16 March 2020

IPEM 2020 – How to grow winning LP/GP relationships

IPEM 2020

We were delighted to be a part of the IPEM 2020 event in Cannes earlier this year. As part of the event, Andrew Harrison, Head of Investor Relations at Silverfleet, moderated the panel ‘How to grow winning LP/GP relationships’. Here are some of the highlights from the Q&A.

“We want to build strategic partnerships with our GPs”. What does that actually mean? I think every limited partner has a different definition, and clearly from a GP perspective we are trying to evolve and make sure that we partner alongside our LPs. I’d be interested to hear from our panel of LPs their thoughts on the key elements of a fruitful and successful GP-LP relationship.

LP1: We want to be a partner with the GP across the spectrum of their capital needs which in turn gives us better visibility as to how they operate, enhancing the overall relationship. We look for great performance, information transparency and look to collaborate with them across a variety of opportunities throughout the life of the investment.

LP2: We also are looking for long-term relationships so we need to be convinced that when we partner with a GP it is a relationship that could last for at least twenty years, and that the GP is really building a firm with a long-term vision and strategy.

LP3: Trust is a two-way dynamic in our GP relationships and we seek assurance that our voice is heard. For example, if they raise a new product or strategy and we have expertise in that given market or strategy, we’d like them to engage with us for advice if there are things that they don’t really understand themselves first-hand.

LP4: I think an additional element of the long-term relationship we look for is not to be reduced in terms of ticket if we are to continue the relationship. Clearly the tables have turned in favour of GPs as many are successfully fundraising and want to re-balance their LP base or diversify the fund composition in terms of investor types or geography. Also, in terms of succession we like to know which partners will remain in the GP teams; performance is important but knowing who contributed to that performance is key.

In relation to a GP’s IR function and their capabilities, could you comment on what you’ve seen, what you think works well and some of the difficulties or deficiencies you may experience being ‘one step removed’ from a GP’s investment team.

LP3: Many GPs have stepped up their internal IR function quite dramatically. In creating large IR functions, as we’ve seen in recent years, GPs can seamlessly interact with LPs and spend dedicated time with existing and prospective investors between fundraising cycles. The issues we have experienced, especially at the larger end of the market, is that GPs have tended to fully delegate that interaction with LPs to the IR function, and in some cases we have lost touch with many of the investment professionals at the firm. It’s good to have an IR person interacting with us but you need to find the right balance and a way to get your investment professionals in front of LPs.

This is particularly important for co-investments, where an LP might be able to share previous experience or lessons learnt from prior challenging investments that could be useful to discuss with GPs in relation to new investments. That ability to stay close to your investor base from an investment perspective is fundamental.

On co-investment partnership, what is it you’re looking for from your managers and what sets one manager apart from others in terms of how they operate their co-investment programme? Do you feel you are treated in the same way across the board as other LPs in the fund, or do you sometimes see special treatment within that LP base?

LP1: In most cases investors have an interest in seeing co-investments. I think mainstream buyout firms understand that co-invest is part of the relationship and part of the business model. From a diligence perspective it’s a great tool to get to know the GP better and validate their story. It also provides the opportunity for investors to cherry-pick certain sectors and investment theses while overall increasing their exposure in relation to underlying appetite, not to mention the fee efficiency that it results in. I would say the model is as strong as I’ve ever seen it and increasingly desired by a larger number of investors.

LP5: LPs are becoming more professionalised and geared up for co-investment. How can LPs differentiate themselves in order to win co-investment opportunities? It’s about transaction certainty and capabilities; re-assuring the GP about internal processes in place and expected timelines. We act quickly ensuring that we give our feedback to GPs along the way, asking for any extra information needed in order to get the co-invest deal across the line efficiently. It’s about communication as well as the ability and willingness to come into the process early; while many investors can do a syndicated deal post-closing, a much smaller set of investors can actually differentiate themselves through their ability to co-underwrite a deal, reducing the number of LPs you’re in competition with for the co-investment.

In Europe you can also make a difference in terms of language speaking abilities. If the deal is in continental Europe, the LP may bring multilingual skills which helps facilitate deal execution where management teams can only speak their native language. There are many ways for LPs to differentiate themselves but in this market environment they’re having to work harder to do so.

