These Boards Are Meant to Protect PE Investors. Why Can’t Anyone Agree on How?


Illustration by II

Limited partner advisory committees can limit conflicts of interest and root out bad behavior — if they’re given the right tools.

Blame the rise of continuation fund strategies: Limited partner advisory committee seats have never been more coveted by allocators.

Private equity firms are increasingly turning to the boards that govern their funds — so-called LPACs — to ask for permission to sell a portfolio company from one of their funds to another. An estimated $125 billion has been raised to target these continuation funds, pushing the role of LPACs to center stage.

The only problem? Allocators and investment managers have a tough time agreeing on an LPAC’s remit.

Asset owners are asking: Do the LP committees serve to appraise the merits of investments? Can they detect fraud? Should they make decisions about how investment managers spend their money? And who, exactly, are members beholden to? The answers, as you might guess, are complicated.

“Each of these is kind of a negotiated deal,” a consultant who sits on about 60 LPACs says. “There’s no industry standard.”

The genesis of LPACs is murky. Consultant Meher Haider says they became more popular following the 2008 financial crisis and are now almost universal. The late aughts and early 2010s were marked by a desire to improve governance and protect investors following the Bernard Madoff scandal and several prominent hedge fund blowups.

“There was kind of a movement post-Madoff and financial crisis where investors were demanding a lot more transparency,” says Jason Scharfman, an attorney and head of compliance monitoring and testing at Corgentum Consulting.

Though an LPAC mandates vary from fund to fund, they share some characteristics. Experts say the governing bodies are often required to approve actions that are outside of a fund’s mandate, including approving a strategy pivot or a larger-than-usual investment. PE firms “want the LPAC to bless the investment,” Haider says.

By way of example: Baylor University’s $2 billion endowment has a representative on an LPAC at a timber investment manager. The fund “was long in the tooth,” says Renee Hanna, Baylor’s managing director of investments. “They were going to need their extension in order to harvest their investment.” At the time, Hanna supported the firm’s plan to liquidate in a year. But she made it clear that she would be okay with only one extension.

At their most effective, these groups can detect fraud, oust wrongdoers, and recoup losses for their clients.

Take Burrill Capital Management. For years, founder Steven Burrill had been siphoning money from the venture firm’s third life sciences fund to cover personal and operating expenses. In addition to using the fund’s cash on hand to cover costs, Burrill called capital early and asked for a cushion to pay investors.

By August 2013, though, the LPAC had detected — through audited financial statements — that Burrill had been misappropriating funds.

The LPAC, using the power it was granted in fund formation documents, removed Burrill and his team from managing the fund. Burrill eventually settled charges with the Securities and Exchange Commission.

“It’s usually bad behavior where the LPAC has to come in and flex the fact that they are the owners of this money,” says someone with direct knowledge of the Burrill situation.

Today, the role of LPACs has become even more important as more managers launch continuation funds, which allow PE firms to hold on to companies by rolling them from one fund into a new vehicle. Most fund documents require LPAC approval for these rollovers — and usually the committee gets 30 days’ notice. But that investor protection provision isn’t in every contract, and it doesn’t always happen, according to allocators.

The Institutional Limited Partners Association (ILPA), which publishes best practices for the industry, suggests that advisory committees avoid pre-clearing conflicts of interest with continuation funds and instead evaluate each strategy.

“The proliferation of GP-led transactions has led to more frequent LPAC votes, in my experience,” says John Beil, head of private equity and real estate at Partners Capital, an outsourced chief investment officer.

ILPA, with its landmark guidelines published in 2019, provides other suggestions to manage continuation funds. But the lack of standards in the PE industry, investors say, is creating tension between managers and allocators.

In part, that’s because the responsibilities of the participants aren’t clear. The allocators on an LPAC have no fiduciary duty to other allocators in the fund. In other words, they are not legally responsible for other committee members or other investors in the fund — instead, they are beholden only to their own beneficiaries.

“It’s there to provide some level of governance, but no one on that LPAC has a fiduciary duty of the fund,” says Chris Hayes, a consultant at RedLine Policy Strategies.

