Involve your investors

The orderly sell-off of various Lehman Brothers private equity assets has included one overriding feature GPs across the industry should carefully note - the inclusion of limited partners in decision making.

Bankrupt investment bank Lehman Brothers officially spun out its merchant banking funds last week as Trilantic Capital Partners, an independent firm that will have $3.3 billion of capital under management and a $2.6 billion fund, Trilantic Capital Partners IV, with $1.7 billion in dry powder.

The move was by no means a surprise to the several hundred limited partners in Lehman's merchant banking funds. Since Lehman's bankruptcy filing in September, a special LP advisory committee was formed that met almost weekly and even hired advisory group StepStone Group and law firm Kirkland & Ellis to ensure their interests were best looked after in the asset auction process. The LP committee was informally charged with helping set the course for the merchant banking group going forward.

“We didn't think that presenting the LPs with one option and one term sheet without giving them a chance to speak up was the way to go,” a Lehman source told PEO in December.

By actively engaging LPs in the process, Lehman learned their concerns and took them to heart. Some investors wanted to cut commitments, and so Lehman offered them the option to reduce unfunded commitments by up to 25 percent in its $3.3 billion Merchant Banking Fund IV. Some LPs took the cut, and others decided to stay fully committed.

Many LPs decided to stick with the Lehman funds not just because of confidence in the management group – illustrated best by the large majority approval LPs gave the spin-out in March – but also because of the open and frequent communication the GPs waged with investors.

The same can be said for its venture arm, which rebranded as Tenaya Capital, and took with it all the LPs in the $365 million Lehman Brothers Venture Partners V.

Lehman's situation is unique, of course – most captive groups do not spin out because their parent has gone bankrupt and subsequently sent shock waves through the global financial system. But as various LPs and GPs confront their own forms of crisis in this changing economic landscape, a lesson is to be had in the way that Lehman openly engaged with its investors and gave them a prominent seat at the bargaining table.

Limited partners make or break private equity; they are the heart of the industry, and their capital, the lifeblood. When crisis hits, GPs must go above and beyond the standard levels of engagement with investors and include them in major, firm-changing decisions. In return, they should be rewarded with loyal LPs who remain committed to their funds.