- EM LPs require more restrictive terms on funds
- Draw stops are used to protect LPs’ investments
- Considered a “nuclear option”
To gain some perspective on how restrictive terms and conditions can be, it’s informative to look at such provisions in the emerging markets.
Limited partners committing to managers in frontier markets often demand restrictive — some might say burdensome — provisions on funds to protect their investments.
One such term is the ability to stop funding capital calls if the manager breaches the LP agreement or if the market or regulation shifts.
At the recent EMPEA/IFC Global Private Equity conference in Washington, one panelist called the provision, known as a draw stop, a “nuclear option.”
“We’ve never implemented one, but it’s an important right,” said Elizabeth Tirone, associate general counsel with CDC Group, the U.K.’s development-finance institution. CDC invests as an LP in emerging-markets funds.
Tirone said draw stops are not something LPs take lightly and are used only in situations with GPs acting badly. “I don’t think anyone has ever used it in any funds we’re in,” she said.
Using a draw stop affects all other LPs in a fund and is not an issue only between one LP and one GP, said Jay Koh, co-founder and managing director of Lightsmith Group, which invests in companies that address social needs.
“It’s not just the GP that’s your counterparty; you’re having a cross-collateral impact on every other LP in the fund,” Koh said on the panel.
If such provisions are not included in the LPA, but are granted to specific LPs through side letters, that should be disclosed to all investors, said Mara Topping, partner with White & Case, who moderated the panel.
“That’s not something that can be hidden in a side letter,” Topping said. “Everybody needs to know.”
AFIG Funds, which invests in Africa, has draw-stop provisions included in its fund documents, said Patrice Backer, the firm’s CIO.
Backer said certain investors require the provision in case government policy shifts, triggering a breach in the institution’s own investment code.
Draw-stop situations become misaligned if they lead to a complete stoppage of fees on investments the managers already made, which require ongoing management, Backer said.
That’s something the firm tries to negotiate when launching a new fund, he said.