Reed Smith attorney Joseph Suh says most fund documents include language that requires limited partners to agree that the committee members do not have to consider their fellow investors’ needs and circumstances.

“Although LPACs are supposed to represent the funds’ third-party investors, the individual members of the LPAC do not really have the obligations of all of the investors,” Suh says. “And where that’s important is that every investor is basically required to consent in the partnership agreement to the authority of that advisory committee.”

As a result, conflicts of interest have become more prevalent.

For example, some LPAC members are invested in multiple funds from the same firm, which gets complicated when managers use several funds to buy an asset.

A pension fund allocator who spoke on condition of anonymity said that scenario recently cropped up. The allocator told the general partner that “we’re invested in just this fund, not all the funds. Then you have to think about what other LPAC members are doing because they may be invested in three funds.”

Other types of investments can present challenges as well, according to Neal Prunier, senior director of industry affairs at ILPA. “An LPAC member could potentially be a lender to a portfolio company, a co-investor, a secondary investor, or hold ownership of an interest in the management company,” Prunier says.

The pension fund allocator recalls sitting on an LPAC alongside an asset owner that held a stake in the investment manager. “When they vote on an LPAC, I’d bring this conflict of interest up and say this investor shouldn’t be allowed to vote,” the pension investor says.

Beil agrees. “If you’re invested only in the fund that is selling in the cross fund and you think that the price is really attractive for the fund that you’re in, that’s a bias that you should disclose to other LPs,” he says. “Similarly, if another LP is leading a co-investment in an outsize deal and the GP is seeking a waiver in the concentration limit, the LP should not necessarily refrain from voting, but at least share with other LPAC members.”

Most LPACs don’t require disclosing these conflicts of interest, sources say. Venture debt firm Applied Real Intelligence requires all LPAC members to disclose these conflicts, according to chief investment officer Zack Ellison. “When in doubt, spill it out!” he says via email. “In other words, transparency is the best policy, because secrets are like bad investments — they’ll come back to haunt you!”

But LPs are often left to find out themselves what conflicts exist. Some managers avoid sharing the names of LPAC members with investors and other committee colleagues (even though LPAC members reveal themselves during meetings).

While some LPs ask that their organization’s name not be used in fund marketing documents, managers “often hide behind” that provision, according to one nonprofit LP. “What GPs are terrified of is if there’s ten members of an LPAC or something, if we all have a call about how the fund is doing without them,” the LP says.

ILPA’s 2019 guidelines suggest that investors ask for a list of LPAC members as part of their LP agreement. But even that might not be enough. ILPA members have told the organization they are often “not being made aware of who else is on the LPAC until after the fund has fully closed,” Prunier says.

Multiple allocators who spoke to Institutional Investor say their asset managers will often call LPAC members one by one ahead of meetings where they have to vote on a matter such as clearing a conflict. Through their networks, these LPs have discovered that their GPs are sometimes providing different information to each member, which then affects how they vote.

If sitting on an LPAC is fraught with potential conflicts, why do so many allocators want to be included?

A Bloomberg report on LPACs published in February suggested that luxury travel is one motivation. Sources acknowledge that could play a small role in the decision-making — but they say most investors are hyper-aware of the risks. “A lot of the press or coverage is always the outliers,” the consultant who sits on many LPACs tells II. “That’s not how 98 percent of the industry works.” The reputational risk isn’t worth it to many investors, especially those at public pensions.

“We’re not staying at the ritzy hotels or flying first class,” says the pension investor who spoke anonymously. “We don’t want that showing up in the press.” (The fund itself pays for the travel.)

And meetings are often held via Zoom or in major cities that LPs already travel to frequently.

LPACs do give investors a different kind of access.

According to Beil, Partners Capital is incentivized in part by the information an LPAC seat offers. “Candidly, it gives you advantaged insight into how the general partner is thinking about their team, managing conflicts, succession, etcetera,” he says.

Baylor’s Hanna added the university works to be a partner to its managers. “We want a voice in terms of getting closer to communication, transparency, and being the first call,” she says. “We want to be at the top of the list when GPs are considering things like amending portfolio company concentration limits or asking for advice about coming back to market.”

