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The LP Collusion Canard

Back in 2008, Dow Jones reported that a group of large institutional investors had formed a lobbying group to collectively press for more LP-friendly fund terms. The story was later refuted by some of the reported participants (one Canadian pension plan rep called it “poppycock”), but not before I wondered if such an effort could be viewed as a form of collusion.

Fast forward to last week, when Private Equity International’s David Snow raised the “C” word in reference to the ILPA guidelines drafted last fall. This was followed up yesterday by WSJ scribe Peter Lattman, who reported that “at least three large private equity firms have retained outside counsel to examine potential antitrust issues.”

In other words, some general partners believe in an LP cartel, with the ILPA guidelines being used as the preferred means of intimidation. Let us count the reasons why they’re wrong:

1. The ILPA guidelines were designed as a set of best practices, not a hard-and-fast checklist. More importantly, I have yet to find any LP who is using them as the latter (including among those LPs who helped draft them). LPs have demonstrated over and over that they’ll budge on even the most fundamental ILPA guidelines if they believe it’s in the best interest of their financial performance. For example, on the same day that the ILPA guidelines were formally announced, turnaround firm KPS Capital Partners announced that it had raised $800 million in “top-off” commitments to its third fund. The new money flowed freely – indications were due just 16 days after initial request – despite a 25% carried interest structure and a 50/50 fee split. If an LP tells you that he’s passing because your fund doesn’t meet all the ILPA guidelines, chances are that’s just his cowardly way of saying: “We don’t think your fund is going to do very well.”

2. There is virtually nothing in the ILPA guidelines that LPs haven’t been asking for since time immortal. Stronger alignment of interests, an end to transaction fee splits, etc. The only difference is that they’re now neatly organized in a 16-page PDF. That’s called codifying, not colluding.

3. GPs regularly talk about the “industry standard” of 2 and 20. Wouldn’t that be GP-side collusion, under the same thesis? If not, how are the ILPA guidelines anything other than an argument for revised industry standards?

4. The GP assumption here is that many institutional investors have banded together to force unsavory terms down the throat of body GP. This would presume that the LP community is at least mildly cohesive when, in reality, it most often resembles a third-grade basketball team. The bigger and more athletic kids sometimes talk to each other, but mostly are looking for their own shots. The smaller and less coordinated kids get court-time, but mill about aimlessly with perhaps just a touch or two per game. In short, it’s a mess.

LP communication has certainly improved a bit over the past year – and some LPs certainly have regular conversations with peers – but there are still no central forums (online or offline) in which the full spectrum of LPs can interact (even ILPA is exclusionary, banning the vast array of funds-of-funds). Moreover, LPs still like to keep things from one another – as evidenced last year when many large Quadrangle Group LPs didn’t know how their peers were planning to vote on the proposed (and failed) investment cycle stoppage.

5. Some GPs may have heard stories about how an early version of the ILPA guidelines were originally drafted by a group of large LPs who then brought ILPA on board to give them legal cover from possible collusion charges. It’s a timeline I’ve also heard from LP sources, albeit one that is strongly denied by ILPA. Even if accurate, LP intent hasn’t matched LP action (KPS is far from the only example). LPs are certainly investing in fewer funds today than in past years, but that is mostly due to larger economic concerns (possible double-dip, etc.) and overall PE/VC performance worries (debt-laden portfolios, middling returns, etc.). Yes, LPs have a bit of leverage on GPs right now, but that’s cyclical and will revert back. It always does (see 2002 compared to 2006).

To be clear, I am not an antitrust lawyer. Nor do I expect to ever play one on TV. But, to me, this charge of LP collusion just doesn’t pass the smell test. Per usual, I’m interested to hear your thoughts…