GPs Hold the Key –

If If the surge in secondary deals has you concerned that an unwanted LP will get into your fund, don’t worry. General partners have the final word on whether the deals get done.

In fact, some firms are now telling secondary buyers that they aren’t welcome unless they are primary investors, meaning the proposed buyer must already be a limited partner in the firm’s fund. This could throw a monkey wrench into the works of some established secondary funds, which may not have the capacity to be active primary investors.

General partners “are getting a lot more strategic about the composition of their investor base,” says Dennis McCrary of Adams Street Partners. “For those funds that are better performing in a better investor space, I think you’re going to see that desire on the part of the GP to have a stable group of LPs who are dedicated to the asset class.”

Some GPs have already indicated that they are very particular about their LPs. Witness Sequoia Capital’s decision to “86” the University of Michigan and the University of California from its latest fund because both LPs had released its performance data to the general public. “Some top-tier funds are already invitation only,” says David Tegeler, an attorney with Testa Hurwitz & Thibeault. “These groups may also consider holding an interest in their funds as a privilege and may not want to extend that privilege to anyone not already on the LP list.”

With these sorts of “members only” only rules, “primary funds are basically forcing people to invest today so they can buy more later [through secondary purchases],” says Ian Charles, a vice president with Cogent Partners, a secondary research and advisory firm. Charles adds that it isn’t common practice – yet. “I’ve seen a couple of buyout funds do it,” he says. “These are large capital buyout funds with managers that have had a lot of turnover and secondary transactions in their predecessor funds.”

At least one secondary investor doesn’t expect the issue to pose a significant problem for the secondary market. “We have seen venture firms do that occasionally – not often, but more often than buyouts,” the investor says. “Almost every GP in this environment is looking for new investors and new relationships. Strong relationships with LPs will win you favor. In a few cases we’ve worked with GPs where they could both satisfy the desires of an existing LP and invited us in as a new relationship in the same secondary transaction.”