- How Limited Partners define and evaluate risk in Private Equity

Abstract

Limited Partners (LPs) have a limited liability in the Limited Partnership Agreement (LPA) when investing into Private Equity (PE). However, due to their limited liability, LPs face different risks and have to manage and evaluate these risks differently due to the low transparency contributed from the General Partners (GPs). This research paper used a qualitative approach, with usage of a questionnaire, to expand on the research question. The research question aimed to expand on the subject on how LPs define and evaluate risk. The findings indicated that there are some common definitions and evaluations between LPs§, meanwhile there are some indications of different definitions and evaluations. The overall definition of LPs risk in PE indicates that the risk is very closely related to the return and past performance of GPs. Also, the overall highest risk is associated with the early years of the funds lifetime if the investments made in the early years are successful later on. In case the investments do not meet expectations, the highest overall risk is associated with the last years of the fund’s life, where the capital risk (realization and performance risk) is highest. The overall evaluation of LPs risks showed indications of market risk being the risk which is toughest to manage, meanwhile all other risks were easier to manage in a portfolio compared to each fund by itself. A complete illustration of LPs risks is defined in this research paper along with an illustration of how risks evolve inside a PE fund from the LPs perspective.