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How is an LPA concentration limit on a single investment calculated?

A 20 per cent single-company limit worked on one deal: the base, the follow-on, the bridge that fails to syndicate, and when the LPAC has to approve.

Julian R. Sterling · from How to Read a Limited Partnership Agreement

An LPA concentration limit is usually tested as the fund's total cost in one portfolio company, including follow-ons, divided by aggregate commitments, at the time of each investment. On an illustrative $750m fund with a 20 per cent limit, a $120m deal plus a $25m follow-on is 19.33 per cent and passes; the same exposure is 22.0 per cent of commitments net of fees and 32.2 per cent of the $450m raised at first close, so which base the clause names decides whether the deal needs LPAC consent.

Worked in full in How to Read a Limited Partnership Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

Reading the clause

A typical investment restriction reads something like: the partnership will not invest more than 20 per cent of aggregate commitments in any single portfolio company, measured at cost at the time of investment, including follow-on investments, without the consent of the advisory committee, which may approve up to 25 per cent. Bridge financing expected to be syndicated within twelve months is excluded. Each phrase is a variable in the calculation:

• "Aggregate commitments": total commitments, or commitments net of fees and expenses, and at which close.
• "At cost": amounts invested, not fair value. A winner that grows to a third of NAV does not breach.
• "Including follow-ons": the numerator accumulates over the life of the investment.
• "Bridge to be syndicated": excluded only while the syndication is pending; it counts once the window passes.

The fund and the deal

Illustrative mid-market fund, $m

Item	Amount
Commitments at final close	750
Commitments when the deal signs, before final close	450
Fees and expenses over the fund's life, as budgeted	90
Concentration limit, and LPAC ceiling	20%, 25%
Initial equity in the company	120
Bridge, to be syndicated within 9 months	45
Follow-on for an add-on acquisition, year 3	25

The calculation, step by step

Step 1, fix the base. On final commitments the limit is 20% × 750 = 150, and the LPAC can approve up to 25% × 750 = 187.5. On commitments net of the fee budget, 750 − 90 = 660, the limit is 132. On first-close commitments it is 90.

Step 2, the initial investment. 120 / 750 = 16.00 per cent: inside the limit with 30 of headroom.

Step 3, the bridge. Excluded while syndication is pending. If the syndication fails and the 45 stays on the fund's books past the window, exposure becomes 165, or 22.00 per cent: 15 over the limit. The GP must sell down 15 or obtain LPAC consent, which is available because 165 is under 187.5.

Step 4, the follow-on. With the bridge syndicated, 120 + 25 = 145, or 19.33 per cent. It passes, with 5 to spare.

What if the base or the bridge changes?

Exposure to the company as a share of each possible base

Exposure	Cost	Of 450 first close	Of 750 final	Of 660 net of fees
Initial only	120	26.7%	16.00%	18.2%
Initial + follow-on	145	32.2%	19.33%	22.0%
Initial + failed bridge	165	36.7%	22.00%	25.0%
All three	190	42.2%	25.33%	28.8%

Three readings of the table matter in practice.

• Net of fees. If the clause measures against commitments less fees and expenses, the follow-on that passed with 5 to spare is 22.0 per cent and needs consent. Funds that define investable capital this way have 12 of headroom after the initial deal, not 30. The same base appears in regulation: the AIFMD II single-borrower limit is set on capital net of fees, worked in the 20 per cent single-borrower limit.
• Before final close. At signing the fund has 450 of commitments, and 120 is 26.7 per cent of that, above even the LPAC ceiling. Only a clause that measures against final or target commitments lets a fund do its largest deal early; otherwise the first close needs to reach 600 for the deal to pass on its own. Read whether the LPA tests at the time of investment "as if the final closing had occurred".
• Everything at once. If the bridge fails and the add-on happens, 190 is 25.33 per cent of final commitments, 2.5 above what the LPAC can approve. The add-on then has to be resized or partly co-invested, not waved through.

The common mistake

Testing the follow-on alone. The limit is on the total in one company, so a 25 follow-on is not "3.3 per cent of the fund" but the step that takes the position from 16.00 to 19.33 per cent. The second mistake is forgetting the bridge clock: an exclusion for syndication within nine or twelve months becomes an inclusion the day after, whether or not anyone looked. Reserve the headroom for follow-ons at the time of the first investment, and diarise the bridge expiry. Co-investment is the usual way to take the excess outside the fund; the look-through on that exposure is set out in look-through exposure on a co-investment. Blank versions of the book's fee and waterfall models are in the free companion files.

Takeaway

Name the base before doing the division. On the worked fund the same 145 position is 19.33, 22.0 or 32.2 per cent depending on whether the clause means final commitments, commitments net of fees, or commitments at the time of investment, and only the first passes without the LPAC.

Questions readers ask

Is a private equity concentration limit measured at cost or at fair value?

Usually at cost at the time of each investment, so a company that grows in value does not cause a breach but every follow-on adds to the test. On a $750m fund an initial 120 is 16.00 per cent; a 25 follow-on takes the total to 145, or 19.33 per cent, under a 20 per cent limit.

Do bridge investments count towards the concentration limit?

Many LPAs exclude bridge financing expected to be syndicated within a set window, often nine to twelve months. If syndication fails, it counts. In the worked case a 45 bridge that stays on the books takes the exposure from 120 to 165, 22.00 per cent of commitments, 15 over a 20 per cent limit and within the 187.5 an LPAC could approve.

What happens if a deal exceeds the LPA investment limit?

The GP needs advisory committee consent, if the LPA allows it, or must reduce the position, typically by syndicating to co-investors. Where the LPAC can approve up to 25 per cent of $750m, the ceiling is 187.5; an exposure of 190 is 2.5 above it and has to be resized whatever the committee thinks.

Also on this site

• How is the AIFMD II 20% single-borrower limit calculated?On capital, not NAV: commitments less the fees investors bear. A 600 million fund with 66 million of fees can lend 106.8 million to one financial borrower.
• How do you measure look-through exposure on a co-investment?Add the cheque to your share of the fund's holding. A 40 co-investment plus 15.0 held via the fund is 55.0, 1.10% of a 5,000 plan, against a 1% limit.
• When can a GP raise a successor fund under a 75% invested test?It depends on what counts as invested. A 500 fund passes at 4.00 years on closed deals, but at 2.75 with fees, reserves and signed deals counted.
• At what multiple does a private equity fund start paying carry?When the gross IRR reaches the hurdle. On an illustrative fund, an 8 per cent hurdle bites at 1.48x and the full catch-up completes at 1.57x.
• Full vs 80 per cent catch-up: how much carry does the GP lose?Only inside a narrow band. With 30 of pref and 20% carry, a full catch-up ends at 137.5 and an 80% one at 140.0; the most the GP loses is 1.50, then nothing.
• How much does a recycling provision add to LP returns?Recycled capital times (gross multiple minus 1), less carry. Recycling 65 on a 500 fund at 2.0x adds 52 to LPs, lifting the net multiple from 1.592x to 1.696x.

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