In the first part of article series called Private Equity and Compliance: Exploring the ‘Nature of the Beast’ we covered the three tiers of compliance in a PE ‘ecosystem’, touched base on Compliance Programs and the role of the Chief Compliance Officer (CCO).
In the part 2 today we’ll focus on some governance aspects and more specifically on limited partners’ involvement by the form of LPACs and (more lightly) advisory boards.
A private equity fund is typically structured as a limited partnership, with investors referred to as limited partners (LPs), or simply the fund’s investors. Like most investments, LPs commit capital to the fund with the expectation of capital appreciation.
Throughout the life of a fund, LPs and the general partner (GP) interact in several ways. For instance, GPs provide quarterly performance updates, either directly or through an administrator—a third party responsible for services like fund accounting, calculating net asset value (NAV), and overseeing shareholder services. LPs may also engage with GPs to ask questions regarding fund performance or due diligence matters.
In some cases, a select group of investors in a private equity fund participate in a Limited Partner Advisory Committee (LPAC). This committee is typically composed of significant investors (a.k.a. seed or anchor investors) and holds rights to be notified of, and in some cases approve, certain fund-level decisions.
The compliance and legal framework governing GP and LP responsibilities is outlined primarily in two documents: the Private Placement Memorandum (PPM) and the Limited Partnership Agreement (LPA). These fund formation documents cover key terms such as fees, permitted expenses, investment mandates, and the roles of the GP and related service providers.
The LPAC plays a vital governance role—especially in areas like conflict of interest management, valuation oversight, capital calls, and fund term extensions. Although not mandated by regulation, LPACs offer enhanced transparency and confidence to investors.
Perhaps it is easy to make parallels with corporate boards here. Although, it could be argued that a Board of Director’s mandate is different and more specifically – broader, however, from governance and compliance point of view (and agency theory), both BoD and LPAC are primarily a ‘checks and balances tool’.
While not mandated by regulation, LPACs have evolved to satisfy the oversight expectations of large investors. Larger LPs—often contributing more capital—expect greater transparency and influence over fund governance. LPACs provide a mechanism for balancing LP oversight with GP autonomy.
Historically, such oversight would have required consent from all LPs or a majority vote. LPACs streamline this process by serving as an intermediary governance body.
Key Responsibilities of LPACs
The specific duties of LPACs may vary by fund but generally include oversight in high-risk areas such as:
- Conflicts of Interest:
- Related-Party Transactions: LPACs review concurrent and cross-investments between affiliated funds, ensuring proper disclosure and fair allocation.
- LP Transactions: LPACs assess any direct transactions between the fund and an LP outside their capital commitment.
- Valuation Disputes: LPACs often collaborate with GPs and third-party appraisers when disagreements arise about asset valuation.
- Capital Calls and Distributions: LPACs may need to approve capital calls made outside of standard commitment periods or tax distributions that exceed predefined limits.
- Overrides and Extensions: LPACs may approve:
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- Exceeding investment caps for portfolio companies
- Funding GP litigation defense costs
- Launching new funds during the active investment period
- Lifting limited operations mode in key person events
- Extending the fund’s term beyond its original duration
Disclosure & Good-Faith Efforts
LPACs rely on complete and transparent disclosures from GPs to make informed decisions. Regulators, including the US SEC, have raised concerns about insufficient disclosures that undermine LPAC oversight, especially in areas involving conflicts of interest—such as GPs holding board seats at portfolio companies.
Fund documentation typically requires the GP to make a good-faith effort to disclose all material facts to LPACs, which is critical for effective governance.
Formation and Membership of LPACs
GPs determine the size and membership of LPACs, often inviting larger or “anchor” investors. Some investors may require LPAC representation as a condition of their investment, which is formalized through side letters—agreements between the GP and a specific LP outlining custom terms.
To maintain neutrality, LPACs typically exclude GP-affiliated investors, though affiliated investments—such as “skin in the game” capital from the GP or its employees—can still exist.
Liability and Indemnification
Serving on an LPAC entails potential legal exposure. If LPAC-approved transactions later result in losses, committee members may face litigation. To mitigate this, LPs are generally indemnified by the fund, covering legal fees unless misconduct (e.g. fraud, gross negligence) is involved.
Parallel Funds & Joint LPACs
Funds may establish parallel funds to address legal, tax, or regulatory needs. These are typically managed on a pari passu basis (i.e. equally alongside the main fund). The LPAC often becomes a joint LPAC, overseeing governance across all related funds.
Advisory Boards vs. LPACs
An advisory board is distinct from an LPAC. While LPACs are formal governance bodies outlined in fund documents, advisory boards are consultative, offering strategic input without regulatory obligations. Members may include industry experts and are typically reimbursed for expenses or compensated through incentives like carry participation.
Summary: The Role of LPACs
LPACs play a vital role in fund governance by:
– Providing enhanced oversight of critical GP actions—particularly related to conflicts and valuations
– Facilitating effective communication between GPs and LPs
However, concerns about exclusivity and potential misalignment between LPAC members and smaller LPs persist. Balancing effective governance with equitable representation remains an ongoing challenge.
