Effective LP oversight of GP

wso_4's picture
Rank: Senior Monkey | 96

For deals that aren't going exactly as planned, what's an LP to do? I'm curious if anyone has examples of when LP's have had a positive influence on the ultimate outcome of a project, even if they were just pref equity and didn't have much legal standing in the operating agreement. For more experienced LPs, are there specific elements of operating agreements that you require in order to give you some real influence over the GP if the project goes south?

Comments (46)

Jun 7, 2019

As an LP... the answer is nothing. GPs are the biggest pain in the world. 90% of the time, we end up running the deal and working directly with contractors, property managers, etc.

Pretty much paying them for sourcing the deal.

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Jun 7, 2019
Ed Chambers:

As an LP... the answer is nothing. GPs are the biggest pain in the world. 90% of the time, we end up running the deal and working directly with contractors, property managers, etc.

Pretty much paying them for sourcing the deal.

Sounds like you should invest in better GPs

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Jun 11, 2019
CRE:
Ed Chambers:

As an LP... the answer is nothing. GPs are the biggest pain in the world. 90% of the time, we end up running the deal and working directly with contractors, property managers, etc.

Pretty much paying them for sourcing the deal.

Sounds like you should invest in better GPs

Seriously. 90% of the time? Newsflash, buddy - that means you are a shitty LP, not that GPs are shitty.

Jun 15, 2019

Not to pile on but if this happens once, I would never invest with that operating partner again and would make sure to do more to screen GPs and their previous experience in future deals. You should understand exactly what your GP is going to provide to the deal and how they're going to do it before investing, that's one of the most crucial parts of the deal. Otherwise you're just taking GP assumptions as gospel when they pitch you for an equity placement, without having any clue as to how those assumptions will be achieved.

Jun 7, 2019

LPs are generally better at asking questions after skimming reports you send them than they are fixing problems or getting their hands dirty.

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Jun 7, 2019

This seems really suboptimal - the reports only have the info that the GPs want to disclose and there's no real way to have any corrective action, even if there's an issue that's uncovered when you're asking questions about what's in the report. Or are there ways, maybe if you deftly put it into the operating agreement?

Jun 7, 2019

I don't think you're fully understanding the relationship between GP and LP. It really should not be adversarial in any way - you're partners and your interests should be aligned. It should also be perfectly clear what everyone's role is. LPs shouldn't have a positive influence on the outcome of a project at all because that's not their job - that's the job of the GP. LPs should give money, read status reports, stay out of the way, and receive returns.

Ed Chamber's situation is not the norm. It is an incredible responsibility to take a LP's money and use it effectively to deliver the agreed upon (or hopefully better) returns and most, if not almost all, GPs take that responsibility to heart. Your entire professional reputation is staked on it.

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Most Helpful
Jun 7, 2019

Couple points I want to address here as someone who is in senior leadership at an LP (running a portfolio of deals/partnerships) that has since turned GP (directly controlling our deals):

  • GPs aren't very different from other industries - operators aren't different from many other industries in that there are the 10% who do their job extremely well and achieve or outperform business plan projections. The rest will achieve a mixed bag of results and that is part of the business, which leads me to my next point...
  • From the LP perspective, underwriting and choosing the right GP team is the most important thing - to steal from the great Howard Marks, in our experience your due diligence on the partner, not the deal is one of, if not the most important contributor to the success of a deal. The GP's efforts, team dynamic, experience, communication (more on that later) are what are going to make or break a deal (assuming you don't take control). Although a case can be made if you buy something at a big enough discount this can offset this risk it still ultimately leaves you as the LP taking over the deal (not ideal for most LP business models).
  • From the GP perspective, investor communication and expectation management is one of the most underrated skills - Perception and expectation management of your investors combined with communication are one of the most underrated skills of being an efficient GP. Although results trump everything, your management of your investor's expected outcomes (whether it be timing, profit, cost, etc) will set the tone and can change how is a deal is viewed both in real time as well as in the rear view mirror. Over promising and under delivering can be a death sentence.

