LP Corner: Thoughts on GP Commitment5/13/2017 4 Comments This is one of a series of posts on fund terms. Other posts include:
Private equity funds (buyout, venture capital and growth equity funds) are typically structured as limited partnerships, which have two types of partners: limited partners, or LPs, which are passive investors in the fund; and a general partner, or GP, which is the manager of the fund. As I evaluate funds, one of the fund terms that receives special attention is the amount of money the GP will commit to the fund - which is called "GP Commitment", "GP Capital Commitment" or "GP Commit." To read more, please click "Read More" to the lower right. The GP capital commitment is made by the firm and/or individuals that own the GP. Historically, this GP commit was 1% of the total committed capital of the fund. For example, if a fund raised $100 million, $1 million of this would come from the GP commitment and $99 million would be from the investor LPs. To understand why GP commitment is so important, a little background on agency theory is in order. Agency theory explores the relationship between a principals and agents in an enterprise, and the problems that can arise. In private equity, the LPs are the principals and the GP is the agent. In private equity funds, the GP has pretty much unfettered control over the management of the fund, and LPs have limited visibility into the management of the fund. In fact, by law, LPs must be passive investors in the fund and cannot be active participants in the management of the fund, or there may be some very unhappy tax and legal consequences. Because of the control GPs have in the fund, they will be incentivized to maximize the cash flows the GP will receive, often at the expense of the LPs. If however, the GP (and the owners of the GP) invest a meaningful amount of How much should the GP commitment be? As mentioned above, it was historically 1% of the committed capital of the fund. However, to me the GP commitment must be a "meaningful amount of the investable assets of the owners of the GP." Let's look at two examples to put this in perspective. Example 1. Fund 1 is raising $100 million. The fund will be managed by two partners, who own the GP of the fund. The GP commit will be 2% of the fund, or $2 million. These partners are young, capable and smart, but they don't have a lot of money. Partner A has investable assets (think of net worth less primary residence and other illiquid assets) of $3 million. Partner B also has investable assets of $3 million. Each will be responsible for $1 million of the GP commit. In this case, the GP commitmentrepresents 33% of each partner's investable assets. That's meaningful. Example 2. Fund 2 is also raising $100 million, and the fund is also managed by two partners who own the GP. The GP commit will be 2% of the fund, or $2 million. The partners are also young, but both have become billionaires from an early venture capital company they founded and took public. Each partner is responsible for $1 million of the GP commit. As both GPs are billionaires, a $1 million share of the GP commit represents 0.1% of their net worth. That's not meaningful. Each fund will be different, and so the amount of the GP commit must be evaluated on a case-by-case basis. Who is the GP? An additional consideration is "who is the GP" for purposes of the GP commit. Some private equity groups allow investment personnel and/or staff to participate in the GP commit. When I evaluate GP commit, I look at the contributions from the core investment team of the fund, and expect the contribution from these individuals to be meaningful. A 5% GP commit from 3 investing partners is better than a 5% GP commit from 3 investing partners, 15 junior investment team members, operations team members and staff. How is the GP Commit Paid? I expect to see this as a cash contribution from the GP, not as a management fee waiver or a loan from the fund to the GP. In my view, the GP commitment should come out of the partner's pocket for it to be meaningful. In this way, the GP is acting like an LP in the fund - writing the same check (so to speak) to fund capital calls. In my view, a management fee waiver defeats the purpose of the GP commitment. Thoughts? 4 Comments Chris Nicholson 5/13/2017 11:55:22 am I agree with your framework, but would add a couple of things. First, even though it's sometimes a taboo topic to discuss, very often a fund's fee stream will meaningfully increase the managers' net worth (apart from the carry). In these cases, I'd want to see a GP Commitment scaled to address this. I'd want to see a large chunk of the "fees in excess of expenses" flowed back through the fund before hitting their bank accounts. This addresses the worst form of agency risk: "I'll get rich no matter what." Second, I'd want to see the GP commitment specified both in aggregate as well as getting assurances that it will be pushed down in the organization to the non-founder MDs/GPs who will be most in tune with the incentive-aligning aspects of "skin in the game" (versus the founders viewing the co-invest as a price of raising the fund). Finally, I'll wryly note the realpolitik dynamic that the GPs of the fund you *really* want to get into don't need to cave on terms despite compelling lectures on agency costs. ;-) Reply Allen 5/13/2017 12:49:27 pm All good points. Thanks for the comment! Reply Brian McDaniel 5/30/2018 07:30:06 pm Above, you write " I expect to see this as a cash contribution from the GP, not as a management fee offset or a loan from the fund to the GP. In my view, the GP commitment is coming out of the partner's pocket, for it to be meaningful. Management fee offset or fund loans defeat the purpose of the GP commitment. Also, there should be no management fee waiver for the GP commit, as management fee waivers effectively reduce the amount of GP commit and I believe the GP commit should pay the same management fees as the LPs do. " This