The Smart LP's Playbook
Navigating hidden risks in fund documentation
Your next commitment could lock you into a decade of unfavourable terms – unless you know what to look for
Every year, limited partners commit billions to private equity funds based on headline terms that seem market-standard. Yet buried in the technical provisions and complex definitions lie risks that can materially impact returns over a fund’s 10+ year lifecycle.
With management fees hitting 20-year lows and competition for LP capital intensifying, fund documentation has become increasingly complex – and the devil is truly in the details.
Why this Guide is essential reading for every LP
This comprehensive guide draws on practical hands-on experience to expose the seven critical risk areas where even sophisticated investors get caught:
What you will learn:
◆ Fee structure traps – How calculation methodologies can cost you millions more than headline rates suggest
◆ Expense allocation games – The hidden costs that should be covered by management fees but end up in your pocket
◆ Governance gaps – Why your protective provisions may be weaker than you think
◆ Investment parameter loopholes – How broad language enables strategy drift and concentration risk
◆ Liquidity landmines – The fine print that could lock up your capital indefinitely
◆ Compromised LP rights – Critical protections you’re unknowingly waiving
◆ Fiduciary duty erosions – How standard of care modifications shift risk to investors
Who needs this Guide
◆ Limited partners conducting due diligence on new fund commitments
◆ General Partners seeking to understand LP perspectives
◆ Investment Committees evaluating governance terms
Unlike generic checklists, this guide provides:
◆ Specific red flags to identify in each risk category
◆ Practical review approaches aligned with ILPA best practices
◆ Market benchmarks for every major provision
◆ Real-world implications of technical provisions
◆ Negotiation strategies for achieving better terms
Don’t let your next fund cost you millions
The difference between a well-negotiated fund agreement and a standard template can mean millions in additional costs and years of governance headaches. With funds raising capital at record pace, the pressure to commit quickly has never been higher – making thorough documentation review more critical than ever.
View the full Guide now
Get instant access to:
◆ Detailed analysis of all seven risk categories
◆ Specific provisions to negotiate in your next fund
◆ Market-standard benchmarks for every key term
◆ ILPA-aligned best practices
◆ Expert contact for additional guidance
This guide is provided by Artizan Governance, specialists in private equity fund structuring and governance. For specific questions, contact Asad Bukhory at asad.bukhory@artizangovernance.com
Identifying key risks in Fund Documentation: What every LP should know
Introduction
Fund documentation is the bible that defines the relationship between investors and fund managers, establishing the rights, obligations, and economic terms that will govern the fund often for over a decade. While headline terms are scrutinised during due diligence, significant risks lie in the subtleties. Technical definitions, complex provisions, or clauses that appear standard carry material implications. Drawing on our extensive experience in private equity, this guide offers a helpful roadmap for limited partners (LPs) to assess non-obvious risks and negotiate effectively.
1. Fee structures and calculations
1.1 Management Fee Calculation Methodology
Potential issues to identify:
◆ Fees calculated on committed capital throughout the fund’s term, without a transition to invested capital post-investment period.
◆ Stepdowns that fail to account for realised investments or permanent write-offs.
◆ Inclusion of reserves within the fee base.
◆ Ambiguity in defining triggers for the end of the investment period.
Recommended approach for review:
◆ Assess the cumulative financial impact of the fee methodology over the fund’s lifecycle.
◆ Benchmark the methodology against prevailing market standards for the asset class and fund size, noting that private equity management fees have hit a 20-year low, with buyout funds now averaging 1.74% of committed capital.
◆ Ensure a clear transition to an invested capital basis after the investment period, typically around years 5–6.
◆ Verify that written-off investments are explicitly excluded from the fee base.
◆ Confirm that fee reductions are proportionate to partial realisations.
◆ Evaluate the stepdown schedule against market norms, typically a 10–15% annual reduction post-investment period.
◆ Check for further step-downs in other circumstances, such as the formation of a successor fund or during fund extensions.
1.2 Management Fee Offsets
Potential issues to identify:
◆ Offset provisions that exclude certain fees, such as monitoring or break-up fees.
◆ High thresholds that delay offset benefits for investors.
◆ Carve-outs for services labelled as “consulting” or “advisory.”
◆ Offset percentages below market standards, typically less than 80–100%.
◆ Offsets applied to future periods rather than the current fee period.
Recommended approach for review:
◆ Confirm that offset provisions encompass all relevant fees, including transaction, monitoring, break-up, directors, consulting, and advisory fees.
◆ Ensure materiality thresholds are removed to maximise investor benefits.
◆ Review the allocation methodology for offsets between funds and co-investors.
◆ Check for “deemed contribution” language to prevent circumvention of offset obligations.
◆ Investigate the manager’s historical application of offset provisions to assess consistency.
◆ Align with ILPA Principles, which state that any portfolio company fees charged should be 100% offset against the management fee.
