17.3 Evolving LP-GP relationships and fund structures
3 min read•august 9, 2024
The private equity landscape is changing fast. New fund structures like evergreen and hybrid models are shaking things up, offering more flexibility and liquidity. These innovations are attracting a wider range of investors and reshaping how deals get done.
Customization is the name of the game now. , co-investments, and let investors tailor their approach. This shift is creating deeper partnerships between LPs and GPs, with more transparency and collaboration than ever before.
Evolving Fund Structures
Innovative Fund Models
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- Evergreen funds operate without a fixed end date, allowing continuous capital deployment and reinvestment
- Deal-by-deal structures enable investors to participate in individual transactions rather than committing to an entire fund
- Hybrid funds combine elements of traditional closed-end funds with more flexible features (open-ended components, longer investment periods)
- invest in multiple underlying funds, providing diversification and access to top-tier managers
- facilitates trading of existing fund interests, offering liquidity to limited partners and new entry points for investors
Advantages of Evolving Structures
- Increased flexibility adapts to changing market conditions and investor preferences
- Enhanced liquidity options address concerns about long lock-up periods in traditional fund structures
- Tailored risk-return profiles cater to diverse investor appetites and goals
- Improved alignment of interests between general partners and limited partners through innovative fee structures
- Expanded access to private markets for a broader range of investors (smaller institutions, high-net-worth individuals)
Customized Investment Options
Personalized Investment Approaches
- Separate managed accounts provide tailored investment strategies for large institutional investors
- Customized portfolio construction based on specific risk tolerances and return objectives
- Greater control over investment decisions and asset allocation
- opportunities allow limited partners to invest directly in portfolio companies alongside the fund
- Potential for enhanced returns by participating in select deals without paying additional fees
- Deepens relationships between general partners and limited partners
- GP stakes investing involves acquiring minority ownership in private equity firms themselves
- Provides exposure to the economics of the overall private equity business model
- Offers potential for long-term value creation as firms grow and diversify
Benefits of Customization
- Increased alignment between investor goals and investment strategies
- Enhanced portfolio diversification through targeted exposure to specific sectors or geographies
- Potential for fee savings and improved overall returns
- Deeper engagement between investors and fund managers fosters long-term partnerships
- Opportunity for investors to leverage the expertise and resources of private equity firms
Investor Relations
Enhanced Transparency and Reporting
- Improved disclosure of fund performance metrics and portfolio company details
- Regular communication of investment strategies, risk management practices, and market outlooks
- Standardization of reporting formats (Institutional Limited Partners Association templates) facilitates comparison across funds
- Integration of environmental, social, and governance (ESG) factors into reporting and decision-making processes
- Use of technology platforms for real-time access to fund information and analytics
Strengthening LP-GP Partnerships
- Increased frequency and depth of investor meetings and updates
- Proactive engagement on key issues (valuation methodologies, risk management, succession planning)
- Customized reporting tailored to individual investor needs and preferences
- Educational initiatives to enhance limited partners' understanding of private markets and investment strategies
- Collaborative approach to addressing industry challenges and regulatory developments
Key Terms to Review (21)
Capital Calls: Capital calls are requests made by private equity or venture capital funds to their limited partners (LPs) to provide a portion of their committed capital. This process ensures that the fund has the necessary liquidity to make investments or cover expenses as they arise. The capital call structure is integral to limited partnership agreements, facilitating effective fundraising and maintaining investor relations.
Carried Interest: Carried interest refers to the share of profits that general partners (GPs) of private equity and venture capital funds receive as compensation, which is typically a percentage of the fund's profits after returning capital to limited partners (LPs). This mechanism aligns the interests of GPs and LPs by incentivizing GPs to maximize the fund's performance, creating a potential for substantial earnings that reflect their success in managing the investments.
Closed-End Fund: A closed-end fund is a type of investment fund that raises a fixed amount of capital through an initial public offering (IPO) and then lists its shares on an exchange. Unlike open-end funds, which continuously issue and redeem shares based on investor demand, closed-end funds have a set number of shares that trade on the stock market, allowing them to fluctuate in price based on supply and demand. This structure has implications for the relationships between limited partners (LPs) and general partners (GPs), influencing how capital is raised and managed over time.
Co-investment: Co-investment refers to a situation where investors, usually limited partners, invest alongside a private equity fund in a specific deal or company, typically at the same time and on similar terms as the fund. This practice enables investors to gain direct exposure to particular investments while also allowing fund managers to raise additional capital for larger transactions. Co-investments can enhance alignment of interests and provide opportunities for investors to participate more deeply in the private equity space.
Due Diligence: Due diligence is the process of thorough investigation and evaluation of a potential investment opportunity, aimed at uncovering relevant facts and risks before finalizing a deal. It is essential in ensuring that investors make informed decisions by validating assumptions, assessing financial health, and understanding operational aspects of the target company.
Evergreen fund: An evergreen fund is a type of investment fund that allows for continuous capital inflow and outflow, unlike traditional funds with fixed lifespans. This structure supports an ongoing investment strategy, enabling the fund to reinvest returns without needing to raise a new fund or liquidate existing investments. Evergreen funds provide flexibility in managing assets and can foster stronger relationships between limited partners (LPs) and general partners (GPs) due to their long-term nature.
