Key Players in the Private Market Ecosystem

For any transaction to go through, we need at least two parties. If there are no buyers, for instance, there will be no sellers and the entire premise of a market will be null and void.

In the public markets, especially in the secondary ones, it is very easy to identify the parties involved. There is a buyer who wants to invest their money in a particular asset. There is also a seller who wants to sell off a specific asset.

Take the stock exchange, for example. Buyers and sellers submit their price bids and whenever there is a match, the sale of shares takes place.

In the private investment space, however, things are slightly different. Of course, the main premise of buyers and sellers still stands. But that is where the similarities end.

In this module, we’re going to take a deep dive into the key players in the alternative investment ecosystem. From the GPs and LPs to the fund managers, from the institutional investors to the involvement of SEBI, we will cover it all.

This chapter will be dedicated to understanding the role of General Partners and Limited Partners.

Quick Recap:

• Private markets allow investors to invest in assets just like the regular stock markets. However, these markets are not open to the public. Hence, the buying and selling of these assets is privately executed instead of being conducted on public stock exchanges.
• These markets allow investors to invest in a variety of alternative assets including startups in different stages of maturity.
• These markets are suitable for high-net-worth individuals and institutional investors since the quantum of investment is heavy.
• Liquidity in private markets is relatively lower than in regular financial markets. This is because there are no standardised contracts and each investment activity has to be finalised manually. Also, the lack of easily obtained information and the fact that these are long-term transformative investments adds to the illiquidity.

Before we delve into who general and limited partners are in the context of private markets, we must understand which assets are traded in private markets.

Private markets allow investors to invest in varied assets like private debt, private equity, real estate, and private infrastructure, among other asset classes. This means these markets can offer every asset that investors trade in the public markets. The only catch is that every trade in these markets is negotiated off-exchange between the company and the investor.

General partners and limited partners are the people behind the steering wheel of private market assets and investment funds.

Why?

This is because the latter provides the funds needed to operate a private equity or venture capital fund while the former manages the assets in a fund!

Let’s understand this in more detail.

General Partners

General Partners (GPs) make crucial decisions about the investment portfolio to ensure investors receive worthwhile returns that meet their expectations. They are in charge of capital allocation based on extensive market research and business analysis.

This means GPs are the ones who set up the private market funds. Investors add their capital to these funds because they want the GPs’ expertise to help maximise their returns.

After all, investing in the private space is not the same as investing in the public markets, is it?

You can’t really find the details of all the investment opportunities on the internet. There is no public disclosure about the performance of companies and not a lot of benchmarks that you can use.

GPs safeguard the financial interests of the investors. They attract and onboard limited partners and other investors looking for high-risk, high-growth investment opportunities.

Roles of General Partners

• Fundraising: GPs are responsible for raising capital to create the fund. They identify potential investors and negotiate terms to secure funding.
• Deal Sourcing and Execution: GPs actively conduct due diligence, negotiate deals and make investment decisions on behalf of the fund. They use their expertise to identify promising assets and manage the investment process.
• Portfolio Management: After making investments, GPs take an active role in managing the value of the portfolio companies or assets. They may sit on the boards of these companies and provide strategic guidance to maximise returns.
• Fund Administration: GPs handle the administrative aspects of the fund, including compliance, reporting and distribution of returns to LPs.

Examples of General Partners:

Peak XV Partners (formerly Sequoia Capital India & SEA) is a leading venture capital firm that focuses on technology and growth-stage investments.

Role: As a GP, Peak XV Partners actively identifies, invests in and supports promising Indian startups. They provide both capital and strategic guidance to help these companies grow.

Example: Peak XV Partners (then Sequoia Capital) invested early in companies like OYO, Byju’s, and Zomato, helping them scale and achieve significant success in the Indian market.

Limited Partners

Limited Partners (LPs) are the investors who contribute capital to private investment funds like private equity, venture capital, real estate and other alternative asset classes. LPs include individuals, institutions, organisations, and even pension funds or university endowments.

If we were to compare it with the public investment space, LPs would be akin to normal investors. Just like we look for good mutual funds and then invest our money for the long term, Limited Partners look for good private market funds to deploy their capital.