1.3 Performance Fee Calculation
Potential issues to identify:
◆ Deal-by-deal carried interest with limited or no clawback provisions.
◆ Clawback provisions with sunset periods that limit enforceability.
◆ Clawback calculations net of taxes, irrespective of actual tax impact.
◆ Clawback obligations imposed at the fund level rather than on the general partner (GP).
◆ Absence of escrow or guarantee mechanisms to secure clawback obligations.
Recommended approach for review:
◆ Ensure alignment with investor interests across the full investment lifecycle.
◆ Assess the enforceability of clawback provisions in practice.
◆ Verify the presence of robust security mechanisms, such as escrow, to ensure recoverability of overpayments.
◆ Confirm the use of a European-style (whole-fund) waterfall, requiring the return of all capital plus preferred return before carried interest distribution, noting that market data confirms these structures have become predominant even in US markets.
◆ Check for comprehensive clawback provisions without sunset periods.
◆ Ensure clawback calculations are gross of tax, with mechanisms for tax true-ups.
◆ Confirm individual GP partner guarantees are in place.
◆ Verify a substantial carry escrow, typically at least 30%, until final distribution.
1.4 Preferred Return Calculation
Potential issues to identify:
◆ Preferred returns that are not compounded annually.
◆ Calculations based on drawn capital rather than invested capital.
◆ Selective or partial application of the preferred return.
◆ Lookback periods shorter than quarterly.
◆ Exclusion of uninvested cash from the calculation.
◆ Carve-outs for specific investment types.
◆ Failure to account for subscription lines of credit in the calculation.
Recommended approach for review:
◆ Confirm that the preferred return is compounded annually at a market rate, typically 7–8%.
◆ Ensure the calculation includes all invested capital, with clear reinvestment provisions.
◆ Verify at least quarterly compounding.
◆ Check that reserves and cash awaiting investment are included in the calculation.
◆ Confirm consistent application across all investment types, without exceptions.
◆ Ensure that for funds using subscription lines of credit, the preferred return accrues from the date capital is at risk (i.e., when the facility is drawn), not just from when capital is called from LPs.
1.5 Strategy-Specific Fee Variations
Potential issues to identify:
◆ Uniform fee structures across different strategies without accounting for strategy-specific norms.
◆ Fees significantly exceeding strategy-specific benchmarks.
◆ Failure to adjust fee structures for fund size within specific strategies.
Recommended approach for review:
◆ Evaluate fee structures against current benchmarks for the specific strategy and fund size, noting significant variations across strategies (e.g., venture capital fees averaging 2.05%, secondaries funds averaging 1.07%, and fund-of-funds averaging 0.76%).
◆ Review fee step-down provisions in the context of strategy-specific norms.
◆ Consider appropriate carried interest percentages based on strategy-specific benchmarks.
◆ Understand that while the overall trend in management fees is downward, some strategies may justify different fee levels based on resource intensity and competitive market positioning.
2. Expense allocations
2.1 Organisational Expense Cap
Potential issues to identify:
◆ Organisational expenses without a cap.
◆ Caps exceeding market norms, such as above 0.2% of fund size.
◆ Inclusion of non-standard items within organisational expenses.
◆ Exclusion of certain formation costs from the cap.
◆ Mechanisms allowing recategorisation of expenses to circumvent caps.
◆ Lack of detailed expense reporting.
Recommended approach for review:
◆ Ensure a market-consistent hard cap on organisational expenses, typically 0.1–0.15% for funds over $500M and 0.15–0.2% for smaller funds.
◆ Review detailed itemisation of included and excluded expenses.
◆ Confirm requirements for comprehensive expense reporting.
◆ Verify explicit prohibitions on expense recategorisation.
◆ Ensure LPs have clawback rights for expenses exceeding the cap.
2.2 Broken Deal Expenses
Potential issues to identify:
◆ Full allocation of broken deal expenses to the fund.
◆ Absence of caps or reasonableness standards for expenses.
◆ No proportional GP contribution, even in competitive processes.
◆ Lack of differentiation between early- and late-stage process expenses.
◆ Unlimited carry forward of broken deal costs.
◆ Inclusion of GP travel and internal costs in expenses.
Recommended approach for review:
◆ Confirm that broken deal expenses are charged to the fund, as per ILPA principles, and understand how they are allocated, especially in co-investment scenarios where they should be shared pro-rata.
◆ Check if there is any GP contribution to these expenses, as this can be a point of negotiation, although it is not universally required by ILPA.
◆ Review different allocation methodologies for early- vs. late-stage processes.
◆ Confirm expense caps for auction processes.
◆ Validate clear limitations on eligible expense categories.
◆ Ensure allocation of competitive deal expenses across multiple funds if applicable.
2.3 Operational Expenses
Potential issues to identify:
◆ Unclear delineation between fund expenses and those covered by the management fee.
◆ Charges for in-house legal, accounting, or operational functions.
