GPs often forget that without LPs, they wouldn’t have a fund to manage. No fund means no carry, and no carry means, well, let’s not even go there. But it’s a tough job for an LP to pick which GPs are most likely to succeed. Unlike public markets, LPs have access to limited information, which most of the time is manufactured to present the best case anyway.

So how does an LP conduct due diligence on a GP to make their investment decision?

1. Past performance: in public markets you often hear the disclaimer, “past performance is no indication of future performance.” If you watched the men’s snowboarding at the Winter Olympics, you’d probably disagree. Actually, if you look at most things in life, you’d have to disagree. If a PE firm consistently outperforms, through thick and thin, that’s a very good bet. But, people and times change, so it’s important to look at other factors too.
2. Team dynamics: I can’t overstate how important team dynamics are in a fund. You need the team committed, engaged and motivated to do its best work. But more importantly, you want them to care about the success of the fund. LPs wrongly think that giving GPs equity will make them care. We’re not that rational. People care about whatever the heck they want to care about. Visit the team, talk to a sample of people, and ask questions that will gauge their emotional commitment. If GPs aren’t excited and engaged, there’s probably an underlying problem that you won’t be able to uncover in the time allotted.
3. Leadership: any group of people can do amazing work if they’re inspired by a great leader. The group doesn’t need to be intelligent by IQ standards, or have contacts within the industry, or even have a history of performance, as long as they’re inspired. An LPs questioning should test whether the employees think they work for the best people in the industry. Any indication otherwise is a bad sign. Apart from the fact people will jump ship, it shows something fundamentally wrong with leadership at the firm.

You may be wondering why I’ve concentrated on the “soft” aspects of a firm. Why haven’t I talked about education, qualifications, seats on boards of public companies, industry lobbying, etc? It’s for one simple reason. An uninspired and unmotivated team is dead wood, no matter how qualified they are.

I’ve seen it time and time again, qualified people who are absolutely useless because they aren’t engaged. But I’ve also seen engaged novices originate leads, close deals and make a difference, without an ounce of finance experience. That’s why I think it’s important for LPs to focus on team dynamics, leadership and care factor.

Of course, I’m not an LP, so I wouldn’t know what works best, but that’s my take nonetheless.