EVCA Handbook Professional Standards for the Private Equity and ...

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32 EVCA Handbook Professional Standards for the Private Equity and Venture Capital Industry3.8.2. LP Secondary TransactionsQuestionWhat procedures should be followed in a secondaries sale?ExplanationIt is likely that some LPs, at some point during the life of the Fund maywish to or need to seek to sell their participation in the Fund. This canarise for a variety of reasons and need not have anything to do withthe performance of the Fund. When such a situation arises, there areadministrative protocols which need to be followed to ensure thetransfer is handled properly in accordance with both the proceduresand requirements set out in the Fund documentation and general law.The LP buying the participation will need to satisfy all the Fundrequirements. It is important that in the process confidentiality bemaintained with respect to information about the Fund and itsunderlying investments.In Funds with a high number of LPs, the GP may also need to bemindful of the obligations under general law with regard to the tradingstatus of the Fund and so may need to limit the number of secondarytransactions which may take place in any year.RecommendationIt is standard practice to state in the Fund’s documentation that theGP’s consent to an LP transfer may not be unreasonably withheld.When an LP is seriously considering selling their participation, theyought to contact the GP at the earliest opportunity and the GP shouldreconfirm the procedures to be complied with and documentation tobe completed before any transfer can be finalised. The GP and LPshould discuss what information about the Fund and its investmentscan be shared with who at what point in the process of executing thesecondary sale. Disclosure should, in accordance with industrypractice and protocol, ideally be timed to take account of the Fund’sfinancial, investment and general reporting cycle. This helps tominimise disruption to the Fund’s operations, and also expensesincurred in connection with the transfer.3.9 Winding up of a FundThe liquidation of a Fund must be undertaken with careby the GP to ensure that neither the Fund, the LPs, northe GP are exposed to unacceptable potential liabilitiesfollowing liquidation.3.9.1. LiquidationQuestionWhat issues should the GP address on liquidation?ExplanationThe liquidation of a Fund will, generally, mean that the assets will bedistributed to LPs. This means that if claims are subsequently broughtagainst the Fund, there are unlikely to be funds available to meetthose claims.RecommendationOn liquidation, the GP should make a thorough assessment of therisk of claims against the Fund and should ensure suitable sums areheld in escrow/are subject to Clawback arrangements to meet suchclaims. The escrow provision should also apply to a portion of theCarried Interest, or alternatively the Carried Interest should besubject to Clawback for a specified period following the end ofthe life of the Fund.3.9.2. Fund documentsQuestionWhat provisions should the Fund documents include on liquidation?ExplanationThe GP’s powers and responsibilities on liquidation will usually be setout in the Fund documents. It is important that these provisions areclear and exhaustive to reduce the likelihood of disputes on liquidation.RecommendationThe Fund documents should include provisions on liquidationaddressing:• the GP’s power to realise the Fund’s investments;• the extent of LPs’ and Carried Interest holders’ liability followingliquidation;• the period in which liquidation should be effected; and• escrow and/or Clawback arrangements to cover potentialfuture liabilities.3.10 Management of multiple FundsA successful GP will often manage more than one Fund inthe same market. This can give rise to conflicts of interestand make it difficult for the GP to act in the best interestsof all of the Funds it manages.3.10.1. Conflicts of interestQuestionWhat should a GP do when a conflict of interest arises between Fundsthat it manages?ExplanationConflicts of interest can arise relatively easily where a GP managesmultiple Funds. For example, one Fund managed by a GP may acquirean investment being disposed by another, or opportunities forfollow-on investment may arise that cannot be exploited by both Funds.Conflicts can also arise when multiple Funds hold investments in aPortfolio Company and a disposal opportunity arises. It is possiblethat it may not be in the best interests of all Funds to dispose of theinvestment (e.g. where one invested on terms that mean disposalwould crystallise a loss to that Fund, while another Fund would realisea profit).
33 EVCA Handbook Professional Standards for the Private Equity and Venture Capital IndustryRecommendationThe GP should discuss all conflicts of interest with the LPAC of bothFunds before making any decision about the best course of action totake. The GP should establish procedures to identify, disclose andresolve conflicts of interest. These should be set out in the respectiveFund documents.3.10.2. Establishment of new FundsQuestionWhen should the GP establish further Funds?ExplanationThe GP could prejudice the interests of LPs in an existing Fund byestablishing a Fund with a similar investment strategy too soon afterestablishing the existing Fund. Doing so can dilute the return to LPs inthe existing Fund and compromise the GP’s ability to implement theexisting Fund’s investment policy. It can also give rise to conflicts ofinterest if an investment in a Portfolio Company is split betweendifferent Funds.RecommendationA GP should seek to avoid making new investments in a PortfolioCompany from more than one Fund which it manages. In general,a new Fund should not be established until the existing Fund issubstantially invested/committed. Fees on prior Funds generallyreduce when the Fund is substantially invested or a new Fund is raised.Specific limits on when a new Fund may be marketed or closed shouldbe set out in the Fund documents.3.11 GP’s internal organisationFor the purposes of this section 3.11, management arethose members of the board who have executive roleswithin the GP’s organisation and those other employeesof the organisation who work with the executivesto deliver the business strategy of the GP. Theirresponsibilities in relation to governance of the businessinclude responsibility for the specific and detailedimplementation of the strategy.The GP has responsibility to ensure that it has adequateresources to source, analyse, negotiate and advise onpotential transactions as well as to invest in, manage anddivest Portfolio Companies. This includes, in particular,human resources, compliance and financial resources.3.11.1. Management are responsible for establishing thecontrol environmentQuestionHow should management go about establishing the controlenvironment?ExplanationManagement are responsible for ensuring that throughout theGP organisation employees recognise and respond to the need forintegrity and ethical behaviour in relation to the achievement of theGP’s and its investment portfolio’s goals. A high standard of corporategovernance sets the framework to meet these goals effectively.RecommendationManagement should identify, select and adopt an appropriategovernance and control framework taking into account the sizeand complexity of the business and should communicate the keyfeatures of that framework, applying it consistently and effectively.3.11.2. Management are responsible for establishing proceduresfor risk assessmentQuestionWhat procedures should be established for appropriate riskassessment on an ongoing basis?ExplanationRisk assessment includes determining an appropriate risk appetite,identifying specific risks, assessing the effectiveness of controls overspecific risks and comparing residual risk to the overall appetite forrisk that has been agreed. Effective procedures for risk assessmentcover strategic and operational matters and operate on a regular androlling basis.Any procedures or processes introduced to an organisation shouldnormally be subjected to an analysis comparing cost and benefits.The introduction of risk assessment procedures should acknowledgethat much of what happens in business process is the proactiveassessment and mitigation of risk and that therefore the introductionof risk assessment procedures is partly a matter of making explicitwhat is already in place. This is particularly true in the case of PrivateEquity and Venture Capital firms that typically will have well developedrisk assessment and mitigation approaches and processes.RecommendationRisk assessment should cover at least:• strategic risk;• risk within the core business processes; and• risk within the resource management processes.Where appropriate, specialist help and advice should be sought whendealing with specific risk areas, for example market/public relationsrisk, treasury risk, labour relations risk, regulatory risk or informationtechnology risk. The assessment of risk should be a regular ongoingprocess and not a “once a year” exercise.
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