LPs to VCs: Behave Yourselves

Usually having a group of limited partners talk to VCs results in a discussion on the finer points of fee structure and carried interest.

But Chris Douvos, co-head of private equity at The Investment Fund of Foundations, livened things up a bit at this week’s Venture Capital Investing Conference in San Francisco with a few points about how the private lives of general partners also factor into LP funding decisions.

When entrusting capital to a venture fund, it’s imperative to have confidence in partners’ character, he says, not just their investment strategy. And that means filling the role of investigative reporter.

“I need to know how likely they are to sleep with their assistant….I need to know why Person X isn’t speaking to person Y,” Douvos says. “I’m not a moralist or scold… I’m concerned about the distraction this causes to the partnership.”

But exemplary office behavior isn’t the only way VCs can win the favor of limited partners. Another LP-pleasing strategy, panelists said, is to invest a large share of one’s own money into the VC fund one manages. Also, for older funds, it’s important to have a multi-generational management team, with founding partners, managers, and emerging managers.

No matter what the strategy, however, LPs say most funds will have difficulty closing, with the exception of top-tier funds that are perennially oversubscribed. The overall take from LPs was that venture investors shouldn’t get their hopes too high about 2010 being a robust period for fundraising.

Although there appear to be more firms out fundraising, the amount of money they end up raising will probably be similar to last year, says David York, CEO of Paul Capital Investments.

Questionable credibility is one concern that’s adding to LP wariness, says Stefan Hepp, CEO of SCM Strategic Capital Management.

“A lot of funds that are now ten years old or older have not returned a lot of capital. I remember when those fund managers were talking about three and four year holding periods.” he says.

Another issue for VCs, Douvos says, is that the venture asset class, with its decade-or-longer periods, is less attractive in a period of scarce liquidity. In the previous investment cycle, he says, investors mispriced the opportunity cost of illiquidity. It turned out to be far costlier than investors had thought.

But fee issues weren’t entirely left out of the conversation. LPs said for the most part, the standard management fee of around 2% is still in place at most firms, with some downward pressure for large funds and for the later years of funds where less active management is required.