LPAC

What is an LPAC?

LPAC stands for limited partner advisory committee. It is a small committee of investors in a private fund, appointed under the partnership agreement, that advises the general partner and signs off on matters where the GP has a conflict. It does not pick investments and it does not run the fund.

What does an LPAC actually decide?

The honest answer is that it clears conflicts and reviews how the GP has valued things. ILPA describes the committee as playing a critical role in fund governance by providing a sounding board for the GP and serving as an important source of input on critical governance determinations, conflicts of interest in particular. Its stated mandate should generally include matters specific to evaluating conflicts of interest as presented by the GP, and review of valuation methodologies and any changes to them as reported by the GP to the partnership and the auditors.

Two rules make that mandate meaningful. ILPA says the GP should not be an LPAC member, actual or perceived, and that because materiality is a subjective criterion, it is best to consult the LPAC in all instances of any conflicts or non-arm's-length transactions, adding that no GP should clear its own conflicts under any circumstances.

In a venture fund the recurring agenda items are predictable: a cross-fund investment where Fund III buys into a company Fund II already owns, a follow-on that breaks the concentration limit, a GP-led secondary or continuation vehicle, an affiliate transaction, a proposed extension of the investment period or the fund term, valuation methodology changes, key person and succession events, and the annual audit discussion.

Who sits on it, and how seats are allocated

The ILPA Model LPA sets the committee at a minimum of three and a maximum of seven members, appointed by the fund manager, each a representative of a limited partner or of an investor in a feeder entity that is not an interested person, with no limited partner represented by more than one member.

Note who appoints: the manager. LPAC seats are granted, not elected, which is why they are typically offered to the largest commitments and negotiated in side letters at the same time as fee breaks and co-investment rights. ILPA's counterweight is a composition standard. The committee should be limited in size to a workable number and comprised of a representational cross-section of investors by commitment size, type, tax status and quality of relationship with the GP, and members should have one vote per institution, meaning no super vote for the largest check.

Do LPAC members owe a duty to the other LPs?

No, and this is the point practitioners most often get backwards. ILPA's position is that LPAC members should be generally understood not to have a fiduciary duty to the fund beyond the duty to act in good faith, and that they should ensure they are appropriately indemnified and not implicated as fiduciaries acting on behalf of other LPs in the fund. Its summary principle is that LPACs should be thoughtfully constructed, mandated and managed as an important adviser to the fund, particularly around conflicts of interest, without obligating LPAC members to serve as fiduciaries of the fund themselves.

The Model LPA drafts that disclaimer explicitly. Section 13.2.2 has all parties acknowledge that, to the fullest extent permitted by applicable law, neither the advisory committee nor any member nor any limited partner a member represents owes fiduciary duties to the fund, the GP, the manager or any limited partner, and that in making determinations each member may consider only such interests and factors as that member desires, including the interests of the limited partner it represents.

The consequence for a non-LPAC investor is blunt. A conflict waiver approved by the LPAC was approved by people entitled to think about their own institution's position, not yours.

Delaware law is what makes the seat safe to accept. Under the state's limited partnership act, a limited partner does not lose limited liability by serving on a committee of the limited partnership or of the limited partners, or by appointing a representative to serve on one and acting through that representative, and separately by consulting with or advising a general partner with respect to any matter. That safe harbor is the reason an institution can put a person in the room without being treated as a general partner.

Worked example

The figures below are hypothetical and chosen so the arithmetic is checkable.

A $400 million fund offers an LPAC seat to every investor committing $30 million or more. Seven LPs qualify, which is the maximum committee size in the Model LPA. Those seven represent 7 times $30 million, which is $210 million of the $400 million fund, or 52.5 percent of commitments. The other 40-odd investors, holding the remaining $190 million, have no seat.

The GP then proposes that Fund III invest $12 million in a company where Fund II, the same manager's prior fund, already holds a position carried at $18 million. That is a cross-fund transaction and a conflict, so it goes to the committee rather than being cleared by the GP.

ILPA's LPA guidance calls for clear voting thresholds, including a quorum of 50 percent of LPAC members to conduct a vote. Fifty percent of seven members is 3.5, so four members must be present. Five attend. Each institution has one vote, so the largest investor's $60 million commitment counts the same as the smallest seat's $30 million. The vote is three in favor, two against, and the conflict is waived.

Now count what was decided and by whom. Three institutions, representing $90 million of the $400 million fund, or 22.5 percent of commitments, cleared a related-party transaction for everybody. That is not an abuse; it is the design. It is also the reason ILPA pushes for a representational cross-section by commitment size, type and tax status rather than a committee made only of the four largest checks, and the reason the in-camera rule matters: each meeting should include an in-camera session, and votes should not be taken without a prior in-camera meeting among LPAC members.

How it shows up in the fund documents

Expect an advisory committee article, typically near the governance provisions. In the whole-of-fund Model LPA it is Article 13: section 13.1.1 establishes the committee, its size band and the appointment mechanic no later than the final closing date; section 13.2.2 is the fiduciary duty disclaimer quoted above; section 13.2.4 commits the GP to seek to implement the best practices described in the ILPA Principles for the committee; and section 13.2.5.5 gives the committee a valuation lever, allowing it to require that a value determined by the GP be confirmed or adjusted by an independent investment banking, accounting or appraisal firm selected by the GP, consented to in writing by the committee, and appointed by the fund.

Three provisions decide whether the seat is worth taking: indemnification of members, which ILPA states plainly as a requirement; the quorum and voting thresholds; and whether the LPA entitles the committee to meet without the GP and with the auditor. ILPA recommends an annual in-camera discussion with the auditor regarding financial statements, valuations, carried interest and fees, and says fees, expenses and carried interest calculations should be subject to periodic review by the limited partner advisory committee and certification by an independent auditor.

Common mistakes

• Believing the LPAC represents all LPs. It does not, and the model documents say so in terms.
• Treating a waiver as a blessing. An LPAC waiver removes a contractual obstacle to a transaction; it is not a finding that the transaction is good for the fund.
• Accepting a seat with no indemnity. Committee service should come with indemnification and a clear statement of the standard of conduct.
• Letting the GP set every agenda and stay in the room for every item. Without an in-camera session, members never compare notes, and a vote taken cold favors the party who wrote the materials.
• Confusing the LPAC with an advisory board of industry experts. The latter helps with deals and has no governance authority at all.

Related terms

A limited partner is the investor whose capital is at stake and who, outside the committee, has information rights rather than approval rights. A general partner is the party whose conflicts the committee exists to price. A key person clause is the adjacent protection that fires automatically on a departure, where the committee's involvement is usually to review the GP's proposed remedy rather than to trigger anything itself.