LPs need to play fair

The past year has been anything but a breeze for the private equity industry – everyone from GPs to LPs and service providers have had to grapple with the fallout of the downturn in a radically different environment than the heyday that ended at the turn of 2008.

Of all the people involved in private equity, however, it has generally speaking been private equity fund managers who have faced the biggest challenges. They have been confronted with difficulties from two directions; their portfolio valuations taking a hit, and then their limited partners on their backs about just that. For many, it has been a grim balancing act of responding to LP appeals to freeze capital calls and reduce management fees, while walking away from investments while valuations are more in line with their expectations. That, by the way, is a relatively positive picture of what most managers have been confronted with.

It has been all too easy to criticise private equity managers in the credit crunch, when both deal flow and fundraising activities have suffered visible setbacks. LPs facing lower, if not negative, returns have been easier to sympathise with in the past 12 months, since they are after all paying fees to managers who have been underperforming.

But bearing witness to the aftermath of a conversation (gone bad) a managing partner had with one of his investors, I came to see the other side of the story. And have become slightly more attuned to the lack of sympathy LPs have towards not only their fund managers but also to macro market conditions.

“Not all LPs are like that but there have been instances when they expect our portfolios and CEOs to buck the market downturn by producing growth, improved sales, or results within shorter than realistic timeframes,” laments a GP who draws the line with LPs who have attempted to prescribe ‘unreasonable’ remedies to businesses that are hurt by the global economic downturn.

The suspicion that investors can do wrong was further entrenched during a conversation with a second general partner – a month later – who accused limited partners of not merely being unreasonable about their expectations toward existing portfolio investments, but veering toward being “immoral” in their behaviour and course of action.

The choice of adjective is surprising. The integrity of a fund manager has always been a topic for discussion, but when the “morality” of investors gets called into question, one cannot help but wonder at the desperate measures LPs must be resorting to in trying to salvage investments that are heading south.

As the saying goes, it is important to keep a cool head when things get desperate in order to find solutions.  As LPs are increasingly seeking to co-invest alongside their managers, institutional investors must recognise the need to recruit professionals who are equipped to do so, and preferably people with operational experience in running businesses. Transferring the frustrations and the wrath of boards onto GPs simply isn’t the way forward, nor will it enhance GP-LP relationships.