Fund-of-funds: A fund-of-funds is an investment strategy that involves pooling capital from investors to invest in a diversified portfolio of other investment funds, rather than directly in individual securities or assets. This structure allows investors to gain access to a broader range of strategies and asset classes, while also spreading risk across multiple funds. Fund-of-funds are particularly relevant in the context of evaluating performance through methods like the Public Market Equivalent (PME) and understanding the evolving relationships and structures between Limited Partners (LPs) and General Partners (GPs).
Fundraising cycles: Fundraising cycles refer to the recurring process through which venture capital and private equity firms raise capital from limited partners (LPs) to finance their investment activities. These cycles typically involve various stages, including planning, marketing to potential LPs, securing commitments, and finally deploying the raised capital into investments. Understanding fundraising cycles is essential for grasping the dynamics of evolving relationships between general partners (GPs) and LPs as well as the structural changes in fund management.
General Partner: A general partner is an individual or entity in a partnership who has unlimited liability and is responsible for the management of the partnership's operations and decisions. This role is crucial in venture capital and private equity as they lead fund management, make investment decisions, and engage with limited partners to secure funding and provide updates on fund performance.
Gp stakes: GP stakes refer to the ownership interests that investors, typically limited partners (LPs), acquire in the general partner (GP) of a private equity or venture capital fund. This investment allows LPs to participate in the GP's profits and may also influence fund governance, as these stakes can lead to a deeper alignment of interests between the GP and LPs, ultimately evolving the dynamics of their relationship and fund structures.
Hurdle rate: The hurdle rate is the minimum return that a fund manager must achieve before they can begin to earn performance fees or carried interest from the profits generated by the investment. This rate acts as a benchmark for assessing whether the fund's performance meets investors' expectations and is closely tied to fund economics, limited partnership agreements, and the overall alignment between general partners and limited partners.
Hybrid Fund: A hybrid fund is an investment vehicle that combines elements of both private equity and venture capital, allowing for a diversified approach to investing in a range of companies at different stages of development. This type of fund can provide limited partners with the flexibility to allocate capital across various sectors and company maturities, balancing risk and return more effectively. Hybrid funds are increasingly popular as they adapt to the evolving relationships between limited partners (LPs) and general partners (GPs), enabling innovative fund structures and investment strategies.
Institutional Limited Partners Association (ILPA): The Institutional Limited Partners Association (ILPA) is a global organization that represents the interests of institutional investors in private equity. It serves as a key advocate for limited partners (LPs), promoting best practices, transparency, and alignment of interests within the private equity industry. By fostering communication between LPs and general partners (GPs), ILPA plays an important role in shaping the evolving dynamics of LP-GP relationships and fund structures.
Investment Thesis: An investment thesis is a clear, concise statement that outlines the rationale behind making an investment in a specific opportunity. It includes the expected returns, the value proposition, and how the investment aligns with the investor's goals. This thesis is critical as it guides decision-making throughout the investment lifecycle, influencing deal sourcing, due diligence, portfolio construction, and the management of relationships between limited partners and general partners.
Limited Partner: A limited partner is an investor in a private equity or venture capital fund who contributes capital but has limited liability and does not participate in the fund's management. They are crucial for providing the financial resources that fuel investment opportunities across various stages of a company's growth, from early startups to later-stage ventures, while maintaining a hands-off approach in decision-making.
Limited Partnership Agreement: A limited partnership agreement is a legal document that outlines the terms and conditions under which a limited partnership operates, defining the roles and responsibilities of general partners and limited partners. This agreement is crucial for establishing the relationship between the partners, detailing capital contributions, profit distribution, governance structure, and the management of the partnership's assets. It is essential in shaping the legal structures of venture capital and private equity funds, as well as influencing the evolving dynamics between limited partners (LPs) and general partners (GPs).
Multiple on Invested Capital (MOIC): Multiple on Invested Capital (MOIC) is a performance metric used to assess the return on an investment, calculated by dividing the total value returned from an investment by the amount of capital invested. This ratio is crucial in evaluating the profitability of investments, especially in venture capital and private equity, where understanding potential returns relative to the invested capital is key to decision-making and capital allocation.
National Venture Capital Association (NVCA): The National Venture Capital Association (NVCA) is a trade association that represents the interests of venture capitalists in the United States. It serves as a collective voice for its members, providing advocacy, education, and networking opportunities, while also working to improve the overall environment for venture capital investing. This association plays a crucial role in shaping LP-GP relationships and fund structures, as it helps define best practices and promotes transparency in the industry.
Secondaries Market: The secondaries market refers to the buying and selling of existing interests in private equity funds, allowing investors to transfer their commitments before the fund's maturity. This market has gained importance as it provides liquidity options for limited partners who wish to exit their investments without waiting for the fund to liquidate its assets. The development of this market reflects changing dynamics in relationships between limited partners (LPs) and general partners (GPs) as they seek flexibility in fund structures and investment strategies.
Separate Managed Accounts: Separate managed accounts (SMAs) are investment accounts that are owned by individual investors but managed by professional investment managers, allowing for tailored investment strategies. These accounts provide clients with greater transparency, flexibility, and customization compared to traditional pooled investment vehicles, making them increasingly popular among institutional investors and high-net-worth individuals. SMAs offer the potential for direct ownership of securities, enabling investors to align their investments with personal preferences and tax situations.
Subscription agreement: A subscription agreement is a legal document that outlines the terms under which an investor agrees to purchase shares or interests in a venture capital or private equity fund. This agreement is crucial as it establishes the commitments of both the investor and the fund manager, including the amount of investment, the rights and obligations of each party, and the conditions under which funds will be deployed. It serves as a foundation for the legal relationship between limited partners and general partners.