Sunday, May 28, 2017

Practical Advice: Limited Partner Advisory Boards

Limited partner advisory committees/boards (LPAC) are a touchy subject that usually come up for conversation only during the legal negotiation of a venture capital fund's capital raise. However, they live on in operation until the fund is dissolved. Herein, I offer some cheeky advice on the need to have one, how to form one, their purpose and how best to use them.  

Every venture capital fund should have an LPAC. A venture capital firm should have one for every specific fund that it forms. I think there are too many conflicts to have one master advisory board/committee for the firm that operates as an omnibus board for resolving conflicts and voting on matters on behalf of every fund. This conflict exists because the members of the omnibus board/committee may be voting on matters for funds that the member is not an actual limited partner of, which seems like a real conflict of interest. As such, I believe that every discrete fund that a venture capital firm raises, should have its own LPAC comprised of limited partner representatives for each specific fund. This is especially true for firms that have multiple strategies and multiple funds, such as an opportunities fund that is doing later stage deals amongst the firm's earlier stage funds and underlying portfolio companies. The practical reason for having an LPAC is that it is generally easier to seek consent for an action under a fund's limited partnership agreement by going to the LPAC than seeking a vote from the entire limited partner base. Such a vote of the entire limited partner base, generally requires engaging counsel and drafting consents with a formal voting process. An LPAC vote can be done orally in-person/telephonically or over email without the need for counsel or the added expense.  

I am a big believer of venture capital firms choosing members of the LPAC based on their ability to add value to the GP and the Fund. Many firms simply choose their largest LPs or longest standing LPs. Venture capitalists should think about forming their LPAC the same way in which their entrepreneurs would think about forming their company's board of directors. Sometimes it's always most appropriate to select your largest limited partners as these are important relationships to maintain. I would suggest it is most important to select members that are best able to support you and offer the best advice and value back to your fund(s) and underlying portfolio companies. That may mean selecting a limited partner that offers strategic value to your companies because the limited partner has business interests that align with your companies and can affect their trajectory by being more closely informed with their operations. This may also mean selecting limited partners that are the best signal of influence as many prospective limited partners will ask who is on your LPAC and want to do LP references with these LPAC members during their diligence. Having allies on your LPAC that can offer a breadth of intimate and well-informed knowledge both about your firm/fund(s) as well as the industry in generally is critically important. With this in mind, you should consider picking your best LPs. Keep your LPAC to an odd number of persons (3, 5, 7) and don't use LPAC seats as cheap currency, because at some point you will inevitably have to make hard choices as you raise subsequent funds and may naturally err on the side of picking the most value added/largest/longest tenured LPs. Most importantly, pick the best individuals with the most experience and not the institution they represent. I have never seen the merit in picking your LPAC to represent different factions of LP organizations. For example, I have seen venture capital firms choose their LPAC members because they want a university, a fund-of-funds, a family office and a strategic. Under Delaware law, your LPAC members do not have a fiduciary duty to act in the best interest of the general partner, the LPAC (as an entity), the other limited partners or the Fund. While they cannot act in bad faith, they only have to act in their own best interest. With that in mind, there is no legal or metaphysical benefit to having a university endowment on the LPAC to represent the "endowment/foundation camp" of your limited partner base. Big name university endowments and white shoe foundations don't guarantee you big time fiduciary guidance or white shoe advice. Pick the best human beings from the organizations they represent within your LP base. 

The function of the LPAC is functionally only to vote on certain matters on behalf of the Fund: term extensions, capital call limitations within a specific time frame, crossing over deals between funds, warehousing, key person events, etc. A minority of firms have their LPAC vote on valuations, which I think this is a mistake. This should be left only to the General Partner. Aside from the formality of what your limited partnership agreement calls for, I think LPACs can be a valued source of advice and counsel for business decisions and an opportunity to share the progress and investment activity of your fund with your most trusted (and sometimes largest limited partners) between your fundraises. I think LPACs should convene twice a year, with at least one of these two meetings being held in person. If you have your annual meeting in October, I would suggest having your in-person LPAC meeting six months thereafter. I would walk through your new investments and follow-on investments within the specific fund. You will likely also want to talk about personnel additions/subtractions and any changes in your investment strategy/investment outlook. Definitely use your LPAC meetings as a forum to ask your LPAC members what they are seeing/hearing in the industry and how this may affect your firm/fund(s).  Give your LPAC members homework and seek their help, where they can. For LPAC members who are seeking co-investment opportunities, these meetings and the informal interactions therein are a great opportunity to gate such interest and avoid your LPs seeking co-investments from constantly calling/emailing seeking such deals. You should definitely preview your prospective capital raising plans with your LPAC first and rally their interest and commitments before approaching the rest of the limited partner base as your LPAC members should be your best references both within your existing limited partner base and prospective limited partner base.

After your annual in-person LPAC meeting, have a dinner with them. However, once you raise a new fund, only do so with your active fund unless you have a small membership of LPAC members with the same cast of characters and doing so doesn't get unwieldy. Don't forget that even though you aren't making new investments and some of your funds are 5-10+ years old, there is still an LPAC. The older a fund gets, the less need there is for meetings/updates and so you will likely only convene a meeting/call on an ad hoc basis to vote on a matter before the LPAC or solicit advice/counsel on a particular matter.

Take attendance and make sure the LPs that you have on your LPAC are engaged, informed and responsive. Lastly, make sure that you enjoy the company of your LPAC members and that they represent your values and the values of your firm/fund(s).  

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