Overview

1. Overview • Applicable law and legal standards • Focus on alternative investments • Private equity funds • Focus on contract rights • Details 115130213v2

2. Goals • Understand alternative investment contracts better • Understand better issues for review and negotiation • Fulfillment of duties 115130213v2

3. Applicable Law • Uniform Prudent Management of Institutional Funds Act (“UPMIFA”) • Adopted in 2006 by National Conference of Commissioners on Uniform State Laws • Enacted in all States and District of Columbia, except Pennsylvania • Revised Model Non-profit Corporation Act • Uniform Prudent Investor Act (“UPIA”) • ERISA 115130213v2

4. Duty of Care in UPMIFA • “Each person responsible for managing and investing an institutional fund shall manage and invest the fund in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” • “An institution shall make a reasonable effort to verify facts relevant to the management and investment of the fund.” 115130213v2

5. Duty of Care in UPMIFA (cont.) • Drafting Committee believes that “reasonable care, skill, and caution” (UPIA standard) are implicit in this language. • UPMIFA makes the duty of care, the duty to minimize costs, and the duty to investigate mandatory. • These duties apply to directors, trustees, officers, employees, and agents of the institution. 115130213v2

6. Investment Process • Management Structure: Board, Investment Committee, Endowment Office • Internal Staff; External Consultants • Asset Allocation: Stocks, Bonds, Alternative Investments • Selection of Asset Managers • Our Focus: Due Diligence on Alternative Investments 115130213v2

7. Hedge Funds • Investors have few legal rights • Remedy for investors is to withdraw • Not always possible • Possible improvements • Limit investment discretion, style drift • Limit indemnification • Limit ability to amend LPA • GP capital investment 115130213v2

8. Structure and Terms of a Private Equity Fund • Fund is a limited partnership or limited liability company • Each investor makes a legally binding commitment to contribute capital contributions of a fixed amount to the fund • The fund sponsor (general partner; “GP”) calls in the capital contributions as investments are made over an initial 3–5 year investment period. 115130213v2

9. Structure and Terms of a Private Equity Fund (cont.) • The investments are harvested over a 10-year life of the fund • The profits are split 80% for the investors and 20% for the fund sponsor 115130213v2

10. Key Legal Documents • Private Placement Memorandum (“PPM”) • Does LPA match PPM? • Fund Partnership Agreement (“LPA”) • Or LLC Agreement • Subscription Agreement • Need to check for unusual provisions 115130213v2

11. Difficulties in Reviewing LPAs • Long, complicated documents • Profusion of defined terms and cross-references • Not noticing even small bits can be significant • Specialized tax and accounting concepts 115130213v2

12. Difficulties in Reviewing LPAs • Misconceptions • Financial advisor is doing legal review • Lack of negotiating power • Big investors have taken care of the issues • Make your requests on early drafts! 115130213v2

13. Review of Limited Partnership Agreements (“LPAs”) • Increase economic returns • Reduce risk of economic losses • Reduce risk of embarrassment due to investment in fund whose terms are revealed to be problematic • Avoid wasted staff time • Document that risks taken were recognized • Avoid investing in problematic funds 115130213v2

14. Review of Limited Partnership Agreements (“LPAs”) • Economics/Alignment of Interest • Firm ownership • GP commitment and contributions • Management fees • Management fee offsets • Placement fees • Organizational fees • Tax considerations 115130213v2

15. Review of Limited Partnership Agreements (“LPAs”) • Economics/Alignment of Interest (cont.) • Allocation of deals • Parallel funds, AIV, etc. • LP contributions • Distributions • Recallable capital • Hurdles • Carry 115130213v2

16. Review of Limited Partnership Agreements (“LPAs”) • Economics/Alignment of Interest (cont.) • Clawbacks • GP guarantees • Liability limitations 115130213v2

17. Review of Limited Partnership Agreements (“LPAs”) • Governance • Fund legal structure/governance • GP’s fiduciary duty to the Partnership • Key persons and triggers • GP transfer of interest • For cause versus no fault • Indemnification • Removed GP • Replacement GP 115130213v2

18. Review of Limited Partnership Agreements (“LPAs”) • Other • Investment objective/strategy • Minimum fund size/hard cap • Fund diversification/concentration • Restricted investments • Leverage 115130213v2

19. Review of Limited Partnership Agreements (“LPAs”) • Other (cont.) • Fundraising time period • Investment period • Fund term • Fund extensions • Fund raise of successor fund 115130213v2