◆ Inclusion of technology, research, and data costs as fund expenses.
◆ Allocation of office overhead or non-investment team compensation to the fund.
◆ Undefined “other expenses” categories.
◆ Absence of expense budgets or caps.
Recommended approach for review:
◆ Ensure a detailed list of permitted fund expenses, explicitly excluding GP overhead.
◆ Confirm that expenses covered by the management fee are clearly defined.
◆ Verify the presence of annual expense budgets, with LP Advisory Committee (LPAC) approval required for excesses.
◆ Check for prohibitions on charging for in-house functions that replace third-party services.
◆ Confirm quarterly expense reporting with sufficient granularity.
◆ Benchmark expenses against peer funds to ensure reasonableness.
2.4 Insurance Costs
Potential issues to identify:
◆ Allocation of the full cost of GP indemnification insurance to the fund.
◆ Inappropriate allocation of multi-product or multi-fund insurance policies.
◆ Inclusion of insurance for non-fund activities.
◆ Lack of reasonableness standards or coverage limits.
◆ Charges for specialty coverage beyond industry norms.
◆ Absence of competitive bidding requirements for insurance policies.
Recommended approach for review:
◆ Confirm that the GP bears the cost of its own D&O and professional liability insurance.
◆ Ensure appropriate allocation methodologies for multi-activity policies, supported by independent verification.
◆ Verify that coverage amounts align with market standards, with excess costs borne by the GP.
◆ Check for competitive bidding requirements on significant policies.
◆ Confirm LPAC approval for material changes in coverage or cost.
◆ Review annual reporting on insurance expenses for transparency.
2.5 Subscription Lines of Credit
Potential issues to identify:
◆ Lines of credit that are outstanding for extended periods.
◆ Lines that exceed a reasonable percentage of fund commitments.
◆ Use of lines to fund early distributions rather than for their intended purpose.
Recommended approach for review:
◆ Ensure that subscription lines of credit are of short duration, typically outstanding for no more than 180 days, as recommended by ILPA.
◆ Confirm that the line is limited to a maximum percentage of fund commitments, such as 20%.
◆ Verify that the line is not used to fund early distributions but rather to manage cash flows related to capital calls.
◆ Ensure preferred return is calculated from when capital is at risk (date facility is drawn).
◆ Validate transparent reporting on subscription line usage and costs.
◆ Confirm LPAC oversight of subscription line policy and implementation.
3. Governance provisions
3.1 Key Person Provisions
Potential issues to identify:
◆ Key person lists that exclude influential non-founder investment professionals.
◆ High time commitment thresholds (above 25–30%) before triggering events.
◆ Extended cure periods without investment suspension.
◆ Replacement mechanisms solely controlled by the GP.
◆ Triggers limited to death or disability, excluding voluntary departures.
◆ Carve-outs for “cause” determinations.
Recommended approach for review:
◆ Ensure the key person list includes next-generation leadership alongside founders.
◆ Verify time commitment definitions require at least 75–80% of professional time.
◆ Confirm immediate suspension of the investment period upon a triggering event.
◆ Check for LP voting rights on replacement proposals.
◆ Ensure voluntary departures and terminations are included as triggers.
◆ Review look-through provisions for complex management structures.
◆ Confirm automatic termination after a cure period, typically 90–120 days.
3.2 For-Cause Removal Rights
Potential issues to identify:
◆ Narrow “cause” definitions limited to final, non-appealable court decisions.
◆ Exclusion of material breaches of fund documents from “cause.”
◆ High materiality thresholds for removal.
◆ Supermajority voting requirements above 75%.
◆ Multi-stage procedural hurdles prior to removal.
◆ Excessive termination payments despite a cause determination.
◆ Restrictive time limits for asserting claims.
Recommended approach for review:
◆ Ensure “cause” definitions align with market standards, encompassing material breaches, fraud, gross negligence, and securities violations.
◆ Confirm interim protections during pending determinations.
◆ Verify a reasonable voting threshold, typically 66–75%.
◆ Review the removal process for clear timelines and efficiency.
◆ Confirm economic consequences post-removal, such as forfeiture of carried interest.
◆ Ensure procedural obstacles are minimised.
◆ Check for independent arbitration options to expedite resolution.
3.3 No-Fault Removal Rights
Potential issues to identify:
◆ Voting thresholds exceeding 80%.
◆ Severe economic penalties for exercising rights, such as losing over 50% of carry.
◆ Exclusion of certain investor categories from voting rights.
◆ Continuation of economics for extended periods post-removal.
◆ Removal rights contingent on full fundraising.
◆ Cooling-off periods or repeated supermajority votes.
◆ Restrictions limiting removal to specific time windows.
Recommended approach for review:
◆ Confirm a market-standard voting threshold, typically 75–80% maximum.
◆ Ensure economic consequences are balanced, such as a trailing management fee for 6–12 months and 20–25% of carried interest.
