Q&A: ‘Know your LP’

Know your LP…catchy. But what does it mean exactly?

We are getting more inquiries from private equity firms asking about their responsibilities to vet limited partners. From our standpoint, firms need to know the source of funds – i.e., is it legitimate money when it comes from a trust, an off shore entity or even a Delaware corporation wherein no officers names are listed? Is the money coming from a legitimate sovereign wealth fund or a knock off?

Why is this LP vetting only catching on now?

Private equity firms had previously argued that due to the fact that they were not registered with the US Securities and Exchange Commission, that they did not need to adhere to provisions under the Patriot Act, Anti Money Laundering (AML) and Know Your Customer (KYC) requirements.  As I’m sure your readers are all aware, that’s all changed since March, and GPs must now register with the agency as investment advisors. As part of that firms will now need to be compliant with AML and KYC requirements.   

Which LPs would you say are the highest risk?

State pension plans, like the California Public Employees’ Retirement System, are very low risk investors not likely to land fund managers in any hot water. GPs should be more concerned about high net worth individuals or family offices that come from a wide range of backgrounds and are less “institutional” so to speak. The risk is one of these investors might be engaged in some activity, or past, that a GP would rather not be associated with. In a way, it’s also due diligence on counterparty risk, as any secrets unearthed could indicate their ability to pay these multimillion dollar commitments. 

Ken Springer

Also lots of GPs now fundraise in the Middle East, or other emerging markets which might be of more interest to regulators or SEC examiners. Just to illustrate the risk, I recall in August the Action Congress of Nigeria condemning the country’s federal government for setting up a sovereign wealth fund which it described as illegal and fraudulent.  

Is vetting something that can be done in-house?

For larger firms, it can be, because they have more resources. Mid-market firms would likely benefit more from outsourcing the job to a third party specialist. The job involves searching various databases, public records and media reports as a part of a LP’s background investigation. And once a vetted LP is in the system, we have software that automatically updates their profile to run a quick screening on an ongoing basis.  

How much does outsourcing the job cost?

Peanuts really. Anywhere from $100 to $500 dollars per LP, but of course that varies depending on the size and scope of the LP in question. Similar to what I said before, GPs can receive annual updates on their LPs at an agreed rate. It’s a service we expect more GPs to begin pursuing in the years to come. It’s starting at the large end of the market and, I would predict, will trickle down to the mid-market over time.