GP Stakes Sales in the Mid-Market: The Next Wave

Over the past decade, the largest asset managers in alternatives (Apollo, Blackstone, KKR, etc.) have looked to the public markets as a source of both liquidity and permanent capital. The results of going down the IPO road have been mixed, but there have been learnings from each of these offerings that have helped educate the more seasoned buyout firms in the mid-market who are exploring similar options. Among the key learnings were that the public markets can be somewhat less enamored with the type of earnings that these firms book and the structure of these firms as limited partnerships is less attractive to public equity investors. Obviously mid-market firms don’t have the scale to justify an IPO, but in many cases they face the same issues and challenges as their larger counterparts, namely (i) how to finance the firm’s expansion, (ii) the best structure and alignment for firm succession and (iii) a consistent source of capital for future funds. What has become clear is that there is another path for mid-market groups and we see it as the next wave in the PE industry.

While the headlines have historically been dominated by GP stakes sales in large cap funds or name-brand hedge funds, times have changed and now sales in GP stakes make up as much as half of the market. This dramatic shift in the landscape shows just how far the market has matured over the past 10 years. At the heart of this shift is the heightened awareness and sophistication that is being demonstrated by both the sponsors and the stake buyers. The result is a dynamic, but increasingly competitive market in which to transact. This dynamic environment leads to stronger valuations and pricing in many cases as the competition on the buyer side continues to become more robust; it also means that more sponsors are looking to this market as a capital solution and therefore there’s a beauty contest developing on the sponsor side that is important to prepare yourself for.

In order to attract an institutional partner, you need to make your firm more “investable.” The way to make this happen is to grow your asset base, institutionalize your firm and processes and support a cohesive culture. In other words, you need some scale to garner the attention of the most active players in this space, but once you have their attention it will be necessary to pass a rigorous investment and operational due diligence process that will surpass that of all but a few traditional investors. If you are selling a minority stake, it will be critical that you properly align incentives within the partnership because a misstep in this effort could lead to very serious backlash from your investor base and younger partners. As founding partners seek an opportunity for liquidity it is important to be cognizant of the fact that a new party is being introduced into the equation that could change the equilibrium in the GP-LP relationship.

Sixpoint has advised clients on these types of transactions and would be happy to provide color on key LP considerations, valuation methodologies and how to develop a strategic business plan to attract outside capital.

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