Beezer Clarkson: Are LPs Open for Business & Why Do LP Incentive Mechanisms Need to Change? | E1073

Fund Size Trends and LP Behavior

• LPs are becoming more selective and are writing smaller checks (e.g., $20–$25 million) rather than the $100–$150 million checks required for large vehicles.
• There is a market shift away from billion-dollar funds and sub-$100 million micro-funds, with capital concentrating in the $300–$700 million "Goldilocks" bracket.
• Some LPs have "pre-spent" future budgets during the 2020–2022 bull market, creating liquidity strains that slow current deployment rates.
• Net new manager fundraising has dropped significantly, with fewer funds raising capital compared to the previous peak.
• Many LPs are reducing fund commitments by 10% to 40% or skipping years entirely, though skipping top-tier managers risks blacklisting.

Portfolio Construction and Power Laws

• Pesar emphasizes that early-stage funds cannot achieve outperformance (3x+) without at least one company returning the full fund size (a "power law" driver).
• Early-stage funds relying on "onesies and twosies" (multiple 2x–3x returns) have not historically outperformed funds with a home run.
• LP portfolios are often over-diversified (300–500 underlying companies across 10 managers), whereas some LPs prefer overlapping managers to capture upside in specific areas.
• Sapphire Partners divides its portfolio by Consumer vs. Enterprise; Enterprise offers consistent exits, while Consumer offers "big spikes" (e.g., Coinbase, Peloton).
• LPs are increasingly skeptical of large IPOs like Robinhood and WeWork, noting that early-stage models do not guarantee sustained public market success.

Liquidity, Valuation, and Market Timing

• IPO windows are not expected to open until the second half of 2025, extending the illiquidity cycle similar to the post-2000 correction.
• The gap between TVPI (Total Value to Paid-In) and DPI (Distributions to Paid-In) is predicted to be the widest since 1999–2000 due to stalled exits.
• Secondary market discounts are reaching 80%, though a consensus between buyers and sellers on price remains a challenge.
• LPs are advised to discount GP valuations by an additional 20–25% due to valuation ambiguity, as GP mark-ups may not reflect realistic exit values.
• There is increased pressure on GPs to sell partial positions in breakout companies (e.g., 10–20%) to generate DPI for future fundraising, despite LPs' desire to hold winners long-term.

Manager Performance and Fundraising Dynamics

• Only 17% of funds successfully raise from Fund 1 to Fund 4, highlighting high breakage rates in the emerging manager space.
• Institutional LPs often avoid new bets on managers in Fund 1–2 due to a 50% breakage rate between Fund 1 and Fund 2.
• "Opportunity funds" are being "unstapled" (separated) from core funds by LPs to manage risk and alignment.
• Management fee structures are under scrutiny; stacked funds (e.g., billion-dollar core funds plus opportunity funds) allow GPs to earn millions in fees without returning capital, creating potential misalignment.
• GP commitment minimums of 30% are viewed as an unnecessary barrier to entry, though some LPs accept higher fee percentages for smaller funds covering overhead.

Specific Events and Future Outlook

• CalSTRS Partnership: Sapphire Partners has been appointed as the early-stage venture specialist for CalSTRS, the world's largest educator pension fund, deploying capital into US emerging managers (Funds 1–3).
• IPO Prediction: Interviewer predicts IPO windows will reopen in H2 2024, while Pesar predicts H2 2025 based on data breaks (e.g., Stripe) being insufficient to crack the IPO market.
• Market Outlook: The industry is currently "bumping along the bottom" but is expected to recover eventually, returning to a more traditional venture model.
• Strategic Advice: Emerging managers are advised to avoid "growth equity mindsets" in early-stage funds, as high ownership and big swings are required for 5x–10x returns.
• LPA Critique: Pesar notes the Limited Partnership Agreement (LPA) is often a confusing legal document rather than a useful tool for relationship management.