LP Turnover: Sounds like Dessert, Feels like Desertion
One of the most frustrating elements of a fundraise is the issue of managing through LP turnover. While existing LPs may decide to not re-up for a GP’s next fund for a variety of reasons, the fact remains that it can be bitterly disappointing for GPs who are trying to take the next step in their firm’s evolution. As you know, these GP-LP relationships often go far beyond the terms of an LPA both professionally and personally, so it is easy to feel a sense of betrayal when investor support dissipates. The key questions are: how do you avoid LP turnover and what are some of the early signs?
Active and in-depth communication with your key LPs at least 12 months in advance of your launch is imperative. LP calendars are built out very far in advance, so for them to appropriately plan to allocate to your fund it requires advance notice. It’s also important to speak with more than one person at each LP. There’s a tendency to speak only with your key point of contact, and while these individuals are often the champion of your deal internally, often you lose access to other decision-makers that you need to convince. Your internal champion may also paint a rosier picture of where things stand that doesn’t accurately reflect reality because it’s colored by their own biases. It’s really important to listen for specific warning signals from LPs. If they keep asking you about exits and liquidity then they may need distributions as a prerequisite to make a future investment. If a GP’s performance is below top-quartile then the unrealized nature of its portfolio can be a very difficult hurdle to clear in IC, even if the LP has a long and strategic relationship with the manager. LPs often encourage managers not to come back pre-maturely for these reasons and while many GPs will ignore this advice, they should then expect turnover unless their performance is truly tops in their peer group. As we know, outperformance is the cure-all when it comes to raising capital.
Many LPs, particularly fund of funds, will look to close later in a fundraise even if they are existing LPs in prior funds. This is a source of particular frustration for GPs that are seeking earlier support and feel like they have earned that early support by being good performers and strong stewards of the investor’s money. It is important that GPs resist the temptation to let the investment style of the LP influence their interactions with them. Obviously, the goal is to continue to build interest over the fundraise and encourage them to be late closers because in this competitive market every dollar counts and being spiteful only hurts the fundraise. The other major reason is references. Even if the existing LP hasn’t committed to the fund early in the process, it will be important that they provide a positive reference to other prospective LPs who may want to move more quickly. There’s no stronger vote than the one that comes with a commitment, but the second best reference is one where the existing LP speaks very highly of the GP and indicates a desire or inclination to get to a later close. This can be invaluable.
One of the most humbling aspects of running a private equity firm is handling the passes and rejections from investors while fundraising. How GPs react to these disappointments can have a material impact on their future success in raising capital. LPs speak to each other frequently about what it’s like to partner with particular sponsors. Maintaining a high quality reputation in a close-knit market can’t be stressed enough and keeping a positive attitude about LPs moving in or out of your capital base is a key part of that effort
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