We’ve been reporting on some of the trends leading the way into the new year on the LP and fundraising side of the business. I wonder how many of those will continue through the first two quarters, like slower fundraising and extreme LP selectivity.
One point that we’ll be scrutinizing in these early weeks and months is the anticipated pressure on “re-ups” by LPs into their existing GPs’ next fund.
The decision by LPs to commit capital to a new fund from a GP with which they already have a relationship has been viewed generally as an almost default move – barring a catastrophic investment loss in the prior fund or partnership split.
This dynamic changed as the market slowed last year, and this year will truly test the LP/GP relationship in many funds. At the very least, LPs will likely be committing less in re-ups they do make compared with their past commitments.
“LPs generally defaulted to investing with their sponsors for at least two vintages,” according to Pacenote Capital in an end of the year note.
This quick re-up usually precluded the ability of the LP to analyze actual fundamental return data, as new funds come back well before the prior funds crystalize returns. “LPs are often left underwriting their re-up candidates on the basis of less quantifiable key-performance metrics: Have you stayed on strategy? Have you executed your initial post-close goals at each of the portfolio companies? Have you built (and maintained) a broader team as planned?”
Over the past few years of the fundraising bull market, the information available to LPs might have been even scantier, considering the shorter fundraising cycles, in some cases, only a year after the prior fund closed.
“Prior to 2022, our sense was that the majority of Fund I to Fund II re-ups felt inevitable,” Pacenote said.
That trend is over, Pacenote said. “If ’21 was the ‘year of the re-up’, and ’22 was a year of playing defense on the public markets front and keeping your head above water triaging private markets re-ups, ’23 will be the year of portfolio pruning.
“The advice we have been giving sponsors is that if an existing LP does re-up with you, even if for a reduced commitment size, this should be viewed as a meaningful vote of confidence.”
Indeed, an LP opening its wallet for a GP in today’s fundraising market is a big thumbs-up, especially if it represents the formation of a new relationship.