Driven by the desire for limited partners (LPs) to deploy capital into strategies that generate attractive returns – and – general partnerships’ ongoing need for operational capital, GP stakes investing has become one of the hottest growth areas within private equity (PE). GP stakes are usually structured as direct minority (typically 10-33%) equity investments in the management companies of general partnerships. Portfolios typically consist of a number of these investments.
General partners (GPs) seek capital for several reasons, including growing or expanding products, executing succession plans and helping to fund their GP commitments as the number and size of their funds increase. Raising equity through GP stakes is often preferable to raising it through public markets, given the expense and ongoing administrative and reporting responsibilities that come with running a public company. Stake selling can also be an attractive alternative to raising additional firm debt. An additional benefit for GPs is access to value-added services offered by some capital providers. Dyal Capital Partners, for example, offers its Business Services Platform to its roster of fund companies, making available such services as client development and marketing support, product development, talent management, business strategy and operational advisory.
While the concept of making minority investments in partnerships is not a new one (CalPERS acquired a 10% stake in Carlyle Group in 2000, for example), assembling a portfolio of minority interests only started gaining momentum in 2012. Early GP stakes investments were largely in hedge fund companies. More recently, however, the industry has shifted its investment focus to private equity and long-term investment structures, which benefit from a nonredeemable capital base and predictable management fees. Many of the firms that have sold their own minority stakes include blue-chip PE shops such as Accel-KKR, Cerberus, General Catalyst, Silver Lake and TPG Sixth Street Partners. In many cases, GP stakes benefit both investors and the general partners who sell stakes in their businesses.
Generally structured as permanent capital vehicles, the attraction for LPs is clear. In addition to the fact that GP stake investments do not generally correlate strongly with the rest of their portfolios, they also tend to generate a steady cash flow stream that will be distributed to LPs over a long period of time – a plus, given the low interest rate environment and challenges in finding investments that offer attractive cash flow yields. Returns from a GP stake derive from three sources. In addition to being entitled to participate in fund performance through their pro-rata share of the GP commitment to the firm’s underlying funds, LPs are also entitled to their share of management fees and carried interest from these funds. The more funds that a GP raises in the future, the bigger their size, the better their performance and the larger the benefits that LPs can accrue.
The amount of GP stakes capital raised in 2019 was the highest on record. According to PitchBook, 2019’s total GP stakes fundraising exceeded $23 billion — more than four times the prior high of $5.3 billion and nearly 10 times the average annual amount of capital raised in the space between 2012 and 2018. While a number of new players have entered the fray, three players currently dominate the space: Dyal, Goldman Sachs (Petershill) and Blackstone — each currently with funds that exceed $4 billion. In fact, at the end of 2019, Dyal Capital closed its fourth vehicle with more than $9 billion, making it the largest fund ever for this strategy.
Over the last year or so, we have witnessed some subtle shifts in the GP stakes investment landscape and it is not clear if they are a direct result of the additional capital in the space. Notably, there has been an uptick in the number of credit managers acquired by GP stakes funds. Intuitively, an investment in a credit manager will yield a lower return than an investment in an equity manager, given the generally lower fees as well as a smaller opportunity to outperform whatever performance hurdle is in place. We have also witnessed an increase in the number of GP stake funds focusing on middle-market PE firms. While the upside is potentially stronger because these smaller, less-proven companies are earlier in their life cycles and there isn’t as much capital chasing them, investors are taking on much more business risk versus what they historically do when investing in the blue-chip names mentioned earlier.
While GP stakes have largely been a win-win for LPs and GPs alike, it will be interesting to see how the influx of capital into the strategy affects returns for the industry overall. This is because: 1) the larger-than-normal supply of dry powder will likely lead to higher purchase prices for some of the larger remaining marquee partnerships, 2) the number of high-quality GPs seeking growth capital is shrinking, which could necessitate future investments in smaller/less-proven general partnerships, and 3) investments in credit-focused general partnerships could potentially lower the overall return expectations for these funds. We will continue to monitor these changes and their impacts with great interest as we, like most institutional investors, are always looking for complementary assets for our investment portfolio.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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