How is commitment risk defined in the context of LP investing?

• A. As the risk of over-investing in multiple funds
• B. As a situation where an LP may default due to insufficient funds to meet capital calls
• C. As the risk of not finding investment opportunities
• D. As the uncertainty in fund performance

Answer: (B)

In the context of limited partner (LP) investing, commitment risk refers specifically to the potential for an LP to default on their obligations due to insufficient funds available to meet capital calls. When LPs commit to a private equity or venture capital fund, they are typically required to provide capital as needed over the life of the fund, rather than upfront. If an LP cannot meet these capital calls when required—possibly due to unforeseen financial circumstances or cash flow issues—they risk defaulting on their commitment. This default can have significant implications for both the LP's relationship with the general partner (GP) and the fund's overall ability to achieve its investment objectives.

Understanding commitment risk is vital for LP investors, as it underscores the importance of maintaining adequate liquidity and the ability to respond to capital demands from the funds in which they have invested. Ensuring that there are sufficient resources available to meet capital calls helps maintain the integrity of the investment process and preserves the LP’s standing within the fund.