LPs Say “No Mas” To Future Funds, But What About Existing Ones?

Twenty percent of institutional investors plan to decrease their target allocation to private equity over the coming year, according to the latest results of a bi-annual survey conducted by Coller Capital. This is the largest percentage of expectant downsizers since Coller began the survey in 2004, with the group usually representing between just 3% and 6% of respondents.

It’s worth noting that another 15% or so plan to actually increase their target allocations, although that figure has dropped precipitously over the past two years (it had approached 50% in the summer of 2007).

One reason for the decrease is simply that there will be fewer private equity firms in which to invest. LPs expect 28% of today’s VC firms and 23% of today’s buyout firms will fail to raise a new fund over the next seven years. Those are pretty heady numbers, particularly for a VC industry that already experienced a minor shakeout earlier this decade. Moreover, 84% of LPs report having chosen not to reinvest with an existing GP relationship, compared to just 45% three years ago.

Presumably, all of this should lead to a sea change in the LP/GP power dynamic — which is traditionally dominated by GPs. For example, nearly 80% of LPs expect buyout fund terms to become more LP-friendly over the next two years, while around 65% believe the same of venture fund terms.

That’s all well and good, but LPs would have more credibility if they began insisting on changes to funds that have already been raised. For example, why have LPs not raised holy hell ovcer the 99.9% of buyout funds that haven’t cut the sizes of funds raised in 2007 and early 2008? Most of those vehicles were far larger than their predecessors, due to expected increases in deal volume and deal size (due to rising valuations). Those capital requirements are no longer operative, but LPs keep paying fees as if nothing’s changed.

Even more egregious are static fees and fund sizes from firms that have cut headcount over the past nine months. Sure the firm might have staffed up right after the fund was raised — an argument made by Carlyle and Sun — but LPs were kind of expecting that when they pro rata doubled and tripled their commitments. LPs were willing to pay more for more work, but shouldn’t be willing to pay more for less.

Finally, only 35% of North American LPs approve of their general partners buying debt in their own portfolio companies, while two-thirds of all LPs disapprove of their GPs buying public equities (PIPEs). But do any of these LPs actually do anything to stop such activities? Save for a scolding phone call here and there, the answer seems to be a resunding “no.”

Limited partners seem to relish their potential power, but should begin wielding it before the balance flips back.

Summer 2009