LP Series: Our Views on LPACS & Reporting

LIMITED PARTNER ARTICLE SERIES

Our Views on Fund of Funds Investing – An Article Series 

OUR VIEWS ON LPACS & REPORTING

As a fund of funds investor, we place significant importance on being able to meaningfully engage with the fund manager. Ideally, this means making a commitment adequate to occupy a seat at the Limited Partner Advisory Committee (LPAC).  Where we are not able to meet the very significant required minimums of larger funds, we take more time to regularly communicate directly with the GP. We value these opportunities to stay abreast of the fund, team and portfolio developments. LPACs are interesting animals and we thought it appropriate to detail our views here.

If as an LP, you have been blessed by investing with very good GPs then the benefits of LPAC participation are obvious. Quarterly meetings provide quantitative and qualitative information across the portfolio in addition to financial information relevant to the fund. Discussion and questions are encouraged, and an in-camera session is afforded to LPs where discussion can be undertaken independent from the GP. 

The better GPs will have provided quarterly LPAC reports 5-7 days in advance of the LPAC meeting giving LPAC members time to digest the information and formulate questions that provide good discussion at the meeting. Reports provided one day in advance usually lead to little discussion and few questions.  Enthusiasm wanes.  The chance to nurture the relationship is squandered.  

Reports reflect the author’s character and abilities. Transparency is essential to a great set of quarterlies; portfolio reports should not only illustrate the quantitative essentials of each portfolio company but also the qualitative elements. Solid back-office systems are important and great systems produce output that reflects a team commitment to quality and robust presentation for the sake of the relationship. A stellar CFO who skillfully blends the accounting function with investor relations in such a manner is incredibly important. The importance of an exceptional fund CFO is often overlooked, and there are precious few who might qualify as top tier.

Similar to company boards, more time should be spent at an LPAC meeting looking forward than looking back at the quarter now spent. This much more valuable time can be achieved only if the package is sufficiently detailed to avert recurring questions about the past. Each report should, in addition to all the financial aspects related to the investment, contain information about sales performance versus plan, key personnel changes/upgrades, changes in market/competitive environment, technology development progress, how the GP views the outlook of the investment and most importantly, information related to the exit plan. It doesn’t have to be flowing prose in storyline form – bullets are fine.  

The key is to keep us informed. If a portfolio company is consistently behind plan, it’s better for us to know this than to be kept in the dark in the hope that maybe things will turn around. We know portfolio companies experience frequent turbulence, so it’s just best to avoid downplaying dark clouds in an outlook and later announce a washout. Transparency does not fully bear the weight of the relationship, but it is a significant pillar. These instances are actually the manager’s opportunity to incrementally telegraph expertise by proactively identifying the steps to “right the ship.” We know it won’t always work out, but are very interested in how the situation is to be addressed.   

Alignment is equally important. With true alignment between GP and LP, much of the potential for friction between parties is eliminated. Alignment and the surety of the maintenance of that alignment can only be accomplished by a good, regularly revisited relationship. Having an LPAC seat provides a great opportunity for that; otherwise, we endeavour to make regular contact with the GP. Alignment is a pattern of behavior, decisions and actions that represents the best interests of the GP and the LP and is the binding principle behind the hard-coded words of the Limited Partner Agreement (LPA). The GP invests in a manner that is consistent with fund thesis, acts ethically and provides little cause for LP consternation. The LP also bears responsibility for alignment; they must adhere to the terms of the LPA, study the quarterly reports prior to the meetings, be dutifully engaged at meetings, act ethically and provide little cause for friction. 

A frustration we have heard from GPs is that some LPs have not prepared for the quarterly meeting. GPs spend a lot of time putting together a meaningful package and it is then disappointing when no discussion or questions ensue. We have experienced LPs who have left themselves unmuted during the meeting while they made another call or asked a question regarding an issue that was clear and highlighted in the report. As LPs that also manage direct investment funds, we understand the consuming work of fund management and reporting; therefore, we commit to being fully prepared and engaged for every LPAC meeting. It is our oath.

LPAC involvement is a particular privilege. The opportunity to ask questions, receive more intimate information regarding portfolio companies and understand the mindset and logic behind certain decisions (such as follow-on or divestment) provides tremendous insight into the stability of process inherent at the fund.  The other LPAC members are also very important because alignment within the LPAC is critical as they represent their respective interests. As they all hope to have garnered a long-term relationship with the GP for a long series of funds, the other LPs are also partners in this longer-term vision. 

As previously mentioned, we try to invest a sufficiently sized amount of capital in order to occupy a seat at the LPAC because we know how valuable such access can be. When it is not possible for us to do so, we are then grateful and humbled when GPs offer us that seat based on their discretion. We have GPs that have repeatedly voiced their appreciation for our engagement, preparedness and logic as LPs in their funds. To be recognized in this fashion simply underscores the strength of the alignment.  

It matters who we invest with as LPs.  A good LPAC is engaged and, when necessary, must be willing to step up and address concerns on behalf of or in consultation with (or, perhaps even rally) the entire base of LPs. It is not common for the LPA to be breached; when this happens the LPAC must act accordingly. Institutional LPs typically align best with other institutional LPs, as the collective viewpoint will pivot on broader fund-of-fund experience to navigate ambiguities or turbulence in fund governance or situations of disagreement with the manager. In addition, LPA amendments are not uncommon. Accordingly, it is the clear responsibility of the LPAC to be sufficiently familiar with LPAs to consider if, and what, latitude is appropriate to maintain alignment under the circumstances. For this reason, most experienced institutional LPs prefer LPACs seated with other experienced institutional LPs. 

Summary

LPACs and quarterly reporting are a significant component of GP/LP interaction and co-existence. When they are well managed, it can contribute significantly to the LP’s decision to throw in again or even increase their allocation to the successor fund. We have spoken repeatedly about the three elements of transparency, alignment and trust. To us, these three elements underpin the GP/LP relationship. One weakened element erodes the relationship. Most teams will respond with upturned hands and high eyebrows, as if anything less would be unthinkable – and yet it is not uncommon to find GPs and their LPs in a fragile state at various times on one or more of the elements. Given that the three elements form the basis of the relationship, we felt it deserved its own discussion in our next article, “The GP/LP Relationship.”