For many investment funds launched in 2021 and 2022, fund sponsors are confronting a very different economic reality than when they began their efforts. While projections contained in private placement memoranda and other offering material included assumptions such as historically low interest rates, the Federal Reserve Open Markets Committee has raised interest rates by 525 basis points since March 2022. Tech stocks have crashed and risen again. Commercial real estate faces headwinds in the credit market. It is a very different economic reality than when many funds that are now in the midst of investment periods began marketing to investors.
Last week, the Wall Street Journal highlighted Sequoia Capital's decision to lower the amount of limited partners' capital commitments in two of its tech-focused funds in half. While the decision in one of the funds was driven particularly by the retreat of the cryptocurrency industry since its 2021-2022 peaks, this should not be viewed as unique to tech-focused funds, and it presents interesting issues for fund sponsors that are confronting headwinds in this economic climate.
The Wall Street Journal article also focuses on other investor-relations and government-relations headwinds at Sequoia Capital, namely, a high-profile investment in the failed cryptocurrency exchange FTX and scrutiny from lawmakers over its investment strategies in China. But, in any investment fund where the economic climate has shifted from under the fund's investment thesis, fund sponsors face the challenges of both maximizing their investors' returns and maintaining investor relations.
Fund sponsors have to be aware of what their fund's documents allow when making decisions in light of an economic shift. Delaware limited partnership agreements are considered creatures of contract, and they place contractual limits on what a fund sponsor can and cannot do. If a limited partnership agreement prohibits the sponsor from taking certain actions, even if that action would enhance the limited partners' returns, the sponsor cannot take that action, and the sponsor cannot owe fiduciary duties to take that action. Additionally, a Delaware limited partnership agreement can sometimes incorporate other documents by reference, including a private placement memorandum. When faced with difficult decisions about the management and lifecycle of an investment fund, it is very important to understand what the fund's documents do and do not allow. From the limited partners' perspective, it is important to understand the fund's documents as you monitor the fund sponsor's performance and fiduciary or contractual obligations in this economic climate.
