The relationship between a General Partner (GP) and Limited Partners (LP) is a multi-trillion dollar industry. General Partners (GPs) sponsor and manage private investment funds. They need capital to invest but demand flexibility and discretion to get the deal done. Limited Partners (LPs) are the investors committing capital to those funds.
There are two types of LPs:
The relationship between GPs and LPs requires a careful balance of caution and trust. Navigating this relationship requires evaluating both sides’ perspectives, motivations and sensitivities. Closing a private investment fund is the beginning of the relationship between GPs and LPs. The limited partnership agreement governing the fund must provide a commercial relationship that will last for at least ten-plus-two years.
The basic principles governing private investment funds haven’t changed in twenty years. The Institutional Limited Partners Association (ILPA) outlines the three guiding principles on the relationship between GPs and LPs:
The terms and conditions underlying these fundamental principles remain consistent. But, the scope of these terms fluctuates over time, and ILPA continues to publish additional guidance under these principles. ILPA Principles 3.0, published in 2019, discusses more on the topics of fund term and structure, financial disclosures, key persons and more. As the financial market’s pendulum swings, so too does the negotiating leverage between GP and LP.
During the record fundraising levels of the early- to mid-2000s, General Partners enjoyed easier access to capital. The GP dictated favorable terms and raised oversubscribed funds during condensed marketing periods.
Following the 2008 financial crisis, the relationship between GPs and LPs changed. GPs struggled to invest dry powder in their existing funds. Institutional investors were hesitant to commit new capital to blind pool funds. As a result, GPs trying to raise capital found that LPs perceived they had much stronger negotiating leverage.
This led to more LP-favorable terms:
The market for private investment funds has returned to those pre-2007 record-breaking levels. For nearly a decade, GPs have enjoyed the improvements in private investment fund terms and conditions and a renewed robust fundraising market. For example, LP Advisory Committee consent rights are steadily replacing veto rights. Portfolio Company fee income still offsets management fees on a dollar-for-dollar basis. But more categories of fee income are being excluded from the offset. Basic financial statement reporting packages are still available to LPs. But supplemental reporting and enhanced information rights come from most-favored nations clauses.
There are those who believe that the market pendulum has reached its apex and is beginning its downward swing. We saw 2017 have near-historic private equity fundraising levels. Now there are some signs that the capital-raising frenzy is slowing down. Fundraising levels remain robust. But institutional investors appear to be consolidating their holdings with fewer, established managers. Marketing periods are getting longer. Blue-chip, top-quartile performing managers are still raising new funds effortlessly. But smaller managers and first-time managers are struggling to get to initial closing.
It remains to be seen if these indicators are predictions of a market correction. But General Partners and Limited Partners alike should be alert to potential shifts in their dynamic. Ever-changing market conditions may once again sharpen their perspectives vis-à-vis the private investment funds that they sponsor and shift the negotiating leverage between GPs and LPs.
©All Rights Reserved. May, 2021. DailyDACTM, LLC d/b/a/ Financial PoiseTM
Gary Levenstein concentrates his practice in the areas of corporate and family office counseling, mergers and acquisitions, private equity, corporate finance, securities regulation and corporate governance. He represents privately and publicly held corporations, private equity funds, financial institutions, family offices and boards of directors. He has a vast network that has enabled him to connect…
Kari concentrates her private equity and investment funds practice on representing private equity funds of funds, other investment advisers, and institutional investors in a broad range of matters involving investment funds and investments. She draws on extensive experience, including several years as general counsel to a global family office and private equity fund, to develop…
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