Overdue: LP defaults

01 June 2009

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It's been a long time since most GPs have asked LPs for money. Special situation secondaries funds aside (last month clocked up $11bn for secondaries), most GPs are sitting tight this year, cosying up to LPs but not asking them for any firm commitments. As one placement agent described it, "To ask for money now is to force a decline." Moreover, "once that 'no' is in the minutes of a meeting, it will be extremely difficult if not impossible to reverse the decision", regardless of the economic backdrop. Hence, wise GPs are waiting until the beginning of next year at the earliest to gauge appetite

The deal-doing side of things is also tense, though it shows signs of abating sooner. Many GPs are now eyeing up targets - and schmoozing their owners - with a view to closing deals at the end of this year. The question is whether they will be able to. Worries of leverage and vendor price expectations aside, LPs need to be convinced to write a cheque when the capital is called, a concern that has forced nervous GPs into inactivity since the first high-profile LP default hit headlines in December.

There is widespread belief that deal activity will pick up from this October, albeit gently. With this is likely to come the wave of LP defaults that failed to materialise at the beginning of this year. The swell will not be tidal, since LPs' "denominator" issues have been mitigated by newfound "numerator" issues as reduced valuations of private equity portfolios have trickled in over the last couple of months. However, many will nevertheless struggle to stump up the cash they've (over)allocated.

Some advisers suggest that the issue is overstated, since truly cash-strapped (or disenchanted) LPs would have defaulted on management fee payments, which have been ongoing. That this has not been the case, the argument goes, suggests that LPs are likely to honour drawdowns.

But this is risky logic. For one, the quantum is different: a management fee is 1.5-2%; a deal can be 5-10% of the fund. Secondly, and perhaps a more salient point nowadays, is that an LP will have to defend any defaults to other potential GPs in the future, and it is easier to persuade a party that it disagreed with a deal proposal than it is to say it had completely abandoned a relationship.

Yours sincerely,

Kimberly Romaine, Editor-in-chief, unquote"

Tel: +44 20 7004 7526

kimberly.romaine@incisivemedia.com.