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LP Involvement: Finding the Right Approach to Protect Value
When it comes to private funds (either private equity or private credit strategies), the investors, more commonly known as the Limited Partners (LPs), delegate day-to-day management and decision-making to the fund’s General Partner (GP). The GP is responsible for the day-to-day and strategic management of the partnership, has the authority to act on behalf of the partnership, and is jointly and severally liable for all debts and obligations of the partnership. The LP has limited liability, provided that they do not participate in the management of the partnership business.
As funds become increasingly complex, and with many funds underperforming against a challenging macro backdrop, many LPs are starting to see the benefits of taking a more engaged approach with GPs and demanding more in terms of oversight of GPs. LPs are seeking greater oversight mechanisms, however, their role does remain constrained by the limitations in the relevant Limited Partners Agreement (“LPA”) and the local legislation (e.g. legislation governing partnerships in fund’s domicile), LPs must remain conscious of the permissible boundaries so as not to lose their limited liability status.
LPs need to engage more directly with GPs where there is a risk that the GP’s interests are no longer fully aligned with their own. And time is often of the essence – the longer LPs wait, the greater the risk of value destruction. Striking the right balance between engagement and oversight can help to protect LPs’ capital and ensure the GP’s interests are aligned with theirs. But deciding when to act, and coordinating efforts, can be a challenge. LPACs can be conservative in their approach and may become frustrated by the lack of options. At Cork Gully Asset Managers, we provide a fully independent and expert third party advisory service to LPs. Here, we explore the issues at stake and offer some practical guidance.
LPs typically reserve their activity to providing capital, reviewing periodic fund reports and attending annual meetings. This approach is fine as long as the GP has a proven track record, the fund performance is in line with expectations, and market conditions and outlook are relatively stable.
Engaged LPs, on the other hand, will seek to be members of the Limited Partner Advisory Committees (LPACs), and require greater transparency and engagement from the GPs. LPACs, while advisory in nature, can exert pressure on the GP in relation to requests for fund extensions, valuation matters or conflicts of interest. LPs may also engage independent advisors. These advisors can be extremely useful, as they will provide unbiased fund performance reviews and, where necessary, guide LPs who wish to drive effective and efficient wind downs and liquidations as a route to value recovery. In this context, independent advisors can bring private equity capabilities to help accelerate the process of value realisation. They will also guide LPs who wish to push for change, such as a replacement of the GP, or a restructuring.
LP involvement therefore needs experience, deep engagement and expertise, all of which require substantial resource. This is where appointing an external advisor can be invaluable, as there is no doubt that an active approach can yield better outcomes in complex scenarios.
We believe that LPs should consider switching to a more engaged approach when faced with the following scenarios:
- a fund is consistently underperforming;
- there appears to be a misalignment of interests such as excessive fees or conflicts of interest;
- a fund is nearing its end of life and presenting challenges, such as illiquid assets or unresolved governance issues;
- a fund is operating in a high-risk geography or volatile sector and requires closer LP oversight to ensure risk mitigation and compliance
Our experience tells us that LP engagement can protect significant value and it also demands resource and expertise. To strike the right balance, LPs should consider their internal capacity in terms of expertise and weigh the potential returns from intervening against the related risks and costs. An external advisor can help with this. Adopting a thoughtful, strategic approach to active engagement can help to ensure that LPs safeguard their interests, improve governance and drive better outcomes.