To give a real world example, I was exchanging war stories with a fellow LP where the straw the broke the camel's back was that neither principal was on the initial leasing calls for a project. Now that might seem petty but the context is that this was this particular group's first deal with young principals building a relatively unique, unproven product. This was combined with several previous key operational blunders but try to picture this from the investor's point of view. These are young owners trying to make their first deal happen and clearly have something to prove yet they don't have the care to be on their team's first leasing call and aren't interested in the results of their newish product? Needless to say the GP got bought out of the deal and I've heard they've been removed from several of their other deals since.

  • From the LP perspective, the only leverage you have is baked into the partnership agreement and aligning incentives - as others have pointed out, once the deal is inked the LP typically has limited control over the outcome. (See previous point - that's why underwriting the GP prior to deal close is so important to protecting risk). The key concept in the previous sentence is once the deal is inked.
    Before you put any money in, you are in a commanding position and you as the LP need to look long and hard at how incentives are aligned in the partnership agreement. This is why this document is so important - it sets the rules by which either side of the partnership "can play". Ideally this is just a piece of paper when all goes well but when it doesn't, this will determine your options for an exit as an LP. Provisions such as buy out clauses, preferred return, catch up clauses, etc all shift power back to the LP if the GP fails to deliver on their business plan.

This is obviously important from the GP perspective as well because you need to understand how much of the deal you control and what your downside looks like. Things such as high preferred returns, catch up clauses, buy out scenarios and even timing of capital contributions (as cited intelligently by others before me) can put you at the mercy of the LP and having to leave a deal that you may want to see through but don't have the financial wear withal to continue.

  • The LP's only other defense, use your gut - get eyes on your partner and assets - the only other defense (if you can call it that) you have as an LP other than above is more of a proactive warning system. Get as much direct exposure and interaction with the partner, their team, consultants and the building as you can. Walk the asset regularly, ask questions, become a real estate student again. The ability to read relationships, interactions and the vibe of the job are invaluable and act as the "canary in the coal mine" for the health of an asset.

This actually is pretty straight forward but assuming you are an out performing individual (many on this site are), ask yourself how you would run the project. Some warning signs include:

  • How much does the leader or team know off the top of their head?

Someone who is really dialed in will know a lot of information about their project because they are intimately involved and/or have prepared well for what questions may come.

  • In a team setting (including consultants, multiple members of the GP team) who answers the most? Do other members clam up? Does it feel like a collaborative environment?

One person dominating the conversation, other members being quiet or "pushed down" May be signs that something may be amiss and is being hidden from you. Real estate at its best is collaborative with everyone contributing ideas and covering loose ends.

  • What does the property look like? Is there litter everywhere? Does there feel like the appropriate activity levels?

This is a timeless construction lesson but it's true - a site tells a lot about the person running it. A clean site typically represents someone who sets the tone, controls their trade and is walking the job regularly to make sure things are running smooth. Trades can sense when the superintendent or owner "doesn't care" and set the tone for how you'll be viewed as well as how they'll act on site. This is why it's so important to walk sites as an owner - everyone knows you are on it and will act as such.

Similarly, if it feels like the site is regularly "dead" your onsite manager is likely not commanding enough respect and isn't controlling the trades where he can get bodies on site when they are needed. The required activity levels will vary for different construction stages but at a certain point you should feel the vibe and buzz of energy and progress.

In the end, others are correct that this should be a partnership - you are collectively working towards a common goal and need to bring respect, care and professionalism to the table if the project and relationship are to thrive. That being said, each side must do their part to protect their side so that any exit can be as smooth and painless as possible. Remember to always trust but verify.

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Jun 7, 2019

+1 SB - this is very good. Lot of good content in this thread but this is the kind of stuff that makes this site such a valuable resource.

Jun 7, 2019

Really great information here.

Jun 7, 2019

+SB thank you, your insights are always so good.