Roles of Limited Partners

• Capital Providers: LPs commit capital to the fund, which is then used by GPs for investments.
• Risk Management: LPs use private investments to diversify their portfolios and manage risk, as private assets can have a low correlation with public markets.
• Due Diligence: LPs conduct due diligence before committing to a fund. They assess the track record, strategy, and expertise of GPs to ensure that their investments align with their financial goals.

Types of Limited Partners

• Individuals: Individuals invest in private equity or venture capital funds, often through fund-of-funds or directly, to diversify their investment portfolios.
• Institutions: Institutions like pension funds, university endowment funds and insurance companies often allocate a portion of their assets to the private markets.
• Family Offices: Family wealth management offices may invest in private markets to create investment strategies for their financial goals.

Examples of General Partners:

Life Insurance Corporation of India (LIC) is one of the largest life insurance companies in India.

Role: LIC acts as an LP, investing in private equity and venture capital funds to diversify its investment portfolio and generate returns for policyholders.

Example: LIC has invested in various private equity funds in India, contributing to their capital base. These investments allow LIC to participate in the growth of Indian businesses and access alternative asset classes to achieve its financial objectives.

In fact, after LIC’s portfolio allocation reached a 16-year low of 14.9% in 2019, it has been rising!

Every business endeavour requires insight and judgement. An investment strategy must check all the right boxes when it comes to wealth creation, and only professionals can bring these objectives to fruition. The same applies to private markets, too, as the private market landscape is challenging to navigate.

In short, this means not everyone can become a General Partner.

To become GPs, individuals should have expertise in a specific area, like real estate or private equity, and sufficient capital to invest. They need a clear investment strategy and must comply with legal and regulatory requirements. GPs are also responsible for raising capital from investors and must manage investments effectively.

Let’s take a look at the skills that GPs require in venture capital and private equity.

Venture Capitalists are often at the forefront of innovation and entrepreneurship. They need a keen eye to spot talented founders and the potential in early-stage companies. Understanding the fluid nature of startups, VC GPs are comfortable with businesses that are still finding their footing and shaping their strategies.

An ideal VC GP is part mentor and part strategist, providing a supportive yet critical voice to help founders refine and grow their ideas. This role often benefits from personal entrepreneurial experience or training within a VC firm. Additionally, a strong network within the VC ecosystem is essential, not only for deal flow but also for offering valuable connections and resources to burgeoning companies.

In contrast, Private Equity GPs operate in a different arena, dealing primarily with late growth stage or mature companies. Their expertise lies in meticulously analysing a business to pinpoint areas needing improvement, such as finance, marketing, or supply chain management.

PE GPs must possess the experience and connections to facilitate these necessary transformations. They are adept at recognising the key attributes that will attract buyers and drive up valuation, like revenue size, growth trajectory, market share, and ESG compliance. Creating and executing a strategic plan to shape the company into an attractive acquisition target is a core part of their role. Prior experience that proves advantageous in this field includes senior corporate roles, consulting, and time spent in a well-established PE firm.

According to McKinsey’s Private Market Review, the global private markets boasted an AUM of US$11.7 trillion in 2022! This means that even though the flow of deals has slowed considerably since 2021, there is still a lot of potential in the alternative investment space.

Source:https://www.mckinsey.com/industries/private-equity-and-principal-investors/our-insights/mckinseys-private-markets-annual-review

It is important to note, however, that this space is still challenging to navigate for individual investors.

A September 2023 NASDAQ report talks about how financial market regulators, governments, and companies are keen to increase the access of retail investors. The number of LPs will soon become much higher as more individuals get access to VC and PE funds. However, retail investors will need to secure the tag of an ‘accredited investor’ to buy stocks of the companies trading in private markets.

Though the private market investment trend began gaining traction primarily in the US, experts expect it to steadily become popular across markets around the world. So does that mean private market democratisation is on the horizon? It might well be!

Retail investors can potentially benefit from trading in private markets. Before it happens, though, some key changes are required. These are:

• Improve access by finding ways to lower the minimum amount of capital required to invest in PE/VC funds. One way to do this is through using vehicles which pool the capital of many individuals. Another is greater incentives for individuals to become accredited investors which lowers the minimum commitment amount.
• Make compliance with regulations easier through the use of tech to help onboard investors.
• Improve investors’ knowledge and understanding of private markets so that they are better able to make good decisions that are suited to their needs.