LP3: GPs need to judge the relationship versus individual transaction execution. If they choose LPs that are deemed ‘easier’ co-investors – for example, those without extensive IC processes, do not need to meet company management or are willing to pay fees and carry – and completely disregard those LPs where this isn’t the case, then they risk jeopardising long-term relationships with investors.

Would you invest in a manager that doesn’t show you co-investment opportunities or has no historical track record of executing co-investments?

LP4: We would invest with a GP that is not offering us co-investment but it depends on the strategy of each fund. It’s not a pre-requisite for investing but is a nice to have and definitely a good way to get to know a GP. If we like the kind of co-investments they’re offering, the way they execute deals and their historical track record then we wouldn’t rule ourselves out.

How effective do you think advisory boards are to the GP-LP relationship? Do GPs use LPs to advise or do you think they sometimes see it as a tick-box exercise? What influence do you think you can have on the GP by being on the advisory board?

LP1: Not everyone uses the advisory board in the same way. Better GPs will use it to gain insight and consult with those members on what they think about certain matters and conflicts.

I would encourage GPs to use the advisory board and to take advantage of the fact that they are comprised of professional investors with extensive experience.

As GPs offer an increasing range of products, will the multi-strategy approach appeal to existing investors who already know the GP’s team and operations, or is it just another way for GPs to increase AUM? What mechanisms are you seeing GPs using to seed these new strategies?

LP4: While we ourselves are a multi-strategy platform, what we don’t like is being asked to make an investment in a new fund just to get access to the main fund. For some GPs they already have a strong franchise with particular specialities and expertise therefore it makes sense to launch new fund strategies, but it doesn’t make sense for all GPs.

LP5: I’m in favour of GPs broadening their product offering if it makes sense strategically and creates synergies with existing platforms. Having one single GP that you know and trust is clearly advantageous. If you’ve already invested time in doing due diligence on the GP, then you only need to get comfortable with the new strategy.

LP3: GPs look around themselves and they see new strategies everywhere and it’s tempting. They see some very successful examples and ask themselves, ‘why not?’. We have seen examples though, where GPs have expressed intention to branch out from their core business but cannot justify the real reasons for launching a completely new product. They’re worried that if they don’t explore new strategies they will not grow, progress and develop.

If it’s only to emulate their peers and not because they fundamentally believe in expanding into a new product, then they are better off not pursuing that path. GPs should carefully consider new products that drive their business in an appropriate strategic direction, not just to rapidly gain AUM. They risk killing a franchise by raising a product they have no real understanding of or ability to recruit the right teams for.

Something we see an increasing demand for is ESG reporting at both the GP and portfolio company level. This is something we’ve worked hard at over the last few years. How are you seeing GPs report ESG progress? Would you invest in a GP partially sacrificing financial return if their investments are having a big impact?

LP2: FIve years from now, I would expect every GP to be fully ESG-compliant because this is a requirement from every stakeholder in the investment equation; LPs, employees and consumers. ESG is now not just something that is a ‘nice to have’ but something that is now at the core of the private equity strategy, and a demand from wider society.

In that case then your point is GPs shouldn’t be raising impact funds because their current fund by default should be an impact fund?

LP4: Given ESG is now mainstream we are not expecting to have lower returns, we’re just expecting the GP to change the kind of deals they will invest in. The industries and the sectors GPs were investing in 20 years ago are different to those they invest in today and will continue to evolve. Additionally, we are seeing more innovative impact funds creating new carry models through tying carry to impact-related measures instead of financial performance. Europe has made good progress in ESG, but in the US there is still a lot to be done. Hopefully US GPs will soon follow Europe’s lead on the implementation of ESG initiatives.

LP5: I think we are still struggling with the definition of ESG – what ESG is for one party may not be the same for another. There are many industry innovators but what we’d like to see is more progress on implementing and tracking definitive KPIs. In the coming years I expect we will be assessing the ‘ESG maturity’ of GPs. We need to set trends as an industry, then the mindset will change as a new generation moves into the industry and ESG is evermore at the forefront of investment.

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