How LP protections play out in first-time funds’ LPAs

Although limited partners often find concentrated and smaller teams, as well as a strong investment focus, to be attractive, there are “safety measures” in place to hedge the risks associated with such managers, a panel heard on Wednesday.

Speaking at Unigestion’s inaugural European Emerging Manager Conference, Gabriel Boghossian, a partner at law firm Stephenson Harwood, said: “Rather than taking an off-the-shelf limited partner agreement, which is a recut version of the fund four or fund five LPA, we are sitting down in a partnership model with the aspiring GP and we draft out protections investors will need in return for their backing and capital and institutional guidance.”

Examples of such protections include clearly defining the GPs’ time commitment to the fund product, ‘bad leaver’ clauses and step-in rights, in which the fund’s largest investor will have the ability to step in and manage, or appoint a replacement manager, if there is a serious breach of agreement.

“Given the concentrated team, the key person [clause] is an obvious place to start,” said Boghossian. He added that although, under the institutional fund model, substantially all of a manager’s business time would be spent on one fund product, such an approach could be “very vague and broad. So, we would tighten that up considerably and make sure that it’s not other products, sidecars, continuation vehicles – it’s only this fund.”

The language around bad leaver provisions is also important. Boghossian noted that aspects of behaviour that do not represent institutional investors’ investment ethos would be included as triggers for a key person event, which could lead to a GP’s removal.

The trigger for raising a successor fund is also higher for first-time managers, he added. Investors want to see the GP invest the majority of capital, whereas larger and more established managers might decide to come back to market when they have reserved about 75 percent of total commitments for future investments.

“When we’re talking about Ts and Cs, it’s as open as a football field,” Boghossian said.

Fundraising during a pandemic has been challenging for emerging managers, panellists at the conference noted. Wilf Wilkinson, managing partner of placement firm Acanthus, said the vast majority of fundraising in the past year had been marked by a rapid acceleration of existing managers coming to market with much larger funds.

“There’s no replacement for an in-person meeting when you are backing someone for the first time,” he added.

That said, investor appetite for emerging managers is mainly driven by premium returns, exposure to differentiated strategies and getting involved with up-and-coming talent.

“One of the bigger advantages of a fund number one is there is no legacy, and 100 percent of that team’s effort and focus – at least until they raise the second fund – is focused on delivering an absolutely outstanding return,” said Wilkinson.

“You usually get a ton of focus and time on ensuring success, but also you get a more attractive cashflow profile because the fund is deploying quicker. And therefore, LPs’ money is put to work and put to return generation in a quicker timeline.”