Jeremy Hocter explains the empowerment of LPs
From the mid-90s to 2007, there was no question that employing middle men for due diligence and introductory services paid dividends in the private equity industry.
It was widely acknowledged then – as it is now – that the illiquid nature of the asset class meant that Limited Partners’ (LPs’) due diligence process for selecting a fund was particularly rigorous and challenging. Larger institutions had plenty of money to disperse and their investment committees valued the assurance of recognized third parties providing recommendations.
That was when the most desirable funds were habitually oversubscribed. Working with matchmaking gatekeepers and strategic consultants, as well as tapping into funds of funds, was the failsafe way for LPs to get into established blue-chip funds and explore new investment areas.
However, as private equity emerges from the aftermath of the financial crisis, there has been a subtle but important shift in the balance of power.
Recent media reports suggest that nearly half of the big-name GPs (General partners) are looking to raise capital in 2011, but LPs are typically becoming even more considered and selective about the managers they choose to invest with.
Indeed, according to Coller Capital’s 14th Global Private Equity Barometer, as many as 87% of LPs will not reinvest with existing managers and more than one industry commentator has pointed out only some of the GPs vying for capital this year will actually get it. Top quartile funds are now competing for LPs, who are in turn telling GPs to improve terms and focus on their strategies.
That’s not to say that due diligence is any less important than it was five years ago. If anything, the reverse is true. With the decision of where and with whom to invest becoming increasingly pressured, LPs need tools to analyze and compare performance to assist in the formulation of these opinions. And with new funds cropping up – either with new personnel, new target geographies, or new investment strategies – LPs need to be able to assess the bona fides of those involved.
There’s also the question of finding the next big thing. Is a fund that focuses on buy-outs in China rather than growth capital in Brazil more likely to deliver the returns that investors are looking for over the long term? If newly empowered LPs use their position wisely, they can lead the market into new areas and successful emergent strategies – and reap the rewards that invariably come with ‘first-adopter’ status.
All of that is going to require efficient access to substantial decision support. These recently empowered LPs also have new responsibilities. Transparency has become the watchword of the financial markets, and as LPs place GPs under greater scrutiny, end investors are applying the same pressures to those who invest on their behalf. Investors want to know which funds they are invested in and what those funds’ returns are. Furthermore they want instant access to performance measurement information rather than waiting until quarter-end to find out.