◆ Verify inclusive voting mechanics for all investor categories.
◆ Review procedural requirements for efficiency.
◆ Confirm transition mechanisms to preserve portfolio continuity.
◆ Ensure equitable treatment of team members not responsible for the removal.
◆ Check for appropriate information rights during the transition period.
3.4 LPAC Composition and Powers
Potential issues to identify:
◆ A small LPAC dominated by GP-aligned investors.
◆ Overrepresentation of strategic or affiliated investors.
◆ Limited authority, confined to narrow conflict approvals.
◆ Restrictions on engaging independent advisors.
◆ Lack of confidentiality exceptions for consulting LP organisations.
◆ No mechanisms for removal or replacement of LPAC members.
◆ Excessive GP influence over LPAC membership.
Recommended approach for review:
◆ Ensure a balanced LPAC composition, typically 7–12 members, based on objective criteria.
◆ Confirm the exclusion or limitation of affiliated investors.
◆ Verify broad authority over conflicts, valuations, key-person events, methodology approvals, and material extensions.
◆ Check the LPAC’s ability to engage independent counsel and advisors at fund expense.
◆ Confirm confidentiality exceptions for internal reporting purposes.
◆ Ensure regular meeting requirements, including executive sessions.
◆ Verify mechanisms for removing or replacing inactive LPAC members.
3.5 Amendment Provisions
Potential issues to identify:
◆ Ability to amend key terms with only a simple majority vote.
◆ Inconsistent voting thresholds without clear categorisation.
◆ GP discretion to determine amendment materiality.
◆ Broad exceptions for “administrative” or “clarifying” changes.
◆ Amendments permitted through negative consent.
◆ Side letter provisions allowing modification of core terms for select investors.
Recommended approach for review:
◆ Confirm that material amendments require a supermajority vote, typically 75–80%.
◆ Ensure economic rights are protected, requiring consent from affected investors.
◆ Verify clear categorisation of amendment types with corresponding voting thresholds.
◆ Confirm amendments require affirmative consent, not negative consent.
◆ Check for limitations on negative consent mechanisms.
◆ Ensure full transparency of amendments to all investors.
◆ Confirm LPAC consultation rights for amendment categorisation.
◆ Verify that side letters cannot circumvent amendment provisions.
3.6 Fund Extension Provisions
Potential issues to identify:
◆ Multiple extension provisions without investor approval.
◆ Unilateral extension rights tied to minimal deployment thresholds.
◆ Extension provisions without fee adjustments.
◆ Absence of clear standards for justifying extensions.
Recommended approach for review:
◆ Verify LPAC approval requirement for any fund extension.
◆ Ensure that no management fees should be charged during fund extensions unless agreed by LPs, as per ILPA principles.
◆ Confirm maximum extension periods and number of extensions.
◆ Review clear standards for extension qualification.
◆ Ensure comprehensive reporting requirements during extension periods.
4. Investment parameters
4.1 Investment Strategy Scope
Potential issues to identify:
◆ Overly broad strategy definitions that permit expansion into unrelated areas.
◆ Ambiguous language regarding sector focus, asset types, or geographic scope.
◆ Undefined parameters for “related” investments.
◆ Lack of quantitative limits on non-core activities.
◆ Expansive manager discretion language.
◆ Ability to modify the strategy with minimal investor input.
Recommended approach for review:
◆ Ensure the investment strategy is precisely defined, with clear parameters for sector, geography, asset type, and investment size.
◆ Confirm quantitative limits on non-core investments, typically 15–20% maximum.
◆ Verify objective criteria for assessing strategy compliance.
◆ Check for LPAC approval requirements for material strategy expansions.
◆ Confirm that fundamental strategy changes require supermajority investor approval.
◆ Ensure explicit exclusion of investment types or strategies outside the agreed scope.
4.2 Concentration Limits
Potential issues to identify:
◆ Weak concentration limits, allowing excessive exposure to single investments (above 15–20% of commitments).
◆ Absence of sector or geographic concentration parameters.
◆ Calculations based solely on cost rather than fair value.
◆ Exclusion of certain investment types from concentration calculations.
◆ Broad waiver rights without appropriate oversight.
◆ Adjustments to limits based on fund size without investor consent.
Recommended approach for review:
◆ Confirm single-investment concentration limits, typically 10–15% of commitments.
◆ Ensure sector concentration limits, typically 20–30%, depending on the strategy.
◆ Verify geographic diversification requirements where applicable.
◆ Confirm calculations account for both cost and fair value.
◆ Ensure all investment types are included in concentration calculations.
◆ Check for LPAC approval requirements for any exceptions.
◆ Review consequences for inadvertent breaches.
◆ Verify regular reporting on concentration metrics and compliance.
4.3 Leverage Provisions
Potential issues to identify:
◆ High or uncapped fund-level leverage allowances.