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Jun 8, 2019

Thanks for this, its exactly the kind of insight that I was hoping for when I asked the question. Agree that its best to do thorough DD of the GP before you sign the partnership.

You give some great examples of observations you want to make as an LP - interaction with gc, subs and trades, general site conditions, etc. Any more examples of what an LP can do when those indications point negative? Aside from the LPs buying out the GPs, have you seen anything else? I suppose the LP could take a more active role and encourage addressing some of those issues observed - like improving the relationship with the trades, encouraging the placement of an engaged site manager, etc.

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Jun 11, 2019

I'm glad you asked because this brings up an important cautionary boundary I forgot to address above - the role of managing member and the risks of overstepping as an LP.

Although many are tempted to do so, an LP has to be very careful about what steps they take when helping an underperforming GP. This is because the GP is the managing member and in most agreements they make almost all the decisions to execute on the agreed upon Business Plan. This is important in that if the LP gets too involved in critical ways that impact the GP's ability to execute then when the LP goes to eventually remove the GP, the GP may be able to sue or make the case that they were limited by their partner to execute the terms of the agreement and deserve to stay on/remain involved. As you could imagine this could lead to a worst case scenario of a really prolonged fight between partners but when groups are involved in a particularly large/important deal relative to their company's future they will fight as long as they can.

It is worth noting that most partnership agreements handle Major Decisions differently with examples including sale of the asset, replacement of the property management, new financing, etc. These are typically structured through some kind of vote by the partners but ultimately it really means the LP has final decision in the end because they often hold majority of the "shares" (equity).

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Jun 11, 2019

Great write-up. I want to elaborate on your discussion concerning who has the leverage in the deal as it relates to the example you provided: young principals trying to get off the ground.

It has been my experience on the both the sell side and buy side that young funds/principals are aware they are playing the AUM game and at some point during Fund I, their attention turns from acquiring/managing the asset (prior to planning for exit) to raising Fund II. I am presently in such a situation. While we have operated efficiently and with a high degree of autonomy from our LPs, our anchor investor has indicated that they will not release more capital (for a Fund II or tack-on commitment for Fund I) until a meaningful portion of our assets have been divested. To me, and to other young GPs, this is truly frightening because this particular LP being our largest commitment, we feel that we cannot solicit new investors for Fund II for fear of burning a very valuable bridge as we will need this whale as "proof of concept". Hence, the leverage in the deal goes beyond just a single fund when dealing with large LPs, especially concerning new funds who need to fund raise at a faster clip.

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Jun 11, 2019

Appreciate this, really good point - I didn't round that out and emphasize it enough in my initial write up. In the end, assuming normal partner conditions/agreement the LP ultimately holds all the power.

Even with a buy sell clause, the LP typically has more financial resources and can execute better/quicker to remove or replace the GP as needed. The main downside for the LP is they don't usually have the local knowledge/relationships as well as the operational horsepower to take over an asset that is not stabilized.

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Jun 12, 2019

This is a fantastic post. Probably one of the best I've seen on these boards.

We've had LPs hire construction managers/owner's reps to oversee the GC, but generally that's to our benefit anyway. There's definitely a bit of an administration/PITA tax, but whatever.

My relationships with LPs have been almost entirely positive, even when shit is hitting the fan. We've even had some offer to open their checkbooks to help spend our way out of problems. Obviously, that affects the IRR/our promote but big picture it helps all of us.

Any reasonable LP will recognize that all projects will hit road bumps. If the GP is engaged, transparent, and honest about what's going on they will 9/10 be understanding.

The LP/GP relationship is symbiotic, not antagonistic. LPs bring the money and GPs bring the knowledge/expertise. Both will fail if they don't cooperate toward the common goal.

Earlier on in my career I felt that LPs and were the big scary hammer/know it alls in the room and I had to cow tow to everything they said. Turns out, LPs know relatively little about real estate/development/construction and more about how/where to place their capital as efficiently as they can. Similarly, I know relatively little about how to place capital and I certainly don't have the relationships with the big institutions.

