The foundation of every successful long-term relationship depends on you understanding and meeting the interests of the other party, and vice versa. In venture capital, it’s critical to develop strong relationships with your limited partners and keep abreast of those interests as they grow and evolve. Here are three ways to create alignment and improve the success of your relationships with your LPs and how to support that alignment with analytics and reporting.
Discuss how to maximize net returns
Achieving alignment with your LPs starts at the beginning of the relationships with the Limited Partnership Agreement (LPA). A recent piece by Greenspring Associates, a venture capital and growth equity manager, outlined some of the terms that are most critical for alignment. According to Greenspring, management fees, recycling, and carried interest have the greatest impact on fostering healthy and enduring alignment between investors and managers.
Andrew Vo, Founder and CEO of Aidos, elaborates on the importance of the LPA and suggests the following:
- For LPs, carefully review and negotiate these terms as it will have a significant impact on the probability that the GP will deliver on their target multiples.
- For GPs, when you understand the math and economics behind these key terms, it can help you be more competitive among the thousands of venture capital fund managers.
Alignment on these points becomes much easier to manage with the right tools to do so. A CRM with built-in analytics allows you to track management fees and potential recycled capital side by side with current deal flow. This added transparency provides direct, shareable insights into prospective net returns and makes it easier to align with your LPs on your most promising deals and create better quality, transparent reports.
Consistently offer quality, transparent reports
Andreas Huber, Partner and COO at 3TS Capital Partners, has worked on both sides of the venture capital-LP relationship and has shared his learnings from this experience. He explains that three key success factors for the GP-LP relationship are:
- Quality and transparency of reporting
- Accuracy of information
- Timeliness of communication
GPs that deliver quality reports and communications directly support LPs who still have their own reports to build based on their funds’ performance. Huber explains that LPs may decide to re-invest into funds with only reasonable returns because they know that “the house is in order” and it is attractive for them to add an efficient, low-risk asset to their portfolio.
Michael Hutto, Executive Director of IHS Markit, has shared his key takeaways from the SuperReturn North America Virtual Conference where nearly 200 panelists, including GPs and LPs, spoke about the importance of data-driven decision making, communication between stakeholders, and transparency across portfolios.
One of the recurring themes across the panels related to the importance of data insights. GPs who had established robust processes and tools that enabled them to provide insight into the status of their funds and portfolio companies were typically perceived favorably by LPs.
Those with robust systems were able to appease their LPs in a timely manner by responding to requests with "crisis dashboards," in-depth reports on their portfolio companies, and details on fund performance. Analytics built directly into your venture capital CRM allows your team to move even more quickly to meet these asks so you can stay on top of your most important relationships.
Understand each other’s incentives
Daniel Roditi, Managing Partner at Meron Capital has described the LP-GP-Founder triangle of conflicts. Using the triangle as a framework, you can see that alignment can be most challenged when performance is strong. When a portfolio company performs well and raises consecutive funding rounds, it is likely that the success will be met with varied points of view.
For example, the existing LP may wish to keep their full pro-rata in the company, adopting a long-term perspective. Yet, this approach may be in tension with what’s in the GP’s best interests in terms of current performance and future fundraising—as well as the best interests of the founders down the chain who might prefer to bring on someone new who can offer expertise in a new field.
Roditi explains that “a complete alignment of interest is still hard to come by in the industry.” GPs find themselves in a trilemma where they struggle to measure important performance data and then must make decisions that benefit the LP and may not be in their own (or their portco’s) best interests.
Leveraging data analytics allows you to plainly set, track, and visualize your most important KPIs, so all three parties in the triangle can easily understand how their partners are performing and make decisions together.
Expectations and incentives
The tips outlined here can help you mitigate the risk of misalignment with your LPs. Alignment inevitably becomes an issue of trust. Without trust as a cornerstone, it will be difficult to work through issues and reach a place where all parties feel their interests are being adequately served.
Working together to establish clear expectations and incentives from both your firm and your LPs and creating transparent ways to communicate those details with the right tools can greatly improve your relationship with your LPs.