◆ Broad authorisation for layered leverage across multiple levels.
◆ Limited disclosure of aggregate leverage exposure.
◆ Permissive cross-collateralisation provisions.
◆ Recourse financing without sufficient protections.
◆ Undefined criteria for qualifying lenders.
◆ Ability to modify leverage limits with minimal oversight.
Recommended approach for review:
◆ Ensure leverage limitations are clearly defined and appropriate for the strategy, covering both fund-level and portfolio leverage.
◆ Confirm comprehensive disclosure and reporting on all leverage layers.
◆ Verify that recourse financing is prohibited or strictly limited.
◆ Check for requirements on qualified lenders.
◆ Review concentration limits for financing sources.
◆ Ensure material leverage arrangements require LPAC approval.
◆ Confirm advance notice for significant borrowing activities.
◆ Verify third-party validation of aggregate leverage calculations.
4.4 Investment Period Extensions
Potential issues to identify:
◆ Multiple extensions without investor approval.
◆ Unilateral extension rights tied to minimal deployment thresholds.
◆ Extensions without corresponding fee adjustments.
◆ Lack of clear standards for justifying extensions.
◆ Automatic renewal provisions.
◆ Extensions applied to partial commitments.
◆ Ability to restart the investment period after suspensions.
Recommended approach for review:
◆ Confirm that investment period extensions require LPAC approval.
◆ Ensure a maximum extension period, typically 12 months.
◆ Verify a limit on the number of extensions, typically 1–2 maximum.
◆ Ideally, no management fees should be charged during fund extensions unless agreed by LPs, as per ILPA principles. If fees are charged, ensure they are significantly reduced, typically by 15–25%.
◆ Review clear standards for justifying extensions.
◆ Ensure detailed reporting on deployment pace and opportunity pipeline.
◆ Confirm acknowledgment of changed market conditions.
◆ Verify prohibitions on restarting the investment period after key person or other suspension events.
4.5 Follow-On Investment Authority
Potential issues to identify:
◆ Broad authorisation for follow-on investments post-investment period.
◆ Excessive reserves for follow-ons, above 20–25% of commitments.
◆ Loose definitions of qualifying follow-on investments, including new projects or expansions.
◆ No time limits on the follow-on period.
◆ Lack of clear standards for determining appropriate follow-ons.
◆ Limited reporting on follow-on deployment.
Recommended approach for review:
◆ Confirm limits on follow-on reserves, typically 15–20% of commitments.
◆ Ensure qualifying follow-on investments are narrowly defined, limited to existing portfolio companies.
◆ Verify time limits on the follow-on period, typically 2–3 years post-investment period.
◆ Check for LPAC approval requirements for exceptional follow-ons.
◆ Review detailed reporting on follow-on deployment by investment.
◆ Confirm clear standards for determining appropriate follow-ons.
◆ Ensure new business lines or expansions do not qualify as follow-ons.
4.6 Waterfall Structures
Potential issues to identify:
◆ Deal-by-deal carried interest with limited clawback.
◆ Complex waterfall structures with multiple tiers.
◆ Unclear calculation methodologies for distributions.
◆ Ability to manipulate timing of distributions to accelerate carried interest.
Recommended approach for review:
◆ Verify European-style (whole-fund) waterfall requiring return of all capital plus preferred return before carried interest, noting that market data confirms these structures have become predominant even in US markets.
◆ Confirm clear, unambiguous calculation methodology for distributions.
◆ Check detailed provisions addressing treatment of partially realised investments.
◆ Ensure transparent reporting on distribution calculations.
◆ Validate alignment with ILPA’s recommendation for whole-fund waterfall models as best practice.
5. Liquidity terms
5.1 Redemption Restrictions
Potential issues to identify:
◆ Suspension provisions triggered by subjective determinations.
◆ Extended or indefinite suspension periods.
◆ Cascading extension mechanisms for suspensions.
◆ Broad manager discretion over partial redemptions.
◆ Redemption fees that escalate significantly during market stress.
◆ Lack of LPAC or third-party oversight for ongoing suspensions.
◆ Inequitable treatment of different investor categories.
Recommended approach for review:
◆ Ensure suspensions are tied to objective, measurable market events.
◆ Confirm maximum suspension periods, with investor approval for extensions.
◆ Verify LPAC oversight, with independent validation of continued necessity.
◆ Ensure equitable, pro-rata implementation across all investors.
◆ Check for clear disclosure of partial redemption methodologies.
◆ Review limits on redemption fees during extended suspensions.
◆ Confirm regular reporting during suspension periods.
◆ Verify independent third-party validation of underlying conditions.
5.2 In-Kind Distribution Provisions
Potential issues to identify:
◆ Broad GP discretion to make in-kind distributions of illiquid assets.
◆ Valuation methodologies controlled by the GP without oversight.
◆ Limited criteria for determining the appropriateness of in-kind versus cash distributions.