The broken record plays again = relationships, relationships, relationships.

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Jun 13, 2019

The best ways to ensure a unseasoned GP works tirelessly to deliver is to (a) subordinate their return of capital and, if it applies to the structure, preferred return and (b) pay out as much of the development fee as possible after final CO.

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Funniest
Jun 13, 2019
InVinoVeritas:

pay out as much of the development fee as possible after final CO.

stop it

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Jun 17, 2019

We need that fee to pay people to build the building!

Jun 9, 2019

Our consulting firm got thrown into the middle of a GP/LP fight, it was expensive. The LP hired us as a 3rd party to investigate excessive GP fees after a deal went bad. The major LP complaints were that PM, AM and development fees were excessive. Our analysis in a nutshell was that while the fees were less than market, the GP had been too aggressive on assumptions of the deal. If the LP had done better DD, this mess would not have happened. The GP is a well known firm but promised the moon for a less than stellar deal. Both sides lost money and my understanding is that our fee was just a start of the pain.

Jun 10, 2019

Cool gig. Without giving too much away, how do you price your services/scope of work?

Jun 13, 2019

So the LP contractually agreed to certain fees and then they whined about it after the deal went south? Sounds like an LP competence issue to me...

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Jun 11, 2019

Currently in a deal that the GP has completely fucked up. Myself and the other LPs made the mistake by agreeing to not have any ability to take over the deal. GP won't sell and cut our losses; instead, he's loading us down with carry costs each month as he tries to scheme his way into a profit. Total disaster.

Key is to make sure that there is some sort of mechanism for LPs to take over should GP demonstrate gross incompetence.

Jun 11, 2019

Sounds like you should fire your lawyer.

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Jun 11, 2019
Danielplainview:

Sounds like you should fire your lawyer.

And whomever picked that GP.

The horror stories in this thread are shocking. Obviously deals go south, but the amount of "My GP is a complete moron" posts blow my mind - if there are really that many incompetent people out there sourcing money and getting deals together, it just gives me hope for my future. If it's that easy...

Jun 13, 2019

.

Jun 13, 2019

Half of my job on the LP side consists of finding where GP is hiding internal overhead in draws and making sure we don't fund it. It also involves consistently bugging them to send us all critical reports, show proof of receipts for deal costs, and ensuring they are watching the general contractor like a hawk.

Jun 13, 2019

Marx Okubo.

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Jun 13, 2019

Thanks, I am going to reach out.

Jun 15, 2019

The implications of the responses on this thread make me scared for the next downturn, whenever it should come. Seems to be a lot of dumb LP money from smaller shops throwing high-rate Pref and Mezz on top of senior debt to take projects to 85-90% leverage. It works for a while, as long as its a bull market and prices, rent, employment and consumer optimism go up, up, up. Something tells me a lot of small-time LP investors doing deals with inexperienced GP's, that are rushing to take advantage of cheap debt, are going to take a high, hard shot to the balls in the next few years.

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Jun 17, 2019
LReed:

The implications of the responses on this thread make me scared for the next downturn, whenever it should come. Seems to be a lot of dumb LP money from smaller shops throwing high-rate Pref and Mezz on top of senior debt to take projects to 85-90% leverage. It works for a while, as long as its a bull market and prices, rent, employment and consumer optimism go up, up, up. Something tells me a lot of small-time LP investors doing deals with inexperienced GP's, that are rushing to take advantage of cheap debt, are going to take a high, hard shot to the balls in the next few years.

Hahah they make me excited. A lot of idiots means a lot of busted deals, which means a lot of opportunity for better investors/GPs to buy assets at a relative discount.

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Jun 17, 2019

Yeah, permitted you got the cash and aren't one of the chumps losing dough, it could be a lot of fun. I've only ever seen bull-market real estate and even I'm starting to look at some of the allocations on deals we look at and go WTF. People are buying apartments in Jack-Off, Alabama for mid five caps and investors are taking them up to 90% leverage for it.

Jun 17, 2019
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