Evaluating GP performance: Warning signs and proactive solutions
General Partners (GPs) play a critical role in the success of private capital funds. They are responsible for managing investments, driving returns and ensuring alignment with Limited Partners (LPs). However, underperformance, misalignment or governance issues can risk LPs’ capital.
Proactively evaluating GP performance and addressing red flags early on is crucial for LPs to protect their interests and maximise returns. In this article we outline the key metrics, warning signs and actionable strategies for addressing GP underperformance.
We consider the key metrics for evaluating GP performance to be:
- Investment Performance: measured by Internal Rate of Return (IRR) and Multiples on Invested Capital (MOIC) which can be benchmarked against industry averages and peer funds to assess relative performance
- Portfolio Quality: focusing on diversification, risk exposure and the performance of key assets and the GP’s ability to generate value through operational improvements and strategic exits Capital Deployment: is capital deployed efficiently and within agreed timelines? Del
- Capital Deployment: is capital deployed efficiently and within agreed timelines? Delays in deployment or overconcentration in certain assets can indicate inefficiencies
- GPs Financial Commitment: low alignment between GP and LP interests can impact fund performance
- Transparency and Reporting: High-quality GPs provide clear, timely, and comprehensive updates, including financial performance, investment strategies, and market outlooks.
Key warning signs of GP underperformance
In our experience, some of the key warning signs of GP underperformance include returns consistently lagging comparable benchmarks, frequent write-downs in portfolio companies and a misalignment with LPs in terms of excessive fees or opaque decision-making, for example.
Another factor that can indicate underperformance is high turnover in GP teams. For instance, frequent departures of senior team members can lead to inconsistency in leadership and the strategic focus of the fund. The high turnover can also lead to weak GP governance, such as lack of adherence to fund agreements or poor engagement with LP Advisory Committees (LPACs).
Proactive solutions
LPs can address the above issues by being proactive on several fronts:
- Engagement through LPACs can help to address underperformance concerns and valuation issues, for instance.
- Engaging third-party specialist advisors will help to provide an impartial view of fund performance, strategy and governance.
- Collaborating with Co-LPs can increase collective influence in addressing GP issues. Encouraging the GP to reassess fund strategies such as portfolio rebalancing or accelerating exits to address performance gapscan also be of value.
- In some cases, LPs can also push for the replacement of the GP, initiate a secondary sale or pursue fund wind-downs to protect capital.
Traditionally, in private equity, LPs tend to adopt a passive approach, delegating day-to-day operations and decision-making to GPs. However, to drive GP performance and optimise fund value, LPs need act well-ahead of a fund’s end-of-life date and take proactive steps early on in terms of evaluation, intervention, and even potential GP replacement to guarantee the best outcomes.
In conclusion, by monitoring key metrics, recognising warning signs and taking early action LPs can mitigate the risks and drive better results. Whether it is through LPAC engagement, third-party reviews, appointing independent specialist advisors, or collective action, LPs have the means to ensure alignment and protect their investments.
