ILPA publishes guidance on allocation of organizational expenses in PE fund formation with emphasis on mega funds

The Institutional Limited Partners Association (ILPA) released new guidance last month titled, "The Alignment Gap: Rethinking Costs in Private Equity Fund Formation," which proposes a framework to address what ILPA characterizes as misaligned incentives and rising organizational expenses in private equity fund formation.

The guidance notes that median organizational expense caps have trended upwards as a percentage of fund commitments, from roughly 20 basis points in 2019–2021 to approximately 25 basis points by 2024–2025. It also highlights ILPA's concern with the allocation of organizational expenses between limited partners (LPs) and general partners (GPs), who control some aspects of the key decisions driving those costs, including selection of fund counsel and budget-setting.

ILPA's guidance proposes a three-part framework. First, organizational expenses borne solely by LPs would be capped at the lower of five basis points of a fund's target assets under management (AUM), or $10 million in total.

Second, where fund formation costs exceed this cap, ILPA proposes that GPs bear 50 percent of total overage organizational expenses, with LPs bearing the remaining half.

Third, the guidance calls for enhanced legal fee transparency, including disclosure of rate schedules and draft budgets for formation-related services to LPs and competitive bidding processes for fund counsel on funds targeting more than $1 billion in AUM.

ILPA's guidance also proposes explicitly treating side letter negotiations and Most Favored Nation (MFN) processes as organizational expenses subject to the proposed cap rather than classifying these as uncapped partnership expenses.

ILPA takes the position that its proposed cost-sharing model is positioned not as punitive, but as a mechanism to create better alignment and incentives for both sides to avoid unnecessary complexity, control legal spend, and streamline negotiations.

If adopted, the proposed framework would represent a departure from the historical cost-sharing approach where GPs bear organizational expenses proportionate to their commitment in the fund (e.g., one to five percent) and would change the dynamics of fundraising negotiations.

The guidance reflects certain institutional investor perspectives regarding outside counsel costs in the fund formation process, most relevant for and particularly in mega funds – where caps on organizational expenses in successive vintages have increased on pace with, and sometimes in excess of, the hard caps or targeted LP commitments to such vehicles.

The guidance may be relevant to participants in the private funds market, particularly for sponsors raising more than $1 billion of AUM, as they assess organizational expense structures and related disclosure practices in upcoming fundraises.

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