Balancing Act: Strategies for GPs and LPs in Today's Market

Episode Summary

In today’s challenging fundraising landscape, general partners (GPs) and limited partners (LPs) are navigating evolving dynamics and seeking alternative approaches. Hosts Greg Norman and Abby Reeves are joined by guest Will Adams to explore the current fundraising environment and its impact on the relationship between general partners (GPs) and limited partners (LPs). They discuss the challenges GPs face in finding suitable exits, the increasing demand for customized investment products and the evolving landscape of investment structures such as separately managed accounts (SMAs) and co-investments.

Key Points

• Fundraising Challenges: GPs are experiencing longer fundraising timelines and difficulty attracting LPs due to limited exits and distributions.
• Customization Trend: While limited partnership agreements aren’t fundamentally changing, LPs are increasingly seeking customization. Larger LPs are pushing for more advantageous fee arrangements and greater influence over governance.
• Evolving Investment Structures: The private fund space is seeing significant growth in co-investments and secondaries, with a notable increase in continuation funds.

Voiceover (00:04):
Welcome to the Preferred Return, Skadden’s investment management podcast covering legal and regulatory developments in the UK and Europe.

Greg Norman (00:17):
Hello, and welcome back to The Preferred Return. I’m Greg Norman, and I’m here with my co-host Abby Reeves and our special guest Will Adams. The preferred return is a Skadden podcast series providing short summaries of legal, regulatory or other topical developments in the UK and European investment management space.

Greg Norman (00:35):
Our podcasts are intended to be accessible by professionals across the sector. We welcome any feedback, particularly if there are topics people would like us to discuss. Our earlier episodes dealt with marketing a fund, spin outs and new fund sponsors, and air from D2. Do give these a listen if you haven’t already, particularly if you’re a first-time fund manager. So Abby, what are we going to talk about today?

Abigail Reeves (00:57):
In today’s episode, we will spend time speaking about how the current fundraising environment has affected the relationship between GPs and LPs. In that context, we will discuss the challenges GPs may face in finding suitable exits, and the push from LPs for increasingly customized products from GPs. We will also give a brief overview of new investment products that are gaining traction, as well as touching on points that GPS and LPs need to be aware of when considering different strategies.

Greg Norman (01:25):
Okay. So we’ve entered 2025 off the back of a few relatively subdued years from a general fundraising perspective. Despite an uptick in deal making activity and an increase in private equity fundraising during the last year, fundraising remains below 2022 levels. While there have been some notable pockets of success, particularly private credit and secondaries, the overall picture remains mixed. So Will, welcome to the podcast. Can you tell us a bit about the impact of this environment on GPs looking to fundraise?

Will Adams (01:56):
Thanks, Greg, and hello everyone. The environment you describe, Greg, has meant that exits and distributions to LPs remain limited. This has a knock-on effect of limiting the amount that LPs are willing to deploy to new funds. As a result, GPs are finding it harder to attract LPs, even those who have participated in their previous funds.

Will Adams (02:17):
LPs committing less capital has also led to fundraising timelines increasing, with the average time in the market having doubled since 2022. Funds that closed in the first half of 2024 took on average 18 months from launch to close, compared to nine months in 2022. Although the situation is more nuanced than a seismic shift in the balance of power in favor of LPs, GPs are having to be more accommodating than in previous years.

Greg Norman (02:44):
Thanks, Will. So Abby, if we aren’t seeing a big shift in dynamics, what has the impact been on the LP side?

Abigail Reeves (02:50):
Well, the challenging fundraising environment means GPS are more likely to miss fund targets or not raise a fund at all. You might think that this would lead to fundamental changes to LPA market terms, but this has generally not been the case. LPs continue to favor larger and more established funds with a strong track record. These funds have less of an issue attracting LPs, and are less willing to renegotiate LPA terms.

Abigail Reeves (03:14):
That said, one area where we have seen resistance from LPs is on the use of financing techniques such as NAV loans. Some LPs have been resistant to fund managers adding terms to LPAs to allow the fund to take on NAV loans, although we still expect the use of such loans to increase over the coming years.

Abigail Reeves (03:30):
Overall, LPAs are not fundamentally changing, which often leads to negotiations being more focused on side letters. LPs have, for a long time, used side letters as a way of tailoring fund terms to their benefit, and side letter processes remain protracted and time-consuming. This is because LPs have their own preferences and versions of particular provisions.

Greg Norman (03:51):
Thanks, Abby. Customization is a theme that we hear a lot. Beyond just side letter terms, many larger LPs are seeking more customized and bespoke products from their GPs. The use of bespoke structures and vehicles has become ever more prevalent with SMAs coming back into fashion. So Will, can you tell us a bit about SMAs and what we are seeing there?