◆ Disparate distribution practices among investor categories.
◆ Inadequate advance notice for distributions.
◆ Lock-up requirements following in-kind distributions.
◆ Treatment of distributions as satisfying waterfall obligations at stated values.
Recommended approach for review:
◆ Confirm that in-kind distributions are limited to specific, justified circumstances.
◆ Ensure LPAC approval for non-marketable securities.
◆ Check for independent valuation requirements.
◆ Verify advance notice periods, typically 15–30 days.
◆ Confirm equitable treatment across all investors.
◆ Review tax-efficient structuring requirements.
◆ Ensure LPs have the option for cash elections with reasonable execution periods.
◆ Verify clear valuation methodologies for distributed securities in waterfall calculations.
◆ Check for post-distribution support provisions.
5.3 Recycling Provisions
Potential issues to identify:
◆ Extensive recycling rights extending significantly beyond the investment period.
◆ High percentage of commitments eligible for recycling, above 30–35%.
◆ Inclusion of current income in recycling-eligible amounts.
◆ Recycling tied to management fee extensions.
◆ Limited transparency in recycling calculations.
◆ Selective recycling for fee purposes while distributing for carried interest calculations.
Recommended approach for review:
◆ Confirm recycling limits by amount (typically 20–25% of commitments), time period (not extending beyond the investment period without approval), and qualifying transaction types.
◆ Ensure exceptional recycling requires investor approval.
◆ Verify transparent reporting on recycled amounts and remaining eligibility.
◆ Check for consistent methodology between fee calculations and distribution waterfalls.
◆ Confirm that recycling current income is prohibited, except in specific strategies.
◆ Ensure LPAC oversight of recycling practices.
5.4 Transfer Restrictions
Potential issues to identify:
◆ Overly restrictive transfer provisions requiring GP consent without reasonable limits.
◆ Subjective standards for evaluating transfers.
◆ Excessive transfer fees.
◆ Prohibition on transfers to competitors without clear definitions.
◆ Extended lock-up periods beyond industry norms.
◆ Disparate transfer rights among investor categories.
◆ First refusal rights benefiting the GP or affiliates without fair market value requirements.
Recommended approach for review:
◆ Ensure transfer rights are reasonable, with objective approval standards limited to regulatory, legal, and administrative considerations.
◆ Confirm clear definitions of prohibited transferees.
◆ Check for standardised transfer documentation.
◆ Verify that fees are proportionate to actual costs.
◆ Ensure equitable treatment across all investors.
◆ Review streamlined approval processes with defined timelines.
◆ Confirm the elimination of subjective qualitative assessments.
◆ Verify LPAC involvement in disputed cases.
◆ Check that transfer request timing aligns with market standards, typically 10–15 business days.
6. LP rights and protections
6.1 Information Rights
Potential issues to identify:
◆ Delayed financial reporting beyond market norms.
◆ Limited portfolio company information.
◆ Restrictive confidentiality provisions preventing appropriate internal sharing.
◆ Absence of standardised reporting templates.
◆ Limited access to underlying documentation.
◆ Restricted site visits or management access.
◆ Selective disclosure practices.
◆ Lack of ESG and regulatory compliance reporting.
◆ Limitations on due diligence for continuation events.
Recommended approach for review:
◆ Confirm comprehensive, timely reporting, including quarterly unaudited financials within 45 days, annual audited financial statements within 90 days, and detailed portfolio company information.
◆ Verify reasonable inspection rights for books and records.
◆ Check for confidentiality exceptions for internal reporting and fiduciary requirements.
◆ Ensure standardised reporting templates are used.
◆ Confirm access to management and site visits.
◆ Verify equal information access for all investors.
◆ Check for enhanced reporting during critical events.
◆ Review detailed disclosures for continuation transactions.
6.2 Excused Investment Provisions
Potential issues to identify:
◆ Narrow grounds for excusal, limited to strict legal prohibitions.
◆ Discretionary GP approval requirements for excusals.
◆ Adverse economic consequences for excused investments.
◆ Restrictions on regulatory or policy-based excusal grounds.
◆ Lack of alternative deployment options.
◆ Disproportionate burden on remaining investors.
◆ Unequal treatment of excusal requests.
◆ Inadequate notification periods.
◆ Punitive mechanics for excusal implementation.
Recommended approach for review:
◆ Confirm excusal rights cover legal, regulatory, and documented policy constraints.
◆ Ensure objective standards for excusal qualification.
◆ Verify reasonable economic treatment of excused amounts.
◆ Check for adequate notification periods, typically 10–15 business days.
◆ Confirm alternative deployment options where feasible.
◆ Ensure equitable implementation procedures.
◆ Verify the absence of punitive consequences.
◆ Confirm proportionate treatment regarding fees and expenses.
◆ Check for clear mechanics to address concentration impacts.
