best practices to govern the relationship between GPs and LPs. Also, the UNEP Finance Initiative for Responsible Investment (UNPRI) issued a second version of its guide for LPs in 2011. There are contributions from the European Private Equity and Venture Capital Association (EVCA), the Australian Private Equity & Venture Capital Association Limited (AVCAL), as well as most recently from the International Corporate Governance Network (ICGN)—all on the same topic.

PE fund governance differs from conventional corporate governance in that investors, as LPs, engage the GP or fund manager to achieve a specific investment purpose over a defined period of time. The relationship between the LP and the GP mainly relies on explicit contractual measures, which are entered into at the outset of the partnership. Fund governance also features another layer, which focuses on the governance—and the PE fund’s influence—on portfolio companies. Proponents of PE would argue that the governance of their portfolio companies is superior because of a better alignment of interests between themselves and their portfolio companies. This alignment, however, seems to be achieved at the detriment of the alignment of interests between the GP and the LP. Many LPs complain that governance structures that supervise the relation between GP and LP do not provide them with sufficient control mechanisms over the ultimate users of their funds. One could thus argue that the PE industry hasn’t actually solved the principal-agent problem that exists in public companies but rather shifted it up the investment chain. Continue reading here…

 

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