20. Review of Limited Partnership Agreements (“LPAs”) • Other (cont.) • Amendments • Advisory board • LP votes—issues in feeder funds • LP transfer of interest • Confidentiality • Side letters • Reporting 115130213v2

21. No Fault LP Rights(Without Cause) • LPs can vote to terminate investment period • LPs can vote to remove GP • LPs can vote to terminate fund 115130213v2

22. Is This the Deal? Main distribution scheme: • Preferred return • Return of capital • Catch-up to GP • 80% to LPs, 20% to GP Short-term income and loss distributions: • To the LPs in proportion to commitments 115130213v2

23. Aggregation of All Profits and Losses (One Pool) 115130213v2

24. Fine Print—An Example • Definitions • “Short-term Income” and “Short-term Loss” mean, respectively, the income or loss realized from interest income on cash held pending investment or distribution, reduced by expenses (including Management Fees) • Distributions and Allocations • Short-term income and short-term loss shall be distributed and allocated in accordance with Percentage Interests 115130213v2

25. Two Pools LP Cost—$400,000 on $10 Million Commitment 115130213v2

26. Two Pools Are Kept Separate Economically • Investment income—distributed in the main waterfall • Short-term loss—LP capital contributions to cover these losses are not returned to the LPs 115130213v2

27. Items to Watch for, Possibly Subverting Distribution Scheme • Liquidation by capital account balances • Short-term income/loss pool includes management fees and/or expenses • Allocation of management fees and/or expenses to LPs • LPs are allocated 80% of investment profits, which is not enough to make up capital lost to pay fees 115130213v2

28. How Are Cash Distributions Determined? • All distributions—non-liquidating and liquidating distributions—are made in accordance with the distribution waterfall • Non-liquidating distributions are made in accordance with the distribution waterfall, but liquidating distributions are made in accordance with capital account balances • Non-liquidating distributions can never exceed capital account balances • Allocations—not the distribution waterfall—determine the ultimate economic deal 115130213v2

29. Operation of Key Mechanisms—Allocation of Fees to LPs 115130213v2

30. Operation of Key Mechanisms—Liquidation by Capital Account Balances Earlier, non-liquidating distributions per waterfall are curtailed if they would exceed (override) capital account balances 115130213v2

31. GP Tax Problem • Origins—GP inability to deduct management fees • Compromise—make up fee loss allocations to LPs by giving LPs special additional capital gain allocations • Transform portion of management fee into profits interest • Have the LPs pay the management fee directly, so the Fund does not pay it • LPs then need extra profits from Fund as payback 115130213v2

32. Another Example of Subversion of Economics • Liquidation by capital account balances • Erroneous allocation of losses, by allocating in proportion to capital accounts instead of reversing 80/20 allocation tier • Actual example 115130213v2

33. Erroneous Allocation of Losses (cont.) • LP invests 90; GP invests 10. Profits 100. • LP pays 20% carry on its 90 profits • Capital accounts are LP 162; GP 38 • Next year, loss 50 • If allocated by capital account ratios, capital accounts are LP 121.5; GP 28.5 (incorrect) • Capital accounts should be LP 126; GP 24 115130213v2

34. Bridge Investments • Defined as those sold or paid off within a short period • Income from bridge investments may not pay a carry • Key issue is make-up of losses on bridge investments • Definitional provisions can be tricky 115130213v2

35. Preferred Return • Calculate from time of LP investment and return to LP • Payment of preferred return after return of capital • Reduces rate, if expressed as interest coupon equivalent; • But expression as IRR is OK • Occasionally a preferred return rate is stated as the • Effective annual rate (achieved by compounding), so the APR is less than the stated rate 115130213v2

36. Fine Print—A Bogus Preferred Return • Distributions • Section 1.1: Distribute the accrued and unpaid Preferred Return • Section 1.2: Distribute the Unreturned Capital • Definitions • “Preferred Return” means an 8% per annum return, compounded annually, on the Unreturned Capital • “Unreturned Capital” means a Partner’s Capital Contributions, reduced by distributions under Sections 1.1-1.2 115130213v2

37. Wrongful Inclusion of Residual Distributions in Case of Hard Hurdle (No Catch-up) • Distributions to an LP in 80/20 residual tier count towards preferred return if there is a catch-up • If no catch-up, such distributions should not count towards the payment of the preferred return 115130213v2

