Not all limited partners are created equal when it comes to fundraising. Depending on a manager’s wants and needs, and assuming the GP enjoys the privilege of being choosy, certain LPs are given priority over others.
Investors’ ability to reinvest in successor funds is the trait GPs value most, while LPs that are indecisive and/or require substantial amounts of due diligence before committing are not viewed favorably, according to Cyril Demaria, a Switzerland-based investment strategist and academic who, with backing from Crédit Agricole Private Banking, conducted a meta-analysis of research papers on fundraising.
In addition to LPs’ ability to re-up, Demaria found GPs also look for LPs with large amounts of cash to commit and whose reputations are strong enough to encourage other LPs to back their funds.
These may not seem like earth-shattering revelations; nor does the fact that LPs have long used whatever clout they have to try and win lower fees, better protections in the LPA and side letter arrangements that often provide substantive rights.
But the tactics used by some GPs to get the results they desire are less talked about. They also factor into today’s fundraising landscape and will be detailed in a forthcoming book on fundraising by Demaria.
He gave us a sneak peek of some of his findings, including the way many GPs will target a certain number of investors per fund large enough to prevent any one LP from having too much power, but still small enough to minimize costs (each additional LP means more information requests and administration). Secondly, even if the right number is found, GPs will consider bringing on new LPs as a way “to renew the pool and keep other LPs on their toes,” Demaria told pfm. Some managers will sometimes even constrain (or downscale) existing investors' ability to re-up in order to create a sense of exclusivity.
Fund formation lawyers speaking with pfm confirmed an element of psychology at play during fundraising. For instance, fund managers set a deadline on LPs’ right to review and comment on the LPA before a first close, mostly as a way to avoid 11th-hour changes that can disrupt the closing process. Jedd Wider, a senior fund formation attorney at Morgan, Lewis & Bockius, is noticing shorter timetables, presumably to instill a “sense of urgency” among LPs to commit. Giving large, existing investors a first look at the LPA, meanwhile, creates a sense of loyalty and prestige – as well as influence, which smaller LPs may dislike.
These practices raise some interesting questions. For example, if successful managers are able to cherry-pick certain investor types, allow some LPs to weigh in on terms when others have not, or set arbitrary deadlines and limits to create a sense of exclusivity, are there potential governance concerns? Or is the GP simply trying to do what’s best for its fund and firm overall, and this is part of the “normal” push-pull between managers and investors?
Happily, private equity academics like Demaria are digging deeper into these issues, but we’re keen to hear your thoughts. Get in touch at Nicholas.firstname.lastname@example.org