What is the magic that makes for a solid and lasting LP/GP union?

LPs want to understand a GP’s process for arriving at a valuation of a portfolio company because they have to trust the manager’s numbers.

According to panelists, strong private equity partnerships require, surprise, surprise, open and robust communications.

This is especially true when it comes to fund investors understanding GPs’ process of calculating portfolio company valuations, according to one LP panelist. (The conference was under Chatham House rules, meaning the information shared could be used, but the speakers’ identities had to be kept confidential).

“Clear and concise valuation policy – not looking for something super detailed but one that the GP uses across all of their existing funds,” the LP panelist said.

“As an LP, as our portfolio matures there’s thousands of companies so it’s almost impossible for us go through each valuation and opine on whether or not we think its undervalued, overvalued so we really have to trust our GPs and understand their process.”

The LP/GP relationship was the topic of a panel of limited partners and managers at the PartnerConnect East 2021 conference on Oct. 7.

Another panelist said he looks for three key factors when considering a GP: consistency, transparency and conservatism.

“Once a GP picks a valuation methodology, we want them to stick to it and be consistent, that is foremost but we also want to see a high-level of transparency in valuations – so if the GP provides a detailed, robust historically financial package … we want to see that relative to budget and forecasts.

“Then we as the LP should be able to use that data to arrive at the valuation we were presented, so transparency is the second attribute,” he said. “And lastly conservatism is something that we love to preach to our managers; no one has ever been harmed by underselling and over delivering so we like to see our managers approach valuations with that mindset and internally that sets us up for a good partnership going forward.”

The first panelists noted that there is no such thing as a “right” answer.

“It’s not so much about getting to the right answer because there is no right answer its more about having a clear and robust process to get to an answer that is reasonable but at the same time not aggressive, we want to be able to show our work and how we got to where we are at,” he said.

He added that when it comes to moving to a fund-of-funds or a continuation vehicle, a non-biased third-party valuation is preferred.

“Our preference is to have a third party come in and reprice the transaction when moving a company to a continuation vehicle, so both parties can understand the new, market-clearing price,” the panelist said. “While we have seen GPS bring in fairness opinions, those are helpful but our gold standard is to have some sort of third party confirmation of pricing to ensure that if they were to go into a full sale of the business they would get a similar price.”