Dynamic Shifts (between GP’s and LP’s) in Private Market Investment

For an increasing amount of years now, the pendulum of economic power has continued to swing back and forth between a funds management team and its limited partners.  Long gone are the days when the majority of general partners could consistently receive, now seemingly, over-the-top economics from their limited partners. 

Likewise, in the public market domain, a similar dynamic continues to occur in in the wealth management and retirement plan provider arena, among various financial service entities and their respective retail and / or plan sponsor clients.  Moreover, with the saturation of competing providers, continued low interest rates, a prolonged lower-return environment, and the increasing disruption and cost reductions from innovative financial technology, this axiom will continue; albeit at a slower pace among the top echelon of GP’s and providers.

With this in mind, I’ll briefly discuss and highlight below some of the evolving aspects among GP / LP relationships that you’ll continue to notice in private market investment globally.

  • Increases in Co-investment:  What used to be offered largely to the top-tier LP’s (usually, a funds anchor investor), is continuing to become more widespread, regardless of investment stage, geography, size or sector. While this trend reduces the overall management and carry fee percentages borne by certain LP’s in a fund, it still benefits GP’s (most of the time) in retaining, or even increasing their overall investment levels.
  • SWF’s, SFO’s and others going direct: Usually among sovereign wealth funds, larger DB plan sponsors, and the top-tier single family offices, this course of action could increasingly undermine the alternative investment manager model, as it directly bypasses the GP. As a result of having significant resources at hand, more SWF’s, some larger SFO’s and others, continue to add more due-diligence and proprietary deal source relationships in-house, and ultimately invest directly with their peers, or simply allocate, monitor, and exit on their own.    
  • Pressure on GP economics:  In addition to some LP’s already going direct, or co-investing, others are simply leaning-in on reducing management and / or carry fee terms. For example, more GP’s are being asked to justify their economic interests with their LP’s.  I know of some LP’s going as far as asking for actual management company budgets, and other verifications to make sure a true alignment of interest exists between the management fee and said budgets and related expenses.  Moreover, discussions on carry fee continues to occur as well.  Mostly by negotiating on a deal-by-deal basis, on the carry fee for the entire fund itself, or some combination thereof.

While the above examples involve some of the main shifts occurring in today’s GP / LP relationships, the small exception will likely continue among the most sought after GP’s that can justify their economics.  Likewise, the most influential LP’s will likely maintain their respective bargaining power, and if stymied, will continue to increase their percentage of direct investment.  As a result, the reality for most GP’s, is they’ll need to further stretch the management fee, in-between fruitful portfolio realizations, across additional areas to run the business more efficiently today.

David M. Kraemer is the Founder and Managing Member of 10 || 2 Capital Partners, LLC.

Photo:  Shutterstock, Inc. (NYSE: SSTK)

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