As a venture capital fund manager, properly managing the relationship with your limited partners (LPs) is critical to the success of your fund.
If you choose the right LPs and manage the relationships proactively, you’ll enjoy a long and lucrative partnership. After all, the average venture partnership lasts longer than a marriage!
But if you fail to manage this relationship well, you’ll find yourself beset with challenge after challenge.
In this article, we offer general partners (GPs) actionable ways to foster a successful relationship with their limited partners.
Consider Potential LPs Carefully
Once a limited partner commits to a venture capital or private equity fund, the relationship typically lasts for over ten years. If you add the screening time and due diligence before the commitment is made, the relationship can extend to 12+ years. Meaning GPs at new funds should be selective on who they bring on board as LPs since the wrong types of LPs can be detrimental to a fund’s progress.
As an emerging venture fund manager, you should not let any LP be more than 20% of your fund. Ideally, you should build a diverse LP base that includes various LP categories, including Funds of Funds, Family Offices, HNWI, and even some institutional investors willing to back emerging VCs based on their prior track records.
VC Managing Partners (GPs) should be wary of LPs with a lack of experience investing in the VC asset class who lack the knowledge of how venture capital works. By understanding the ins and outs of the industry, communication between LPs and GPs will be easier.
Just like LPs are discerning about where they invest their capital, so should GPs consider potential LPs carefully. As Masha Drokova, founder and General Partner at Day One Ventures, explains, “For fund managers, an LP has much more influence than just cash in an account, especially in the early stages. For new managers, there’s always a temptation to quickly raise money instead of raising the right money.”
Take the time to research potential partners before signing them on because they will influence your relationships with other LPs, your portfolio companies, and your team. Learn about their values, their level of risk aversion, and what success means to them. Make sure there is clear alignment before taking the next step.
Think Long-Term and Take Your Time
Most LPs have a different level of risk than VCs. Whereas VCs are usually more comfortable with risk and less affected by normal ups and downs, some LPs are generally more careful.
For instance, a pension fund investing the retirement savings of government employees is typically quite conservative. They want a return, of course, but not at the expense of the principal. Nor are they willing to dive into an agreement with an unknown GP after a couple of meetings. The cycle is often longer, and the GP must take broader steps to build a relationship and make the LP feel comfortable.
As a GP, rushing potential LPs to invest in your fund is a quick way to erode the relationship. If you push faster than they’re willing to go, they’ll get that “slimy car salesman” feeling from you and either find ways to slow the process or abandon you together.
Find Balance to Prevent Undue Leverage
Both parties need to remember that each brings something to the table that the other needs. The GP is the investment manager that identifies investment opportunities and provides management expertise, while the LPs provide the bulk of the capital needed for transactions. This symbiotic alignment means neither can operate without the other.
In order to maintain a good relationship, no party should have an unusual amount of leverage. If anyone develops too much leverage, they can exert an unusual amount of control. This is especially problematic if an LP starts to override the decision-making autonomy of the GP.
Barry Eggers, Founder, and Partner at Lightspeed Venture Partners offers three key pieces of advice to maintain balance:
- Don’t let any LP be more than 20% of your fund; otherwise, they will start to expect special terms. Your largest LPs should represent 7–10% of your fund.
- Prioritize LPs that have their internal source of capital. You are taking on too much risk if you have to fundraise on their behalf.
- Focus on LPs that have demonstrated a long-term commitment to the venture capital asset class. You don’t have time for tourists who need their hands held. Look for LPs that have a bias to keep investing in your fund as long as it performs.
Establish Trust Early in the Relationship
Some of your LPs may be high-net-worth individuals, but they’re still handing you their greatest asset. The more LPs trust the GP, the more comfortable they will be taking on additional risk and holding steady if performance declines. So it’s essential to create a sense of trust as early as possible in the relationship.
Take your time here. Trust building can’t be rushed. Nor will it develop by simply insisting they trust you. Avoid over-promising as it creates an environment where under-delivering is inevitable. Chris Douvos, the founder of AHOY Capital, says it well: “Sometimes when VCs chat about their portfolio, everything is a ’10X this or 10X that.’ When there are too many X’s, LPs know it’s BS.”
It’s better to be conservative rather than optimistic, especially at the beginning of the LP/GP relationship. This ensures that your predictions resemble your performance, helping LPs trust you.
Avoid Scope Creep or Risk It All
You may find it tempting to break into a new industry or take advantage of a unique opportunity when it presents itself, even if that opportunity is outside of your wheelhouse. In a performance-based setting, some general partners struggle to say no to what seems like a good deal, even though it’s outside their expertise and the fund’s scope.
Keep in mind, however, that your lack of expertise means you can’t discern whether a deal is good or not. That “good deal” might be terrible; you just can’t see it.
Furthermore, your LPs won’t appreciate their money being used for something they never intended. They signed on with you and committed capital because they understand your expertise, skills, and experience. If you abandon those things to chase an out-of-scope opportunity, then you abandon the value you bring to the fund.
Maintain a Robust Reporting Policy
Some LPs request frequent reporting on the state of their investment. They want up-to-date information in a timely manner. Others take a more “laissez-faire” approach and don‘t require such frequent updates.
As a GP, your job is to keep your LPs in the loop and periodically communicate with them. If they feel you withhold information or are cagey with data, they might assume you are behaving irresponsibly with their money.
The best way to handle this is to be transparent through regular reporting. Here are some examples of information you should report to your limited partners:
- Cash flow and operating income
- Company information
- Overall operations
- Management fees
- Partnership expenses
- Realized gain/loss
They also want access to up-to-date metrics, such as your net burn rate, internal rate of return, return on investment, sales, runway, and more. They want to see this information about the fund and sometimes the fund’s portfolio companies.
You will have to set a reporting frequency that is right for your fund. The reporting requirements will vary based on the type of LP. Some LPs want quarterly reports, while others want them more often. For example, large institutional LPs such as university endowments and pension funds may have stricter reporting requirements than a family office or a high-net-worth individual. The rule of thumb is to be as transparent and forthcoming as possible.
Be Authentic, Honest, and Humble
Imagine you are an LP: Everything you hear from your GP is good news. No problems or challenges. Everything is up, up, up. You know that even the best investments come with struggles. It makes you doubt that your GP is being honest with you.
Now consider the alternative: You only hear bad news from your GP. He only speaks with you when there’s a problem they need you to solve or when they need more capital. Over time, you start to fret every time you see their name ringing on your phone. That certainly isn’t good for the relationship either.
As a general partner, you should be humble and authentic. Share the bad along with the good. Don’t exaggerate your history or success. Do not hype your future performance too much. If your LPs feel that your information is accurate and reasonable, they’ll be more willing to take your word on it and stick with you for the long haul.
As you can see, fostering a healthy relationship with your limited partners takes time. It’s easier to maintain a successful relationship than to repair one, so your best course of action is to take the relationship seriously from the beginning.