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Investors Adopt More Active Role In Partnerships

Jim Hill, an attorney who works on private equity fund formation, was driving home from a board meeting about three months ago when he answered an odd telephone call.

It was a member of a state pension’s investment committee calling with a list of demands before agreeing to invest in a $700 million buyout fund Hill was representing. One of the demands: the authority to approve or disapprove the fund’s investments.

“I told him he should go back and talk to their lawyer, because that was so far outside of any LP’s request,” said Hill, the chairman of the private equity group for the Cleveland-based law firm Benesch. “I told him, ‘I don’t think you want to go there.'”

Hill got the impression that this committee member didn’t quite understand the typical relationship between limited and general partners. Such power would have effectively made the pension a general partner, thus losing its limited liability status and potentially exposing itself to untold legal risk. And indeed, the pension never revived the request (instead, it argued for lower management fees and ultimately invested in the fund).

But the anecdote is symptomatic of the swagger LPs are feeling today. More unified than ever thanks to the publication of LP-friendly recommended terms by the Institutional Limited Partners Association, investors are demanding lower management fees and other favorable economic terms and conditions.

To be sure, some sources disagreed with the notion that some LPs are taking an “activist” position on advisory committees. Instead they say the private equity industry is evolving and that LPs are simply more engaged than ever with GPs rather than merely being a passive sounding board. “I wouldn’t say they are so much ‘activist’ as actively seeking opportunities to talk with their fellow LPs about issues of common concern,” said Michael Harrell, a partner with the law firm Debevoise & Plimpton LLP.

Still, LPs are also increasingly demanding a seat on LP advisory committees, which typically review how a firm’s portfolio is performing and deal with potential conflicts of interest, such as a firm’s desire to re-invest in a portfolio company with a different fund.

ILPA recommends that these committees “should be made up of a small number of voting representatives of LPs, with larger funds having as many as a dozen members.” But sources say GPs are increasingly offering more places at the table, sometimes as a way to entice more commitments. Michael Goss, COO of Bain Capital, said he knows of one mid-market firm that has an advisory committee with 29 members.

“Their attitude on that was, ‘Hey, why tell anybody no? If it’s important to them, fine,'” Goss said. Bain’s advisory committee has 10 members, which Goss said is practical, particularly if Bain needs to convene a meeting on short notice.

Advisory committees are also becoming more assertive, several sources said, demanding more say on portfolio company valuations; the right to approve—not merely review—conflict of interest issues; and the right to meet with fellow committee members without the general partner present, which the revised ILPA principals released earlier this year specifically recommends. Some committees are also requesting to meet with the fund’s accountants without the GP present.

Buyout firms Providence Equity Partners LLC and Doughty Hanson & Co., for example, have acquiesced to limited partners’ requests for the advisory committee to meet without representatives of the firms present. Executives at the firms declined to comment or were not immediately available for comment.

“LPs now have more muscle than they used to, and they aren’t being shy about flexing it where appropriate,” said John Beals, a partner with the law firm Nixon Peabody LLP. “Our clients on committees are taking their roles more seriously and getting more involved in conflict issues.”

The scales have tipped in favor of LPs to such an extent that some industry professionals are concerned LPs are going too far. Erik Hirsch, CIO of Hamilton Lane, an investment management firm with $16 billion in assets under management and an additional $89 billion in advisory assets, expressed concern about LPs taking an “activist” stance on limited partner advisory committees at the Buyouts New York conference late last month.

“LPs need to be careful about stepping over that LP boundary,” said Hirsch, who is on advisory committees for several firms including Apollo Global Management, The Blackstone Group and The Carlyle Group. “We don’t believe we’re there to run the firm.”