Dear SaaStr: What Risks Do Limited Partners in VC Funds Face That General Partners Do Not?
Limited Partners or “LPs” are the folks that give the VC partners (the “General Partners”) the actual money to invest. There are many types of LPs, but the vast majority of the money comes from large endowments, non-profits, and sovereign wealth funds. Folks with billions and billions to invest over the long term.
A few LP risks in a VC fund:
- A risk the General Partners make significant money, but the LPs do not. This is an inherent risk in the fee structure of VC funds. About 20% of the fund goes to the GPs as “fees”, even if the fund does not return any capital. This happens somewhat frequently.
- A risk they can’t stop funding a fund they’ve lost confidence in. LPs don’t fund 100% of their commitment up front, they fund it over many years. If they lose confidence in the GPs and stop funding, they can lose 100% of their investment.
- A timing risk in capital calls. GPs call capital to get it. LPs fund that capital. LPs model out a pacing here for all their managers and GPs, but can get caught if everyone asks for their cash at the same time. Especially if the rest of their assets are less liquid than planned.
- A general risk of not understanding underlying fund performance, and of performance being overstated. Especially at smaller and earlier-stage funds, the nominal value of the investments has a lot of discretion to it. The assets may not really be worth what the GPs say.
- Team risk in GPs. There is a fair amount of partner turnover at VC funds. As an LP, you have very limited say here other than some “key man” provision clauses.
You sort of have to Hope and Pray a bit as an LP. This is one of many reasons LPs tend to “re-up” and concentrate in proven managers.
(LP-GP image from here)
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Jason Lemkin, Khareem Sudlow
