Is the LP-GP Relationship in Venture Capital Broken? How Short-Termism and Risk Aversion are Destroying Trust and Undermining Returns.

The world of venture capital (VC) is dynamic, fast-paced, and always evolving. As entrepreneurs and innovators continue to disrupt traditional industries, the need for capital to fuel their growth has never been greater. While venture capital firms play a crucial role in providing funding to early-stage companies, the relationship between general partners (GPs) and limited partners (LPs) can be complex and fraught with tensions. In this article, we explore two common areas of tension in the LP-GP relationship: short-termism and risk aversion. We delve into how these tensions can erode trust between the two parties, potentially leading to missed opportunities and underperforming portfolios.

As the venture capital industry continues to evolve, the relationship between general partners (GPs) and limited partners (LPs) is becoming increasingly complex. While GPs are expected to act in the best interests of their LPs, there are instances where LPs themselves may engage in activities that erode the trust of GPs, resulting in a breakdown in the relationship.

Focus on Short-Term Gains in a Long Game

Venture is a long-term game, especially if you are in the business of deeptech. It takes time to commercialise, scale and exit a patent-backed company. One of the main areas of challenge can be that of an LP who is overly focused on short-term gains. This can result in pressure on GPs to make hasty investment decisions that may not be in the best long-term interests of the portfolio. When GPs feel this pressure, it can lead to suboptimal investment decisions that harm the portfolio as a whole.

3 key takeouts here:

1. LPs who are overly focused on short-term gains can put pressure on general partners (GPs) in deeptech venture capital (VC) to make hasty investment decisions that may not align with the long-term growth trajectory of the portfolio companies.
2. A deeptech VC fund is focused on long-term growth, which means that investments may take years to bear fruit. LPs who are not willing to wait for these long-term returns can disrupt the GP's investment strategy and potentially harm the overall portfolio.
3. It is essential for LPs to have a clear understanding of the investment strategy of a deeptech VC fund, including the timeline for returns and the risks involved. By focusing on the long-term potential of the portfolio companies, LPs can help ensure the success of the fund and generate significant returns in the future.

Risk aversion

Another area of concern is LPs who are overly risk-averse. While GPs are expected to take calculated risks, some LPs may be overly cautious and unwilling to take the necessary risks to generate the desired returns. This can result in missed opportunities and an underperforming portfolio.

Venture capital is a high-risk, long-term asset class, and risk aversion can be a significant source of conflict between limited partners (LPs) and general partners (GPs) in this industry.

3 key takeouts here:

1. LPs who are overly risk-averse can undermine the investment strategy of a VC fund. While GPs are expected to take calculated risks to generate returns, some LPs may be unwilling to take the necessary risks to achieve these returns. This can lead to missed investment opportunities and an underperforming portfolio.
2. In deeptech VC, where investments often take years to bear fruit, risk aversion can be particularly problematic. LPs who are unwilling to take a long-term view on investments may pressure GPs to make short-term decisions that do not align with the long-term growth trajectory of the portfolio companies.
3. To mitigate this conflict, it is essential for LPs to have a clear understanding of the investment strategy of the VC fund and the risks involved. GPs can also work to provide transparent and comprehensive information about the portfolio and the investment process, helping to build trust and confidence with their LPs.

In summary, risk aversion can be a significant source of conflict between LPs and GPs in the VC industry, particularly in deeptech VC where long-term investment strategies are essential. To overcome this issue, LPs must be willing to take calculated risks and have a clear understanding of the investment strategy, while GPs must provide transparent and comprehensive information about the portfolio and investment process.

Furthermore, some LPs may engage in activities that undermine the fiduciary duty of GPs. This may involve attempting to exert undue influence over investment decisions or attempting to circumvent the established decision-making process.

These activities can erode the trust that GPs place in their LPs and can ultimately result in a breakdown in the relationship. When GPs feel that their LPs are not acting in their best interests or are engaging in activities that undermine their fiduciary duty, they may be less likely to work with those LPs in the future or may be less willing to take on new LPs.

To address these concerns, LPs must recognize the importance of building trust with their GPs. This may involve being transparent about their investment goals and expectations, providing the necessary capital and resources to support the portfolio, and respecting the fiduciary duty of GPs.

The relationship between GPs and LPs is one of mutual trust, and it is up to both parties to maintain that trust through open communication, transparency, and a shared commitment to long-term success. By doing so, they can build a strong and sustainable venture capital industry that benefits everyone involved.

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About the Author

Leesa Soulodre is the General Partner of R3i Capital, a global sustainable development venture capital fund investing in climate change adaptation and the transition to value-based healthcare. Reach out if you would like to learn more about our mission in the R3i Future Fund.

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