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LP Defaults: What Exactly Happens?

It isn’t happening on a large scale, but we’re hearing that family offices, high net worth individuals, offshore vehicles, and even some general partners themselves, have begun to default on capital calls for private equity funds. As capital calls begin to roll in with no exits in sight, some private equity investors are asking themselves, what are the consequences if I simply don’t cough up the cash?

Depending on the terms of the limited partnership agreement, a few things can happen. Typically, the other investors receive a second capital call to cover the defaulted money. They may give the investor a 30-day period to pay them back, and the fund manager can seize around half of the defaulting LP’s account balance. Either way, the LP is still responsible for the money and in some cases, the GP has sued in order to get it.

Right now the default action has been limited to the aforementioned parties: smaller players like family offices and individuals, not institutions. The number one thing holding back limited partners from defaulting is reputation damage. At a Capital Roundtable Masterclass yesterday, one at advisor told me, “Anyone who wants to play in alternative assets again will not default.”

How are general partners are avoiding that potentially messy situation? Some funds have drawn up to 20% of their capital upon closing, panelists at the Masterclass said. “It’s a way for GPs to make sure their investors have skin in the game from the start.” One panelist said he knows of two funds that decided to simply call down the remaining 60% to 70% of their fund so they could sit on the capital.

Read more detailed descriptions of the legal remedies (from lawyers) to LP defaults here, here or here.

Earlier: LPs Worst Fear