Choosing Limited Partners for your Fund
As you seek out appropriate LPs for a new private fund, focus your targeting efforts on LPs that are likely to bring higher investment contributions and fewer problems down the road. You’ll want to look for traits that indicate stability, steadiness, the willingness to weather potential storms and early-stage setbacks, and the ability to clearly communicate needs and expectations. You’ll want patient investors who understand what they’re getting into and you’ll want investors who understand (to at least some extent) where your fund fits in the larger market.
In order to pursue the right LP’s, it helps to understand why investors are drawn to limited partnership structures in the first place. The primary reason: as the name suggests, limited partners cannot typically lose more than they invest. Their losses are controlled, and chances are, your target LPs appreciate this and are not interested in being taken on a wild ride of unlimited risk and reward. Limited partnerships also allow legal teams to adjust the operating terms of the partnership agreement, and many potential partners are attracted to this type of flexibility.
So once you understand the motivations of the LPs who are interested in signing on, how should you choose who is in and who is out?
Choose LPs who are comfortable with your fees and profit share.
Fund fees typically fall between 1.5 and 2.5 percent, and profit share or carried interest typically falls between 15 and 25 percent of total profits. If your fund is large, you have a successful track record as a fund manager, or you have something unique to offer that warrants higher fees and carry, you can command more from LPs. If your fund is small and your experience limited, you will have to keep fees and carry low. In either case, your LPs will need to find satisfaction with your terms based on your track record.
Choose LPs who are comfortable with your investment strategy.
Your LPs should fully understand the philosophy behind your investment decisions and the companies you decide to back. They should believe in both your chosen sector (energy, healthcare, crypto, etc.) and your chosen vetting method. If you lean toward struggling companies with high upside potential, or small startups with bright futures, your LPs should support the general reasoning behind your decisions.
Choose LPs who can contribute at a scale that works for you.
If your management approach is hands on and your staff is small, it may not be worth your time, labor and risk to accept LPs who invest very small amounts. If your LPs are willing to invest more than you can responsibly manage, they may be better off with a much larger fund. In all cases, open communication and a clearly written, fairly negotiated operating agreement will be essential to successful and lasting partnership.