Will Adams (04:12):
Broadly speaking, an SMA is a structure between a fund manager and a single investor. The fund manager will create a portfolio of tailored strategic asset allocations optimized for the individual legal, tax, operational, regulatory and commercial needs of the investor. SMAs are becoming increasingly popular. However, since the LP bears the operational and organizational costs of the SMA, LPs should consider whether the benefits of the customized product are worth the increased costs.

Will Adams (04:44):
SMAs also often require large commitments for access. So where they are used, the LPs tend to be committing significant pools of capital. When negotiating SMA arrangements, LPs tend to push for more advantageous management fee and carrier arrangements than the traditional 220 arrangement, where you bear a 2% management fee and get a 20% upside. For example, SMA fees are often based on invested capital rather than committed capital.

Will Adams (05:13):
As well as the more commonly negotiated points surrounding increased influence over governance, transparency and reporting, LPs may also push for shut-off rights. I.e., the ability for the LP to cease deploying new capital at any point. GPs on the other hand, need to consider how to balance providing solutions to the LP against running an efficient business. In reaching this balance, GPS will want to factor in the size of the investment mandates and whether the SMA can be integrated into any of the GP’s existing structures. This might involve the investment being made in an aggregating vehicle that makes the underlying investments.

Greg Norman (05:50):
Thanks, will. We should note that SMAs are only one example of how the private fund space has evolved from the typical co-mingled blind pool fund into a much wider array of structures. Co-investment and secondary transactions are two other examples that we talk about a lot. Abby, can you provide some insight on co-investments and some of the considerations for the GPS involved?

Abigail Reeves (06:11):
Sure, Greg. The value of global co-investment deals in 2024 was down relative to 2023. But since co-investment activity tends to mirror broader M&A activity, we may see an upswing throughout 2025 if the predicted activity comes to pass. Traditional syndicated co-investments where a co-investment opportunity is offered after a deal has been signed or closed often have a large number of LPs coming into the GP-managed vehicle. These LPs tend to be less involved in deal-making decisions as there will be more emphasis on the co-investment process being efficiently run by GPs.

Abigail Reeves (06:46):
In contrast, in co-underwriting investments where the co-investment opportunity is offered before a deal is signed, there will be a small pool of LPs who are often highly sophisticated institutions. Co-underwriting can create added complexity for the GP at the deal level, as participating LPs may demand board seats, influence over governance arrangements and may create regulatory or competition issues as a result of their involvement.

Greg Norman (07:12):
Okay. And Will, this must have an impact on the LPs as well?

Will Adams (07:15):
That’s right, Greg. Co-investment teams and institutional LPs are becoming increasingly experienced in executing transactions as an independent co-investor, participating in portfolio companies directly rather than through a vehicle managed by the GP. This can improve the economics for the LP even further than a typical co-investment. Smaller LPs who may lack the resources of the larger institutions are trying to achieve similar results by requesting information, training and insights from GPs. The structure of these relationships can vary, and LPs may look to leverage an existing relationship with the GP to enter into an advisory or consultant type relationship. GPs should try to ensure that they have appropriate protections in place in the legal framework.

Greg Norman (08:00):
I think it’s fair to say that a successful co-investment program needs to find an appropriate balance between these dynamics. Although we are a long way from LPs directly competing with GPs, GPs need to remain mindful of competition and conflicts when more LPs start to participate in this space. So we would of course be remiss not to mention secondaries and continuation funds. So Abby, can you give us a brief overview of where we are in that space?

Abigail Reeves (08:26):
So the secondaries market is expected to continue its rapid growth as GPs seek alternative ways to manage liquidity and generate returns for LPs. Continuation funds are an increasingly important part of the secondaries landscape, and made up 43% of secondary deal volume during the first half of 2024. That being said, LPs may not always be convinced that a continuation fund is the best option, and we expect demand and desire for cash exits to continue through 2025.

Abigail Reeves (08:54):
In addition, the conflicts of interest between the selling fund and the continuing LPs mean that a successful continuation fund process needs to be carefully managed by the GP in a way that can be quite different from a typical sales process. As well as being thoughtful on pricing and managing the process, both new and continuing LPs will expect to see a clear strategy for further growth and development on the relevant asset. While continuation funds are and will remain very much within the toolkit of GPs, they should be considered and used carefully.

Greg Norman (09:25):
I think a consistent theme across all of these topics is the importance for GPS of achieving the right result for their LPs. Whether that being connection with future fundraising or seeking to cross-sell other products to their LPs, the GP-LP relationship remains a cornerstone of the private funds industry. Notwithstanding a desire to standardize as much as possible, the flexible and nimble solutions that private funds provide to LPs mean that well-advised GPs will continue to be thoughtful in managing all of these processes as the market develops.

Greg Norman (09:55):
That seems like as good a place as any to draw this to a close. Thank you to Abby and Will for joining us today, and thank you for listening. This was The Preferred Return, stay invested.

Voiceover (10:08):
Thank you for joining us on the Preferred Return. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don’t miss any future episodes. Additional information about Skadden can be found at skadden.com.