Should different investors be offered different terms?

Explanation

The terms of an investment in a fund will normally be the subject and result of negotiation. Given the diversity of potential LPs in private equity, some LPs may require specific terms, for example to meet their own regulatory obligations.
LPs may also be interested in obtaining certain preferential rights or economic benefits (e.g., positions on the LPAC, preferential access to co-investment opportunities, reduced management fees or carried interest participation). It should also be noted that commercial and strategic investors may have different investment priorities than financial investors. However, a fund is generally deemed to treat all LPs fairly (and applicable law may require fair treatment).

For example, the AIFMD provides for mandatory disclosure regarding differential treatment of investors, including a description of the preferential treatment and the type of investor that received such treatment. The inclusion of such disclosure would also be consistent with the Code's conflict of interest disclosure principle.
The extent to which certain LPs are granted influence over the management of the fund should be carefully considered.

If such influence alters the management structure of the fund, it may jeopardise the LPs' limited liability. Significant influence over a fund's management (particularly investment or divestiture decisions) may subject the fund to merger rules and reporting requirements, with undesirable consequences for both the fund and its LPs. Some LPs may also have a problem with another LP rather than the fund manager playing a role in investment decisions.

Recommendation

Whenever possible, GP should try to ensure that all LPs in the fund are treated fairly. Different terms may be offered to different LPs but, wherever possible, preferential treatment or a specific economic advantage for individual LPs or groups of LPs should be justified (e.g. with reference to the amount invested by a particular LP or the specific experience of a LP, which adds value to the fund).

Also, any preferential treatment should be clearly disclosed to all other LPs at the outset, so that those LPs at least know that certain other LPs may benefit from preferential treatment. If different conditions apply to certain LPs, this may have implications for the alignment of LPs' interests.

LPs generally should not participate in the day-to-day management (including the investment decision-making process) of the fund. If they do, they and their fellow LPs should be aware of the legal risks of doing so in certain jurisdictions, which may result in a LP losing its limited liability. They may also expose themselves to claims from other LPs.

In setting initial terms and in subsequent negotiations with potential LPs, a GP should consider the general alignment of interests of LPs. Most favoured nation (MFN) clauses are often used to give some LPs the right to claim the same benefits granted to other LPs, so the fundraising team should consider the impact on existing LPs as well as laws such as the AIFMD, which require fair treatment of investors and disclosure of unequal treatment in concessions to potential
LPs in subsequent negotiations.

If a fund is structured as multiple parallel partnerships or entities, the fundraising team should seek to avoid having any such entity or single minority LP (in the context of the fund as a whole) in a position to unduly influence the fund or block special resolutions without adequate justification.