An investment management agreement (IMA) is a legal contract between the owner of an asset and a manager that defines the responsibilities, benefits, and liabilities among them. The IMA will include such things as:
- Strategy statement
- Investment mandates
- Performance evaluation metrics
- Methodology for determining fees or compensation
- Identification of service providers, including criteria for selection and termination
- Definitions of service levels and procedures for reporting discrepancies
- Protection of trade secrets and confidentiality clauses
- Indemnification provisions in the event of lawsuits due to errors and omissions.
An investment management agreement (IMA), also known as an advisory agreement, is a legal contract between the owner of an asset and a manager that defines the responsibilities, benefits, and liabilities among them.
Types of investment management agreements:
There are contracts that rely on the laws of the jurisdiction in which they are executed. The offering memorandum contains the parameters, parameters, and conditions for investment management services, including all fees involved with each type of service.
There are four types of investment management agreements:
- Percentage Fee
- Advisory (Non-Discretionary).
Each type of agreement has different requirements regarding how much information must be provided to investors about an adviser’s background, qualifications, and compensation structure. Each state also imposes its disclosure requirements. Decisions about the type of agreement to use should be made after consulting legal counsel or other experts familiar with local rules and laws.
1) Discretionary Agreement
The discretionary agreement allows advisers to take action on behalf of clients without first soliciting their approval for each decision. Advisers relying on the discretionary deal must be registered as “investment adviser representatives” (IARs).
IARs must comply with requirements and conditions imposed by federal and state laws, securities self-regulatory organizations, and National Association of Securities Dealers (NASD) rules. They must also pass an extensive examination that tests their investment knowledge and suitability requirement. The analysis can be challenging; passing rates range from 50% – 75%.
2) Flat-Fee Agreement
A flat-fee or percentage-based fee approach is based on a sliding scale that generally allocates more responsibility to the client as assets increase under management. These agreements are standard in brokerage and insurance transactions.
3) An Advisory Agreement
An advisory agreement provides for a simple percentage fee (usually 1 – 2 percent of gross assets under management), which may be reduced when the client’s net worth is over a certain amount. As with other types of investment management services, investors have to pay all costs associated with an advisory agreement, including administrative fees and expenses for record-keeping, advice, and reports. Advisers should not perform any additional services outside their primary advisory service without first receiving consent from clients.
4) A Non-Discretionary Contract
In a non-discretionary contract, clients retain discretion when giving or withholding approval to take action on their behalf. The adviser must inform its customers in writing before taking any action that will primarily benefit itself.
The elements of an investment management agreement:
This section describes the elements of an investment management agreement between a manager and an investor.
The fund (including its fund managers, the general partner(s), and other principals) and the investors (limited partners, including their respective directors, officers, employees, agents, and affiliates). This is to be distinguished from parties to the transaction, i.e., where there is no breach of fiduciary duty or any issue of contractual liability that may arise under such agreements.
Each party agrees to adhere to the terms stated within this agreement and those stated within its governing documents (if any). These may include private placement memorandums (“PPMs”), subscription documents, and offering circulars that contain specific terms to which the parties agree.
3) Investment Tranches:
The investor will make an initial investment (the “Initial Investment”) and further investments (each, a “Subsequent Investment” and collectively, the “Investments”). This is crucial, so the manager does not have discretionary power overvaluations of portfolio companies to increase fees. Also, this prevents the manager from favoring confident investors with better discounts than others simply because said managers are friends or business associates with one or more such investors.
4) Investment Warranty:
The manager warrants that it has good title to all investments made with investor funds. If there is any encumbrance on these assets, they must be disclosed in detail within this agreement and a valuation of the encumbered assets.
5) Disclosure Letter:
Within a certain amount of days from when each Investment is made, the manager must provide a letter disclosing all material facts that it knows about the Company and its business. In addition to this disclosure obligation, the fund documents may contain representations or warranties concerning such matters as company structure and organization, authority to conduct business, control over financial reporting, and compliance with laws and contracts. These are subject to various “materiality” standards that vary depending on your opinion (that is why they are so often litigated).
6) Investor Rights:
This section captures several rights afforded to investors under applicable law or this agreement. It contains rights regarding inspection (“Right of Inspection”), rights regarding access to books and records of the Company (“Right of Access”), rights concerning specific conflicts of interest (“Conflicts Rights and Procedures”). The actual language and scope of these provisions will vary depending on applicable law.
7) Investor Consent Regimes:
This section captures the process for obtaining investor consent under various circumstances. Such provisions are typically included, for example, when the manager wishes to engage in an affiliate transaction or other transaction involving a conflict of interest or other material transaction which would require the consent of investors.
8) Restrictive Covenants:
This section captures certain covenants made by the Company concerning its business during the term of the agreement. These will vary depending upon the applicable law and, in some cases, may not exist at all. They typically include a covenant not to compete with the manager’s investment business, a confidentiality covenant, and a common industry “drag-along” provision whereby the Company must consent to any sale of equity by other investors in the Company.
9) Board Representation:
This section contains certain rights granted to managers or directors of a manager concerning the Company’s board of directors (“Board”). The particular provisions include representation on committees, “Golden Parachutes” compensation, and indemnification rights in connection with the Company’s actions in good faith.
10) Exit Strategy:
This is a crucial element of the agreement and is typically negotiated heavily between the parties with an eye to investors’ exit strategies concerning their investments in the Company. In most cases, three different types of exits will be available concerning each Investment: a sale of the Company, a “trade sale,” in which another entity and an IPO purchase all or a significant portion of the Company.
Each of these has its pros and cons for investors, managers, and the Company. Consequently, the agreement will contain provisions governing who is responsible for preparing the necessary registration documents for an IPO, who is responsible for organizing information memoranda used by prospective buyers, and what happens if there is a change of control.
Investment management agreements are essential to establish an adviser’s standing with clients and the SEC. The layout specific requirements on how advisers should conduct their business, communicate information about their background and manage assets on investors’ behalf.
Although there is no legal requirement for advisers to use one type of agreement over another, it is recommended that they consult counsel before deciding which form to employ. Advisers who do not adequately disclose fees or maintain client records can face severe sanctions by regulators if their actions are deemed detrimental to the investor’s interests.
Private equity funds use this agreement when they hire investment managers. The terms and conditions of this agreement, including advisory and fees of management bind investment manager entities and funds.