◆ Ensure appropriate confidentiality around excusal reasons.
6.3 Default Provisions
Potential issues to identify:
◆ Severe default remedies exceeding market norms.
◆ Punitive forfeiture provisions, above 25–30% of commitment.
◆ Short cure periods misaligned with institutional processing needs.
◆ Limited force majeure exceptions.
◆ No distinction between wilful and administrative defaults.
◆ Cascading consequences disproportionate to the default’s impact.
◆ Cross-default provisions across unrelated funds or investments.
Recommended approach for review:
◆ Confirm cure periods align with institutional needs, typically 10–15 business days, with extensions for good faith efforts.
◆ Ensure remedies are proportionate to the default’s magnitude.
◆ Verify a clear distinction between wilful and administrative defaults, with corresponding remedy differences.
◆ Check for force majeure exceptions.
◆ Review staged remedy implementation with increasing severity for continued defaults.
◆ Ensure no punitive forfeiture for first-time or administrative defaults.
◆ Confirm LPAC consultation for material default situations.
◆ Verify appropriate confidentiality around default circumstances.
6.4 Tax Structure and Reporting
Potential issues to identify:
◆ Inappropriate or inefficient tax structures for the investor base.
◆ Inadequate frequency or detail in tax reporting.
◆ Delays in providing tax documentation.
◆ Lack of tax structuring for specific investor categories.
◆ Limited advance consultation on tax-sensitive transactions.
◆ Inefficient withholding mechanisms.
◆ Absence of cooperation provisions for tax matters.
◆ Restrictions on tax information for investor jurisdictions.
Recommended approach for review:
◆ Ensure the tax structure is tailored to the investor base composition.
◆ Confirm comprehensive tax reporting aligned with filing requirements.
◆ Verify timely delivery of tax documentation.
◆ Check for cooperative provisions for tax audits and inquiries.
◆ Ensure advance consultation on tax-sensitive transactions.
◆ Review efficient withholding mechanisms with appropriate documentation options.
◆ Confirm specialised structuring for tax-exempt, governmental, and non-US investors where needed.
◆ Verify reasonable efforts to operate in a tax-efficient manner.
7. Fiduciary duties and standards of sare
7.1 Fiduciary Duty Modifications
Potential issues to identify:
◆ Complete waiver of fiduciary duties without replacement standards.
◆ Elimination of loyalty obligations.
◆ Materiality qualifiers for the duty of care.
◆ Carve-outs for affiliated transactions.
◆ Subjective good faith standards without objective components.
◆ Vague or circular definitions of duties.
◆ Elimination of implied duties without specific replacements.
◆ Modification of duties for certain transaction types without justification.
Recommended approach for review:
◆ Confirm that modifications to fiduciary duties are limited, specific, and disclosed.
◆ Ensure core loyalty obligations are retained.
◆ Verify that waived duties are replaced with specific contractual standards.
◆ Check for objective components in good faith determinations.
◆ Review appropriate carve-outs for critical protective provisions.
◆ Ensure enhanced disclosure and approval requirements where duties are modified.
◆ Confirm specific standards for affiliated transactions.
◆ Verify that waivers are limited to particular categories, not blanket eliminations.
7.2 Standard of Care
Potential issues to identify:
◆ A gross negligence standard (instead of ordinary negligence) paired with broad exculpation.
◆ Subjective determination methodologies.
◆ Materiality qualifiers for negligence.
◆ Sector-specific carve-outs.
◆ Exclusion of certain activities from the standard of care.
◆ Expertise disclaimers that contradict marketing representations.
◆ Different standards applied to different aspects of the manager’s role.
Recommended approach for review:
◆ Ensure the standard of care aligns with the fund’s strategy and complexity.
◆ Confirm reasonable limits on exculpation, preserving accountability for core obligations.
◆ Verify objective standards for measuring compliance.
◆ Ensure consistent application across all activities.
◆ Check for the absence of subjective qualifiers.
◆ Confirm alignment between marketed expertise and legal responsibility.
◆ Verify appropriate carve-outs from exculpation for fundamental obligations.
◆ Confirm specific performance standards for specialised strategies.
7.3 Indemnification Provisions
Potential issues to identify:
◆ Indemnification covering acts beyond standard market exclusions.
◆ Advancement of expenses without repayment undertakings.
◆ No repayment provisions for unsuccessful defenses.
◆ Indemnification for inter-partner disputes.
◆ Restrictions on clawing back advanced amounts.
◆ Broad indemnification for investigations, regardless of outcome.
◆ Insufficient carve-outs for serious misconduct.
◆ Preferential indemnification rights for GP entities versus individuals.
Recommended approach for review:
◆ Confirm indemnification excludes fraud, willful misconduct, gross negligence, material violations, and breaches of fund documents.
◆ Ensure expense advancement is conditioned on a repayment undertaking.
◆ Verify clear repayment obligations for unsuccessful defenses.
