No Sizzle, All Stake: The Evolving Market for GP Minority Stakes
The private equity market has reached a critical milestone in its maturation process as the industry has recently seen a dramatic proliferation of innovative structures and ventures / partnerships between LPs and GPs. Historically, these creative partnerships occurred as one-off transactions at the upper end of the market between mega funds and the larger and typically more sophisticated buyers or LPs. Over the past 12 months, those one-off discussions and structures have worked their way into the heart of the middle and even lower-middle market. It should be of no surprise that the mega funds are at the forefront of developing new and creative ways to form GP-LP partnerships because we’ve seen his time and time again. A few recent noteworthy examples of this dynamic are: (1) the evolution towards discounted fees, (2) the maturation of the co-investment market, (3) increased interest around Separately Managed Accounts (SMAs) and (4) the pursuit of permanent capital. We are now seeing this same dynamic take place with respect to GP minority stakes.
There has been a rise in the number of high-profile transactions in the past few years where large GPs sold a stake of their management company as a way to assist founding partners with liquidity issues to facilitate succession plans or secure long-term capital or strategic partnerships. As we know, these issues impact all private equity sponsors and aren’t reserved to the household firms that have pioneered some of these types of transactions. The interest in acquiring GP minority stakes has increased to the point today that there are sophisticated groups that have raised funds dedicated specifically to this strategy. This is obviously a tipping point because it transforms what were one-off opportunities into an actual market. In the same way that the secondaries market started with the exchange of a handful of LP interests many years ago and today is a $40 billion a year marketplace, there are similar dynamics at play with respect to the evolution of the market for minority stakes in GPs. The orders of magnitude will clearly be different, but we are likely to see the institutionalization of terms, structures and a lexicon of this new market take shape over the course of the next few years. The influx of capital targeting GP stakes for funds that range between $300 million in size to $2.0 billion in size has served to dramatically escalate conversations in the sponsor community, but there are material questions about how these transactions work and who best to partner with.
Key among the questions that partners need to consider are: what are the goals of the transaction? Is there a liquidity need, a retiring partner or is the firm seeking a form of longer term capital? What are the distributable and long term cash flows? It is very important for sponsors to have a keen understanding of the investor’s reputation in the LP community and to assess their capital base. An ability to evaluate the value proposition in terms of the transaction’s economics is also imperative. Lastly, this new partner’s ability to support the sponsor’s core strategy and willingness to assist the GP in addressing a new strategy can be a crucial element to making these decisions. As in any aspect of business, there is a wide spectrum of quality and choosing the right partner can be one of the most transformative decisions a GP can make for the future of his or her firm.
For more information on the evolving marketplace for GP minority stakes please contact Sixpoint Partners.
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