Private placement memorandum
As GPs increasingly recognise their approach to responsible investment to be of value during fundraising, they will likely highlight this within the PPM. The GP may also provide its responses to the PRI Limited Partners’ Due Diligence Questionnaire in the PPM or fundraising materials in anticipation of its importance to prospective LPs. The advantage of this is that all LPs that consider investing in the fund are aware of the GP’s stance on responsible investment early on.
The PPM is a vehicle through which the GP can disclose its approach to responsible investment. The fund terms are a means of documenting the GP’s responsibilities, as agreed with the LPs investing in the fund.
The LP should review the GP’s PPM and LPA to get a better understanding of the GP’s responsible investment commitments (if any) before deciding on the extent of requests for ESG-related provisions in the fund terms that might be considered necessary. The LP should note that the PPM provides more space for explanation and narrative around the GP’s approach to responsible investment than does the contractually binding LPA, and that there are reputational implications for the GP if this is not adhered to. Importantly, the PPM provides a form of assurance to the LP as any disclosure is a representation by the GP that may be actionable if false or misleading.
However, the LP will have greater protection as to its responsible investment requirements if there is a contractual relationship (whether set out in the LPA or in a side letter) expressly highlighting the GP’s responsibilities. Furthermore, if the LP has specific policy and reporting requirements in addition to what is voluntarily expressed by the GP through the PPM, the LP should, if possible, make these requirements known early during the review and negotiation process for the fund terms.
Incorporating responsible investment in the PPM
As a disclosure document, the PPM is an appropriate place for the GP to disclose its responsible investment policy. The PPM also allows the GP to provide more narrative around its approach to responsible investment than in the fund terms, and to elaborate on the opportunity side of integrating ESG factors into the investment process whereas fund terms are primarily concerned with limiting downside risk.
A GP’s PPM may cover the following points:
- the firm’s responsible investment policy or any formal disclosures on the topic;
- organisational accountability, resourcing and capacity for executing the policy;
- any plans for value protection and enhancement initiatives;
- any thematic or strategic basis for ESG integration.
When reviewing a PPM, the LP might consider a lack of any language on responsible investment to be a cause for concern.
Fund terms: LPA or side letter?
The GP will draw up an LPA for initial review by the investors that are committing to the fund. The LP can then request ESG provisions or provide a mark-up on existing ESG provisions in the LPA. Alternatively, the LP can seek ESG provisions through a side letter.
An LPA or side letter obligation on the GP provides a greater level of contractual certainty and access to a wider range of legal remedies to the LP than statements of intention in the fund’s PPM.
ESG-related provisions in the LPA will commit the fund to an ESG policy or ESG-related obligations (which may already be part of the GP’s operational and governance framework) from which all investors should be able to benefit and enforce. The advantage to the GP of incorporating ESGrelated provisions into the LPA is that it allows the GP to adopt a standardised approach and officially informs all investors in the fund about the extent to which the GP’s operations might be influenced by responsible investment considerations. It may also result in a more streamlined drafting and negotiating process, as there may be fewer side letter requests from LPs. The LP will recognise that the GP will be considering the requirements of all LPs when drafting the LPA, and, accordingly, any language is likely to be relatively generic in nature.
A side letter is an agreement entered into by the GP and a specific LP, which clarifies and/or supplements the terms of the fund documentation when applied to that LP. Side letters permit investors with particular ESG-related priorities or bespoke requirements to put more tailored provisions to the GP for bilateral agreement (this can be particularly suitable for ESG reporting provisions which are specific to the LP in question and not applicable to the broader population of LPs committing to the fund).
Furthermore, if the GP needs to renegotiate on these requirements during the lifetime of the fund it will be more expedient to do this with the single LP in question rather than the broader population of LPs committed to the fund.
GPs that have accepted ESG-related provisions through side letters in previous funds might consider reincorporating some or all of this language upfront in the LPA, if appropriate. Such a step may be perceived as an improvement and a sign of goodwill by LPs. It will also avoid repeated side letter requests for processes that are already in place.
Whilst there are advantages of consistency and transparency in placing a core set of ESG-related provisions – or a statement of core responsible investment principles – in the LPA as opposed to side letters, there is a range of approaches to this in the market. The GP may deem it inappropriate in its case and will instead propose separate side letter agreements with each LP that negotiates successfully for ESG-related provisions in the fund terms.
GPs may wish to make their side letter provisions relating to ESG available to all interested LPs through the MFN provision found in many LPAs. The provision generally allows each LP to benefit from the side letter provisions negotiated by LPs, although it may only be available to those with the same or greater levels of commitment.
|BENEFITS OF THE LPA||BENEFITS OF THE SIDE LETTER|
|Full disclosure and transparency to all investors in the fund.||Subjective or idiosyncratic requests (i.e. from LPs on non-typical excuse, opt-out rights, exclusions or reporting requirements) could be placed in a side letter.|
|Provision on ESG reporting would mean that all LPs in the fund would receive this, not just the LPs that request it through side letters.||LPs are at different stages regarding ESG integration and it might be difficult to reach a common standard in the LPA.|
|May achieve expediency in reaching general consensus if responsible investment commitments are included in the LPA.||It is complicated to construct the right opt out provisions for certain ESG-related provisions in the LPA.|
|For practicality, may reduce variance of provisions through multiple side letter requests by including core set of ESG-related provisions in the LPA.||LPs committing to the fund after the first close would likely choose to make any tailored requests through a side letter as any amendments to the LPA will then typically require the consent of a majority of the investors.|
|The GP may have other investors in the fund that are indifferent, and possibly opposed, to the concept of responsible investment. It is important for all other investors in the fund to know whether the GP is potentially constrained, and how. ESG-related provisions may protect the GP from investors subsequently arguing that adherence to such ESG obligations negatively impacted on the performance of the fund or of specific portfolio investments.|
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Incorporating responsible investment requirements into private equity fund terms