This information, according to one manager who spoke on background, can also provide prestige.

“They trade in relationships and ideas,” the manager says. “The more and better relationships and ideas and information they have, the more influential they can be within their circles. The more influential they are in their circles, then the more deal flow and ideas they get, and the more progression they can see in their careers.”

And it’s easier now to land an LPAC seat than it was two years ago, experts say. In a challenging fundraising environment, PE firms are more willing to offer LPAC seats to curry favor with allocators who are reticent to sign checks.

This fundraising environment has allowed some LPAC members to become more candid with their GPs — but that hasn’t always been the case.

In the heady days of 2020 and 2021, allocators clamored for access to PE funds, often agreeing to invest in side strategies that they didn’t necessarily want in their portfolios.

This, sources say, led to a dynamic on LPACs where some investors did not feel comfortable speaking their minds or voting against a GP proposal. “They don’t want to spoil the well by being too aggressive with the GP,” Corgentum Consulting’s Scharfman says.

The pension allocator has seen this in action. “I can think of a scenario that just recently happened where what the GP was asking was clearly not in the best interest of LPs,” he says. “Certain LPs were concerned if they voted no, it might damage the relationship. They voted alongside the GP, and it clearly was not in the best interest of LPs.”

Some large allocators choose to abstain from voting. In certain cases, they’ll be taken out of the voting pool completely; in others, their abstention counts as a vote in favor of the proposal — and the GP.

Now, allocators have more power as fundraising has become much more difficult. That has resulted in asset owners not only asking for LPAC seats, but also trying to dictate how those committees operate. In addition to asking for the list of LPAC members, some investors are asking for provisions such as the right to meet in private with colleagues before making decisions. They’re also requesting that meetings and materials be provided to fellow LPs, and for oversight over fund costs.

There are logical best practices that could be put in place. According to Beil, an LPAC should include five to eight well-qualified LPs representing a mix of large allocators. He adds that the members should attend all meetings and be senior enough to make decisions, ideally in real time.

But some asset owners send different team members to LPAC meetings each time, which presents continuity challenges among members. Beil’s view is that the LPAC should focus on process rather than investment decision-making. This might involve clearing conflicts of interest, handling key-person issues, and ensuring that LPs receive all information necessary for voting.

PE firms increasingly appear to want to define — and perhaps rein in — what an LPAC can do, notes Brian Forman, an attorney at Morrison Cohen.

“One of the things I’ve seen that is interesting in a fund document is the manager imposed a standard on how the LPAC would make decisions,” he says. LPACs are essentially telling PE firms, “We want to make unfettered decisions regarding your behavior. We want a covenant from you guys to go out and hire an independent counsel to resolve any conflicts,” he says.

For investment managers, there are consequences for not offering such provisions in the years to come. “If the investor feels that a GP isn’t engaging with these types of issues, then they might not invest in a subsequent fund or reduce their allocation size,” Scharfman says.

Brian Hoehn, Prunier’s colleague at ILPA, agrees, adding that members might consider ditching managers who don’t work well with them. “Especially in this environment where LPs are at their allocation limit or even over it, they’re in a place where they may be forced to cut managers, including those who have performed well in the past,” he says. “One thing that has separated GPs in this environment is the ones who have partnered with LPs.”

These managers could also face more scrutiny from regulatory bodies in the coming years.

In the recently passed private fund rule, the SEC took its first crack at LPACs.

“Although some private funds may have LPACs or boards of directors, these types of bodies may not have sufficient independence, authority, or accountability to oversee and consent to these conflicts or other harmful practices as they may not have sufficient access, information, or authority to perform a broad oversight role, and they do not have a fiduciary obligation to private fund investors,” the rule reads. The SEC does not provide remedies for these issues, but it noted in its 2024 exam priorities guide, released October 16, that it plans to address the role of LPACs in more depth next year.

LPs and their investment managers alike say they want a more structured approach to LPACs, although with the number of differing viewpoints and needs among members, that will be tough to navigate.

Still, the health of PE funds depends on it. A well-functioning LPAC can root out bad behavior, just like Burrill’s LPAC did.

The members just have to be able to work together.