LP Transparency Needed

The Shifting Dynamics of Venture Capital and LP Transparency

Over recent years, the abundance of capital available to startups has altered the power dynamic, increasingly favoring founders. This shift is evident throughout a startup’s development, influencing term sheets in early funding rounds and even public listing agreements.

However, one area has remained largely unchanged: the anonymity surrounding a fund’s limited partners (LPs). Venture capitalists (VCs) seldom fully reveal the identities of their LPs, even to the founders they have invested in.

Both LPs and VCs possess motivations for maintaining confidentiality. Nevertheless, I anticipate a change in this practice if these justifications become insufficient.

In my assessment, the primary catalyst for this shift will be pressure from founders.

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As competition intensifies for promising investment opportunities, VCs are compelled to actively attract founders. In this evolving landscape, the traditional model of extensive founder due diligence without reciprocal inquiry appears increasingly obsolete.

Entrepreneurs, when given the opportunity, are likely to inquire about the fund’s LPs.

Lolita Taub, a general partner operating in stealth mode, highlighted founders’ concerns by questioning her Twitter followers about the feasibility of identifying a fund’s LPs. Unfortunately, a definitive answer remains elusive.

While some entities, such as public pension funds and nonprofit organizations, openly disclose their investments, the majority of this data remains fragmented and accessible only through exclusive platforms like PitchBook and Preqin.

Taub further emphasized a crucial point: the tech industry does not operate in isolation. She posited the need for a publicly accessible database to identify the sources of investment capital, tweeting, “There should be a public investor background check site that lets us know who we’re taking money from.”

In an age defined by “know your customer” protocols and offender registries, both founders and general partners (GPs) may desire insight into those providing the funds.

A recent, albeit limited, survey conducted by Taub suggests that this information would influence investment decisions.

Although Taub’s survey may be subject to bias, it demonstrates a clear level of interest in LP transparency.

Are these responses simply aspirational when capital is readily available? Perhaps not. The example of Endeavor returning a $400 million investment from Saudi Arabia following the murder of Jamal Khashoggi illustrates a willingness to prioritize values over financial gain.

Furthermore, capital is not currently scarce; the focus is increasingly on selecting investors aligned with a company’s principles rather than foregoing funding opportunities.

This brings us back to the central question: How can one ascertain the origin of funds when they are channeled through an intermediary?

Drawing from my experience as a millennial, I recall a time when individuals routinely cautioned each other about specific entities. As a journalist, I’ve also observed instances where VCs or founders who have engaged in questionable behavior have quietly transitioned to roles as board members or LPs.

However, access to these informal networks is not universal, suggesting that a move towards greater transparency is warranted.

Increased transparency regarding LPs would also benefit emerging GPs. Securing funding presents a significant challenge for solo VCs, particularly those lacking established connections, and greater access to information about potential investors could help level the playing field.

Beyond founders and GPs, LPs themselves could derive advantages from increased transparency. While there are both benefits and drawbacks, this explains the resistance primarily originating from LPs.

Some LPs legitimately prefer to remain anonymous. For instance, high-net-worth individuals and family offices may be concerned about potential security risks, such as kidnapping, particularly in regions like Latin America.

However, LPs encompass a diverse range of entities, and some stand to gain more than they risk by disclosing their identities. Elizabeth “Beezer” Clarkson of Sapphire Ventures recently shared insights on the LP perspective for 2022 via a Twitter thread.

“Sharing the LP perspective” is the core mission of #OpenLP, a crowdsourced initiative launched by Sapphire Partners in 2015 and led by Clarkson.

“VCs and entrepreneurs are eager to understand the thinking and operations of ‘the money behind the money,’ which has historically been relatively opaque. The desire to hear more from LPs is evident, and consequently, the #OpenLP movement has grown substantially,” Sapphire stated in a blog post last August.

Greater LP transparency can manifest in various forms, including high-level commentary. “Venture investors and entrepreneurs need to understand how ‘the money behind the money’ thinks and operates,” Clarkson wrote.

The practice of directly connecting LPs with portfolio companies is already occurring. Many venture capital funds host annual LP Days, resembling Demo Days but with even stricter access controls. Portfolio founders present their ventures, and attending LPs can pose questions.

I anticipate that startups will increasingly request invitations to LP Days as part of their due diligence process, even before finalizing a deal with a VC. We expect founders to proactively inquire about LPs during investor evaluations.