Further thoughts on LP defaults

LP defaults: happening, but not a trend, for now; Which vintages will suffer?

Defaults: As my colleague at sister title Buyouts, Chris Witkowsky, mentioned in a recent email, as of yet, many – perhaps the large majority – of GPs and consultants are unworried about large-scale LP defaults. And as far as any of us at PEI Media know, there haven’t been any in the US.

On the other hand, the idea of elevated defaults is a thought that has crossed minds, as Private Funds CFO and Private Equity International have written, among others. Part of that is because of the size and synchronicity of timing of calls. Now, more businesses need immediate cash injections than during the 2008 crisis, which began as a bank balance sheet issue and manifested as a financial liquidity crisis. One exec I spoke with, who moved their capital call up to be safe, said that while the firm isn’t very worried about a default, it is slightly worried that LPs will balk at the size of the call, which represents what was going to be two separate capital calls.

Other dynamics are at play that make this a different kind of crisis, with different potential consequences for PE. Very non-exhaustively: there are more LPs than 2008, and some haven’t been through a crisis; there are more GPs than in the crisis – some with longer track records and better LP relationships than others; and the use of subscription lines is now widespread. The subscription lines could be a good thing by affording GPs some flexibility, but also introduces a potential sudden shift in expectations around the timing of demands on LPs’ liquidity, when some have perhaps gotten used to knowing exactly when their calls are coming. Sister title Secondaries Investor reported (we’ll post it on our site soon) that preferred equity financer 17Capital is seeing some very similar deals to what it saw during the 2008 crisis, including LPs who need to fund capital calls.

I’ll say that most I’ve spoken with who have expressed concern – without having first-hand knowledge of any actual defaults – have directed that concern to high-net-worth individuals and family offices, whose liquidity profiles obviously differ from, say, a major pension fund.

Anyway, it’s all to say: who knows? All we know now is that two European LPs have indeed defaulted. We’re re-publishing this extract from The LPA Anatomised (published in 2018, but still as relevant as ever), in which Goodwin Procter’s Ed Hall lays out the options for GPs that find themselves facing an LP default. It includes items similar to the GP remedies I outlined in Friday’s article, adding some additional insight on points of negotiation and jurisdictional variations.

Vintages: Kalliope Gourntis, of sister title Infrastructure Investor, has this cross-asset class piece, suggesting that LPs would be forgetting one of the lessons of the great financial crisis if they pulled back from PE in the current downturn, and that it may well be that recent-year vintage funds will be the ones to suffer the most damage (given many have deployed significant cash at the top of the market). The piece is partly based on a recent webinar from the Investment Management Due Diligence Association, in which it was also suggested both that fund managers be careful about the assurances they make to LPs, and that LPs get as much as they can in writing, should any such assurances be found misleading, in retrospect.

Email prepared by Graham Bippart and Philippa Kent