Key warning signs of GP underperformance
In our experience, some of the key warning signs of GP underperformance include returns consistently lagging comparable benchmarks, weak internal governance, 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 (both investment and operational teams) 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, operational errors, 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 via the LPAC or coordinated voting on fund matters. As a group LPs can request increased transparency and reporting to help identify performance gaps more effectively, and push for improved operational oversight of portfolio companies
- Encouraging the GP to reassess fund strategies such as portfolio rebalancing or accelerating exits to address performance gaps can also be of value. Accelerating exits can help with addressing short-term liquidity issues although this must be carefully balanced with the need for long-term value maximisation.
- Exploring governance tools such as clawback provisions, renegotiation of fee structures, or even the appointment of new non-executive independent directors to the fund/ fund manager.
- In some cases, LPs can also push for the appointment of a sub-advisor, replacement of the GP, initiation of a secondary sale or pursuit of fund wind-downs to protect capital.
Traditionally, in the private funds space, LPs tend to be relatively reluctant to to to take action when there is an issue, given the need to preserve their LP status . 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.
