The world of private markets investing has changed significantly over the past twenty years. New asset classes, such as private debt, grew dramatically after the global financial crisis as low returns from traditional equity and bond markets sent capital in search of greener (and less correlated) pastures. One thing, however, has remained constant - the importance of a good relationship between the limited partners (LPs) invested in a fund and the general partner (GP) tasked with managing it.
At Star Mountain, we are both LPs to the U.S. lower middle-market funds in which we invest, and a GP to the investors that entrust us with their capital to make direct and fund investments in the U.S. lower middle-market. We are well-acquainted with both sides of this coin and can say unequivocally that transparency, communication and alignment of interest are the key things that we believe will ensure a successful long-term relationship between LPs and GPs.
The nature of LPs and GPs
Institutional investors, pension funds, sovereign wealth funds, foundations, and the like have long participated in private markets by way of long-term investments that co-mingle investor capital into limited partnership structures. The partnership’s LPs then delegate management of the capital to a GP, which is a fund manager charged with making the investment decisions on behalf of the partnership in return for management fees and a percentage of the profits generated by the portfolio (often called carried interest). The interplay between a fund’s LPs and its GP is a critical element in the long-term success of the partnership, especially given the long-term time horizons of most private markets fund vehicles.
LPs have become more sophisticated about private markets investing, and have broadly re-cast relationships with their GPs to focus on properly aligning incentives and boosting transparency. In fact, many have made future investments with a fund conditional on the GP’s adherence to a set of core guidelines like those established in 2009 by the International Limited Partners Association (the ILPA Principles include proper alignment of interest, effective governance, and reporting transparency). Some 450 institutions representing more than $2 trillion of private equity AUM have endorsed the ILPA Principles, including Star Mountain Capital. People like Peter Freire, the former CEO of ILPA and current Star Mountain Senior Advisor, have helped establish and institute these ILPA Principles for the benefit of both LPs and GPs.
GP with an open line of communication to its LPs can offer co-investment opportunities more easily, which in turn can boost returns and lower risk for all concerned.
From the GP’s perspective, the increased reporting and transparency demands from LPs often require additional support staff and technology. Changes in the regulatory landscape have dramatically increased the disclosure, reporting and compliance requirements for GPs, while LPs understandably require comprehensive data and reporting for their constituents. Other elements, such as responsible investment and a commitment to environmental, social and governance (ESG) criteria, are also increasingly important to LPs. GPs able to deliver these attributes can find themselves with a strong and collaborative relationship with their LPs – a material advantage when raising capital.
GPs, meanwhile, have their wish list of things that can make or break the relationship with their investors. Chief among them is a partnership approach founded on a mutual understanding of the fund’s investment process and strategy. Particularly when it comes to retention and re-commitments, the conversation is more comfortable when everyone at the table fully appreciates what the GP is doing every day, why they are doing it, and the timeline they expect will be necessary for an LP to make an investment decision. Furthermore, the GP with an open line of communication to its LPs can offer co-investment opportunities more easily, which in turn can boost returns and lower risk for all concerned.
Transparency, communication and alignment
We believe underlying any successful LP-GP relationship is effective communication. When it works well, lots of advantages can accrue to both sides – not only is transparency dependent on quality communications in the form of regular reporting and data access, but the personal and business networks can be accessed and shared for mutual benefit. Experience regarding deal flow, diligence, vendor relationships and the like can be shared for mutual benefit, and help avoid potentially costly mistakes.
Increasingly, GPs are relying on a mix of both modern and traditional communication tools for their outreach to LPs. For example, at Star Mountain, we have combined semi-annual in-person meetings with digital media and customised LP reporting to keep our investors up to date and have anchored it on a roster of full-time operations specialists who manage all our third-party administrative service providers. The result is a group of LPs who have easy access to the information they need and are fully and proactively informed by their GP through multiple communication channels.
Of all the changes in the private markets space since the crisis, we believe the push for increased transparency, communication and alignment has had the greatest impact on the LP-GP relationship. The more forthcoming and open both sides are to the other, and the more aligned they are in a shared outcome that will be ultimately beneficial to both, the more effective the long-term partnership becomes. We have seen it both ways and can attest to the value that can accrue when the relationship works well. Regardless of what side of the table you are on, look at your LP-GP relationship and ask what you can do to make it more transparent and better aligned and it will serve you well.