view, though common, is misguided. First, its important to realize that capital contributions can be funded by management fees, whether done on a roundtrip basis, or via a management fee waiver. So, at first glance, there should no difference in the incentives of the GP about whether their capital contributions are funded via management fee waiver or not. However, the reason that management fee waivers exist is to enable to GP to use tax arbitrage to effectively treat the management fee as capital gain rather than ordinary income. In order to make this work under the tax law, the receipt of the credit for the waiver must be subject to "entrepreneurial risk"; there must be a meaningful risk that, if the fund does not perform, the credit for the management fee waiver would not be realized. In other words, the management fee waiver technique turns the management fee into a form of carried interest. (Admittedly, usually the waiver is structured in a manner that the risk of the credit is low). Thus, the use of the management fee waiver technique actually _increases_ the alignment between the GP and LPs. Reply Allen Latta 7/22/2018 12:38:20 pm Thank you for your insightful comment. In my view, using a management fee waiver to fund capital calls a GP must make has two downsides: (1) the GP isn't writing a check like an LP does to fund a capital call; and more importantly, (2) because, as you note, there's a tax arbitrage for a management fee waiver that effectively reduces the net amount of the capital call paid by the GP. This effective reduction in the GP commit is what's problematic for me. To me, I want the GP to be in the exact same shoes as the LP when it comes to capital calls - the roundtrip basis you mention. Reply Your comment will be posted after it is approved. |
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FAQs
What is the average GP commitment to private equity funds? ›
According to Investec's Private Equity Trends 2024 report, the typical GP commitment averaged around 3 percent in 2023, down from the peak level of 4.8 percent in 2021. High interest rates have slowed dealmaking and distributions, reducing the amount of capital GPs can commit to their own funds.
What is the role of the general partner in a private equity fund? ›This is generally comprised of a General Partner and a Management Company. General Partner (GP): The entity with the legal authority to make decisions for the fund. This entity also assumes all legal liability.
What is the general partner commitment? ›The General Partner (GP) Commitment, or Lead Commitment, refers to the amount of personal capital a GP, the individual or entity responsible for managing a private equity or venture capital fund, pledges to invest in their own fund.
What is the minimum GP commitment? ›While a significant commitment may vary, a general rule of thumb is for the GP commitment to be a minimum of 1% of total committed capital.
What is the 80 20 rule in private equity? ›80% of your returns will usually come from 20% of your investments. 20% of your investors will usually represent 80% of the capital. For portfolio companies. 20% of your customers will usually represent 80% of your profits.
What is the 2 20 rule in private equity? ›The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
How much does a general partner in PE make? ›As of Apr 30, 2024, the average annual pay for a General Partner Private Equity in the United States is $113,105 a year.
What does general partner mean in private equity? ›The managing partner in a private equity management company who has unlimited personal liability for the debts and obligations of the limited partnership and the right to participate in its management.
What is the role of a general partner in a fund? ›Key Takeaways
Private equity general partners manage the fund's operation, including identifying which companies to buy and when to sell them later. Likewise, they are responsible for finding other investors, called limited partners and raising the capital used to acquire companies.
| Advantages of a Partnership | Disadvantages of a Partnership |
|---|---|
| Extra set of hands | No solo decision-making |
| Additional knowledge | Disagreements |
| Less financial burden | Shared profits |
| Less paperwork | Not a separate legal entity |
What are the 4 criteria of a general partnership? ›
It requires at least two partners. Each of the partners can obligate the general partnership. All of the partners have unlimited liability are liable for all of their own acts and omissions and those of the general partnership and of the other partners. Each partner is liable for all debts and obligations of the GP.
What is the purpose of a general partner in a limited partnership? ›General partners are responsible for the daily management of the limited partnership and are liable for the company's financial obligations, including debts and litigation.
What is carried interest in private equity? ›Carried interest is a share of profits from a private equity, venture capital, or hedge fund paid as incentive compensation to the fund's general partner. Carried interest typically is only paid if a fund achieves a specified minimum return.
What is a GP catch up in private equity? ›The GP catch-up provision allocates distributions to the GP once the fund manager returns contributed capital and reaches the preferred return. The provision's purpose is to incentivize fund managers to create returns in excess of the preferred return.
What is a GP stake in private equity? ›Discover the benefits owning a stake in private asset management firm. A GP Stake involves the purchase of a minority and passive interest in a Private Equity (or Private Credit) firm, allowing investors to access the long-term success and growth of the firm itself.
What is the typical fee charged by managers general partners of private equity funds? ›Private equity firms normally charge annual management fees of around 2% of the committed capital of the fund.