Emerging Manager Limited Partnership Agreement (LPA)

The limited partnership agreement (LPA) is a lengthy document you may create with your legal counsel. It covers legal terms that may govern your limited partnership (LP). Once established, your limited partnership becomes the actual legal entity that accepts investments from your fund investors and that you use to make investments into companies.

You may also need a general partnership agreement (GPA), typically not completed until after your first close, and a fund management company. All three constitute separate legal entities established by you and your lawyers. “Since LPAs can take a long time to draft, you may also want to create a term sheet in tandem that you can provide to LPs when you’re earlier in the fundraising process,” advises Efrat Turgeman, a managing director at SVB Capital.

The LPA may include:

• General fund terms
  • Fund size: An estimate of the total fund size you plan to raise, ideally including the minimum and hard cap.
  • Management fee: The percentage paid to the overarching management company for each fund. A 2% fee is typically the norm for most emerging managers.
  • Returns distribution: An outline of how and when returns will be distributed to the GP and LP base. There are two types of distribution waterfalls:
    • Deal-by-deal distributions (or American distributions): Proceeds available for distribution are calculated for each individual portfolio investment.
    • Fund-level distributions (or European distributions): Proceeds are available at the fund level in aggregate.
  • Carried interest distribution: The returns distributed back to the GP are often referred to as carried interest. A 20% carried interest distribution is typically the norm for most emerging managers.
  • Term of the fund: The length of time in years you’ll be investing this fund. Most investment terms allow for up to two one-year term extensions.
  • Fundraising term: The length of time in months or years you’ll be adding new limited partners. This term is typically 12 months from the date of first close through the final close.
  • GP commitment: A percentage of the fund capital that the GP(s) will personally commit to the fund. While the average expected GP commitment is typically 1%, this figure can vary. LPs typically expect your stake to reflect your organizational growth plans (the larger the fund size, the larger the personal commitment expectation) and your personal wealth. A previous founder with multiple healthy exits may be expected to contribute a higher percentage than a first-time manager coming out of a startup, for example.
  • Recycling: A clause that dictates whether you will allow recycling of funds in the event of exits. Fund recycling generally can be advantageous for both GPs and LPs because it may increase the number of investments that can be made on a fund. It also may increase the carried interest potential.
  • Fund expenses: The estimated amount of capital you plan to use for operating expenses like legal and fund administration. Most LPs expect a cap on expenses.
• Downside protections
  • Default: A provision that outlines the mechanisms that prohibit LPs from defaulting on their capital contributions to the fund.
  • Key person: A provision that prohibits the fund manager or GP from making key investments if one or more named key principals fail to devote a specific amount of time to the partnership for any reason.
  • GP removal: A provision that gives LPs the right to remove and replace a GP for certain bad acts.
  • GP clawback: A provision that requires the GP to return distributions if certain conditions are not met (e.g., LP preferred return is not met, or GP has received carried interest above set distribution rate).
  • Indemnification: A provision that allocates the risk of losses across the GP and LP base.
• LP relationship terms
  • Co-investments: An outline describing how and when LPs can make direct investments into companies alongside the fund.
  • Capital calls: A provision that dictates how and when capital will be “called” or drawn down from LPs by the firm over the course of the fund term.
  • Conflicts of interest: An explanation of how conflicts will be handled when they arise.
  • Limited partnership advisory committee (LPAC): A committee of LP representatives (typically three to five larger investors) appointed by the GP to provide additional oversight and handle sensitive matters.
  • Side letters: Formalized agreements that specify special terms for a subset of fund investors to override the standard fund terms. Side letters are typically reserved for the large LPs, who often request a most-favored-nations (MFN) clause that allows them to see and opt into the terms of side letters given to other investors. Morgan Lewis has written a great article for those who want to delve deeper into side letters and MFN clauses.

What matters most to LPs?

In-market and fair terms.
There are some common terms that LPs typically expect across emerging managers, many of which we’ve already outlined above. These are commonly expected because they are generally accepted as both fair and efficient for both GPs and LPs. If your LPA includes term(s) that are not market-norm, anticipate explaining them in more detail to prospective LPs.

Long-term thinking.
Short-term thinking can be problematic when it comes to LP relationships, according to SVB’s Efrat Turgeman. “We see a common mistake where emerging managers think about the LP relationship in terms of a 10-year fund cycle, instead of a firm cycle, which can be 50 years or more,” she explains. “There’s going to be a huge evolution in your firm over that period of time, and the LP agreement you set now sets the tone for that relationship. The most thoughtful VCs think about things like market cycles, GP retirement and generational transfer. LPs usually want to know that you’re preparing to manage through these complex changes.”

Alignment.
As your “shareholders,” LPs typically want the opportunity to share in the upside, while maintaining clear downside protections. Both can be important given the duration of a venture partnership.

Legal protections.
Given the complexity of the LPA, we do not recommend that you put one together without a lawyer who specializes in fund formation. You should also consider relying on your lawyers to help you determine the difference between reasonable and unreasonable requests from an LP. “LPs are people too—so sometimes you’ll get a strange pet request,” says SVB’s Alex Marshall. “But that’s when you evaluate the benefit of that LP versus the added complexity it creates in your process.”

Accuracy.
It’s unwise to try to save on costs when writing an LPA, according to emerging manager back-office consultant Kristen Ostro at Strut Consulting. “LPAs are complex, and when they are not put together right, it can easily end up costing double to correct it,” she says. “To avoid this possibility, consider working with a firm that specializes in the space and knows it well, even if it’s expensive.”

Resources

Review a sample Limited Partnership Agreement by Institutional Limited Partnership Association (ILPA)

• Model Limited Partnership Agreement by the ILPA