38. Preferred Return—Example • Jan. 1, Year 1: Capital in 100. • Dec. 31, Year 1: Distribute (i) Return of capital 100; (ii) Preferred return 6; (iii) Residual profits of 7.5 are split 6 to LP and 1.50 to GP • Jan. 1, Year 2: Capital in 100 • Dec. 31, Year 2: (i) Return of capital 100; (ii) Preferred return—zero; (iii) Residual profits of 6 are split 4.80 to LP and 1.20 to GP. • Wrong result 115130213v2

39. Tax Distributions • Excess tax distributions • Reduce LP IRR • Prevent proper clawback • Causes of excess tax distributions • Failure to include earlier loss years • Estimated tax payments offset by later losses 115130213v2

40. Management Fees—A Few Checklist Items for an LP Who Is Watching Every Dollar • Interest factor paid on fees at later closings are usually borne by all LPs • Ask for step-down date when a successor fund starts paying fees • Step-down to base of invested capital • Reduce for writedowns, under GAAP, not tax loss • Exclude write-ups, unless perhaps to extent of writedowns • Avoid fees on fees • Recently, committed but uncalled capital is included • Apply lower rate to publicly traded investment 115130213v2

41. Management Fee Offsets • LPs want 100% offset—many funds have this • Rebates if transaction fees exceed management fees • Valuation of in kind transaction fees upon sale of options, etc. 115130213v2

42. Cost of Incorrect Fee Offsets • Venture capital fund invests $2MM in each of 10 investments. Fund receives 20% of each company, and GP receives options (as board member) for 0.5% of each company. • Fund receives negligible management fee offset, due to low valuation placed on GP’s options upon issuance. • Fund sells investments for $40MM (2x). Of $20MM profit, GP receives $4MM as 20% carried interest. • In addition, GP receives $1MM from its board options. 115130213v2

43. Clawbacks • Calculation by reference to distributions is more certain than basing them on capital account balances or net profit calculations • Both prongs of the clawback should be present • Guaranteeing a return of capital and preferred return • Guaranteeing carried interest distributions do not exceed 20% 115130213v2

44. Clawbacks (cont.) • Alternatively, a clawback can be based on a hypothetical liquidation, aggregating all profits and losses • Both two-pronged clawback and hypothetical liquidation work properly if the catch-up distribution tier to the GP is 100% to the GP 115130213v2

45. Clawbacks (cont.) • However, the hypothetical liquidation clawback is needed: • If the catch-up to the GP is 50/50 or anything except 100% to the GP; or • If the residual profits are not simply 80/20, but instead have two or more tiers • For example, 80/20 to 15% IRR; 70/30 in excess of 15% IRR 115130213v2

46. Example of How a Two-Prong Clawback Does Not Guarantee to the LPs the Benefit of a 50/50 Catch-Up LP invests 100 on Jan. 1, year 1. At end of year 1, distributions are 8 preferred return; 100 return of capital; 5.33 catch-up is divided 2.66 to LP and 2.66 to GP. GP is now caught up.  LP invests $2.66 on Jan. 1, year 2, and it is lost. Fund liquidates. LP received the preferred return and return of capital, so that prong of clawback does not apply. Overall profit was 10.67—102.66 invested, and 113.33 distributed. 20% of that 10.67 profit = 2.13. So the 20% prong of the clawback requires the GP to return $0.53 excess carry. However, the GP has received a better catch-up than 50/50. If the clawback is instead drafted to say excess carry is defined, not by the two prongs, but by aggregating all profits and losses and running them through the waterfall, the GP gets only the 50/50 rate of catch-up. Aggregated distributions would go as follows:   1) 8 preferred return 2) 102.66 return of capital 3) 2.67, split 1.33 to LP and 1.33 to GP So GP gets 1.33 in accordance with 50/50 catch-up deal, not 2.13. GP owes $0.80 more in clawback, in comparison with two-prong clawback. 115130213v2

47. Security for Clawback • Escrows—confirm the clawback mechanism works • Avoid bogus escrow accounts • Personal guarantees • Confirm all recipients of carried interest distributions execute guarantees or • The key persons guarantee the clawback portion for those not executing a guarantee 115130213v2

48. Careful Analysis Is Needed of Key Issues • If liquidate by capital accounts, are allocations correct? • Are management fees and expenses paid back? • If not, can one of compromise arrangements protect LPs and help GP with its tax problem? • Bridge investments • Preferred return • Tax distributions • Management fee offsets • Clawbacks 115130213v2

49. The Message • LPs should make sure that alternative investment contracts (investment fund partnership agreements) are reviewed and negotiated by competent advisors 115130213v2