◆ Check for exclusion of indemnification for inter-partner disputes.
◆ Review procedures for managing conflicts in indemnification determinations.
◆ Ensure expense coverage has reasonable boundaries.
◆ Confirm parity between entity and individual indemnification standards.
◆ Verify LPAC oversight of material indemnification events.
7.4 Conflicted Transactions
Potential issues to identify:
◆ Broad pre-approval of conflict categories without specific review.
◆ Limited disclosure requirements for conflict situations.
◆ Absence of fairness requirements or validation mechanisms.
◆ LPAC approval with insufficient information or evaluation time.
◆ Conflicted roles without proper safeguards.
◆ Lack of specific standards for cross-fund transactions.
◆ Limited consequences for unapproved conflicts.
◆ Unequal economic treatment in affiliated transactions.
Recommended approach for review:
◆ Ensure conflicts are approved case-by-case with robust advance disclosure.
◆ Confirm mandatory fairness opinions for material related-party transactions.
◆ Verify specific standards for cross-fund investments and co-investments.
◆ Check for third-party validation requirements.
◆ Review a detailed procedural framework for LPAC conflict reviews.
◆ Ensure adequate information and evaluation periods before approvals.
◆ Confirm specific consequences for unapproved conflicted actions.
◆ Verify prohibitions on inherently problematic conflict categories.
◆ Check for explicit fairness standards on pricing, allocation, and terms in related transactions.
8. Side letter and MFN provisions
8.1 MFN Limitations
Potential issues to identify:
◆ Extensive MFN carve-outs excluding economic or governance provisions.
◆ Artificial investor categorisations creating selective access.
◆ High qualification thresholds beyond commitment size.
◆ Subjective qualification criteria.
◆ Limited disclosure of categorisation methodology.
◆ Temporal limits preventing access to later-negotiated terms.
◆ Exclusion of specific investor types from MFN eligibility.
◆ Restrictive confidentiality preventing term comparison.
Recommended approach for review:
◆ Ensure comprehensive MFN rights with limited, reasonable exceptions.
◆ Confirm objective qualification criteria, primarily based on commitment size.
◆ Verify transparent categorisation methodology.
◆ Check that all material economic and governance provisions are included.
◆ Ensure equitable access to subsequently negotiated terms.
◆ Review reasonable confidentiality provisions allowing effective comparison.
◆ Confirm LPAC oversight of MFN implementation.
◆ Verify minimal temporal limitations.
8.2 Side Letter Disclosure
Potential issues to identify:
◆ Limited or delayed disclosure of side letter terms.
◆ Redacted disclosure masking economic provisions.
◆ Selective disclosure to different investor categories.
◆ Disclosure only upon specific request.
◆ Side letters designated as entirely confidential.
◆ Lack of disclosure for terms granted outside formal side letters.
◆ No notification of subsequent side letter execution.
◆ Informal arrangements without documentation.
Recommended approach for review:
◆ Confirm prompt, comprehensive disclosure of side letter terms to all investors.
◆ Ensure unredacted access to economic and governance provisions.
◆ Verify disclosure of all material investor arrangements, regardless of form.
◆ Check for timely notification of new side letter execution.
◆ Confirm LPAC oversight of side letter implementation.
◆ Verify prohibitions on undocumented arrangements.
◆ Review clear disclosure procedures for confidential regulatory terms.
◆ Confirm regular certification of side letter compliance.
◆ Ensure equal access to disclosure for all investor categories.
8.3 Implementation Mechanics
Potential issues to identify:
◆ Unclear processes for electing MFN provisions.
◆ Short election windows misaligned with institutional decision-making.
◆ Complex documentation requirements.
◆ High administrative burdens for election.
◆ Subjective approval rights for election requests.
◆ Limited assistance in identifying beneficial provisions.
◆ Restrictive confidentiality hindering necessary analysis.
◆ Implementation delays beyond reasonable administrative needs.
Recommended approach for review:
◆ Ensure a clear, practical implementation process with straightforward documentation.
◆ Confirm reasonable election periods, typically at least 30 days, with extensions for complex provisions.
◆ Verify the GP’s obligation to identify potentially applicable provisions.
◆ Check for administrative support during the election process.
◆ Ensure objective standards for election qualification.
◆ Review streamlined implementation procedures.
◆ Confirm minimal documentation requirements.
◆ Verify the absence of procedural obstacles.
◆ Check for prompt implementation timelines.
◆ Ensure regular certification of MFN compliance.
This guide is provided for informational purposes only and does not constitute legal, tax, or investment advice.
While each fund must be evaluated in the context of its specific strategy and market position, these guidelines offer a helpful framework for identifying and addressing potential red flags in fund documentation.
By reviewing these risk areas, LPs can better protect their interests and ensure effective governance.
If you have any questions, please contact Asad Bukhory at asad.bukhory@artizangovernance.com