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The paper barrier to private equity investment

Partnership agreements are unnecessarily complex and lengthy – and they tend to be in favour of the private equity firm rather than the investor. Isn't it high time that agreements were standardised, asks the Railways Pension Trustee Company's Susan Adeane.

Investment in private equity is growing as it becomes increasingly more attractive as an asset class and a means of diversification for institutions such as pension funds. Last year, institutions and private individuals invested £9bn in private equity funds, according to the British Venture Capital Association. This was an increase of 55 per cent on 1999's £5.8bn. Now that the Myners Review has been published, it's likely that this figure will increase in the long term as it encouraged investment in private equity and stressed its benefits in helping enterprises to realise their growth potential. 

The railways pension schemes have been investing in private equity since 1988 and our allocation to the asset class has steadily increased. Currently, we have seven private equity managers. These are a mixture of discretionary and fund of funds providers that invest in the UK, Europe and the US, at all stages of the private equity cycle.

The trustee company supports this asset class. At the end of 2000, the value of our internal direct investment pooled funds was £459m. So far, the investment has worked well for us and has exceeded the returns in the UK equity market by a substantial margin. It sounds good so far. There's just one problem: I am uncomfortable with, and suspicious of, partnership agreements.

Complex and impenetrable
As company secretary and compliance officer to the trustee company, I carry out a lay person's legal review of investment management and associated agreements. I have some experience in this area and will normally sign off that I am content with the terms of any agreement on behalf of the trustee. This worked well until I encountered our first partnership agreement. I remember opening a meeting with a potential advisor by saying that their draft legal agreement was the most complex, impenetrable and user-unfriendly that I had encountered. Unusually, I had to hand the documentation to our solicitors to consider on the trustee's behalf. I was extremely uncomfortable with the complexity, lack of transparency and opportunity to negotiate.

Many partnership agreements down the line, and not being one to abdicate responsibility, my knowledge of them is still on an upwards learning curve. And yet I still have misgivings. The contracts are unnecessarily lengthy and wordy. This simply makes me suspicious. What has been hidden within the convoluted wording and myriad of inter-related clauses?

Size matters, but only sometimes
With other legal documents, I, together with our solicitors, negotiate strongly on behalf of the trustee. As one of the largest pension funds in the country, we are usually successful in our negotiations - in some cases size really does matter. However, it is much more difficult to negotiate terms in partnership agreements in the trustee's favour. Some concessions are possible, but we are severely hindered by the fact that anything agreed would apply to all the limited partners equally. It's also true that even if the investment is a relatively small one for us, consideration of the contractual documentation will take up more time and incur more legal fees than, for example, a global equity portfolio in the order of £1bn.

If the Railways Pension Trustee Company is encountering these difficulties with our relevant experience, plus access to internal expertise and top city lawyers, then these problems will be far worse for pension funds that are smaller and/or new to private equity.

Paul Myners and the BVCA want to encourage investors into private equity. Myners himself said that the ‘English law governing limited partnerships is archaic' and wished to remove the barriers to entry. I agree. To simplify the process of investing in private equity, limited partnership agreements should be more standardised. At present, private equity partnerships are a legal minefield, which means that the bias of the documentation is in favour of the managers and is a highly lucrative source of work for solicitors. I don't know the exact costs involved, but I wouldn't be surprised if the legal charges incurred for a complicated partnership approached £1m. And these are just the charges to be met by the partnership itself. Separate legal fees will be incurred directly by potential investors when reviewing the partnership agreements themselves.

Start standardising
Things are starting to change. There is now more room to negotiate than previously. The BVCA and the National Association of Pension Funds are preparing a joint explanatory guide on partnership agreements. This is to be welcomed. However, I would encourage them to go one stage further by introducing an industry standard that private equity investment managers could adopt voluntarily. This is not a new concept and there are appropriate comparisons in other areas. For example, the IFMA/LIBA terms are used for many discretionary investment management agreements. There is also a modern instrument of incorporation for open-ended investment companies.

Of course, a standard agreement model shouldn't seek to predefine the key commercial terms and conditions. Yet there are ways around this. One option could be, as far as possible, to have a default position or a standard draft, where any changes from the norm were highlighted. Another could be to have the more specific technicalities dealt with in separate schedules. But however standardisation is achieved, it should ensure that the criteria of simplicity, consistency, transparency and flexibility are met and that any variations are clearly highlighted.

Of the various clauses, there are some obvious candidates for standardisation: the definitions of the rights and duties of the general partner, for example, or the assignment and accounts. Nor should it be difficult to have similar clauses on the constitution of the partnership, conflict of interest and termination and liquidation. And I would particularly urge that representations and warranties are standardised.

People within the pension fund industry support this view and I understand that there is some agreement with it within the BVCA. A number of investment managers also seem to be in favour. Is there any reason why there shouldn't be a move towards standardising limited partnership agreements? Who would like to start the ball rolling?

I would welcome your views on these proposals. Please respond to me at susan.adeane@railpeninvestments.co.uk And if you share my concerns, please let your feelings be known both to the BVCA (bvca@bvca.co.uk) and the NAPF (membership@napf.co.uk). 

Susan Adeane is company secretary and compliance officer of the Railways Pension Trustee Company, which is responsible for the £16bn of assets of the railways pension schemes.