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GP equity deals still a key gear driving the private markets engine

The trend for dedicated funds targeting GP equity stakes is likely to remain strong as investors seek out opportunities in early stage and middle-market PE groups.

Just as private equity provides strategic capital investment to help global businesses grow, likewise PE groups need growth capital to expand and evolve. And with investors only too keen to deepen relationships with GPs, over the last five or six years it has led to a vibrant market for acquiring GP equity stakes.

The trend for dedicated funds targeting GP equity stakes is likely to remain strong as investors seek out opportunities in early stage and middle-market PE groups.

Just as private equity provides strategic capital investment to help global businesses grow, likewise PE groups need growth capital to expand and evolve. And with investors only too keen to deepen relationships with GPs, over the last five or six years it has led to a vibrant market for acquiring GP equity stakes.

The economics for doing so are attractive. As reported by PitchBook, Dyal’s second fund has returned 24.25 per cent net to investors, per New Jersey pension documents.

With investors cognisant of the success enjoyed by early movers in this space – led by the likes of Dyal Capital Partners and Goldman Sachs AIMS with its Petershill programme – and GPs becoming more open to the concept to free up liquidity, this is creating a fertile deal environment.

Dyal Capital announced in December 2019 that it had raised more than USD9 billion for its fourth GP stakes fund, making it the largest of its kind. To put that into context, Bain & Company’s Global Private Equity Report 2019 showed that USD17 billion had been raised by market players since 2012; that Dyal has just raised USD9 billion itself suggests this market is significantly maturing. 

“In the European market, Nordic Capital announced a sale of a minority interest in the GP to Ottowa Avenue Private Capital last September,” comments Magnus Goodlad, Head of Transactions at Rede Partners. “BC Partners completed an equivalent transaction with Blackstone Alternative Asset Management in August 2019, and EQT completed a successful IPO in September, which was a public market means of the broadening of the equity ownership of the General Partner.”

In his view, it is a further manifestation of the deepening of relations between GPs and investors (including other PE groups) and explains the growing volume of transactions and capital raised. 

This is the case in Europe as well as the US. 

Matthew Dickman is International Counsel at Debevoise & Plimpton LLP and an investment funds lawyer with experience both in the US and Europe.

“In the last few years, we have seen a significant increase in GP minority transactions in the US, and we are starting to see increasing interest in these transactions in Europe,” says Dickman.

A GP equity stakes deal is an elegant way of enabling both value creation for founders who are no longer active partners in the firm, who would otherwise be passive shareholders on the register. Such a deal allows a PE manager to bring on active investors who are aligned, either by capital provision or by utilising their own internal value-added groups to manage the minority stakes. 

Growth capital is undoubtedly a key driver on the supply side.

“There are a handful of frequent drivers for these deals. One such driver is providing growth capital. Investment management firms need capital to grow just like any other business, and the proceeds from these deals can be used to fund larger GP fund commitments, open a new office, hire new talent or other growth initiatives,” remarks Dickman.

He explains that buyers in GP minority transactions understand that a large part of the economics is driven by management fees, “which in a typical private equity fund are generally fixed for a certain period of time”.

“Another driver for these deals is providing some liquidity to founders or senior partners,” says Dickman.

While some of the largest PE groups have already done equity stakes deals, there remains a phalanx of opportunities across the middle markets. Strategic third party minority equity ownership is now an accepted practice, with Goodlad pointing out the likes of Petershill “have set out their stall in the mid-market and upper mid-market and do not want to play at the top end of the market”. 
 
“There are more and more groups coming forward with mandates to do that. I think it will be a trend that we continue to see develop further down the scale of GPs in terms of assets under management.”
 
For those who may be considering an minority equity sale, he advises:

“As with the portfolio companies you are investing in, as a GP you don’t want to shut your eyes and take the highest price. Rather, decide who is the best long-term partner for the firm. How will they will be perceived by your wider LP base? Think about whether or not they will act in an aligned and supportive way when deciding how to guide the strategy, hiring new staff and so on.”

However much GPs have a deep relationship with their LPs, they are still on the other side of the table. With a minority equity deal, however, the investor is sitting on the same side of the table. Carefully assessing who one allows to own part of one’s management firm is a sensitive affair that cannot be rushed.

There are a host of potential conflicts of interest that arise in transactions. Dickman breaks them down into three categories.

“First, an investment management firm that makes GP minority investments has the potential for conflicts of interest in connection with its other affiliated businesses.  For example, the firm may have affiliates that make fund investments or direct investments in portfolio companies.



“Second, an underlying sponsor has to think about potential conflicts of interest that could arise after a deal is completed.  For example, the underlying sponsor might have a portfolio company in one of its funds that is being marketed to third parties, including an affiliate of the GP minority investor.

“Third, conflicts of interest can arise between the GP minority investor and the underlying sponsor.  The legal documents in these transactions typically seek to align their interests as much as possible and include obligations to mitigate potential conflicts of interest,” he says.

One other aspect to consider for any GPs ahead of a potential equity deal is that while most deals in the US might fall within the 10 to 20 per cent range, in Europe, because of the diverse tax/regulatory/legal landscape, change of control filings are more common up to the 10 per cent level.

Looking ahead, GP stakes deals will undoubtedly continue evolving. Sixpoint Partners, for example, has established a private equity seeding platform to target spinout managers with a defined path to exit, according to PitchBook. Meteor5 Capital, meanwhile, will focus on first-time managers and invest in the GP’s first few funds, as opposed to a permanent stake.

While this is good news for PE investors who want GPs to remain in the private market, Goodlad concludes by stating that a bigger hurdle to overcome could be when GPs take the public market IPO route to raising equity.

“Some LPs might have concerns that the moment a GP becomes public, the first thing they think about in the morning will be the share price. As an investor, you want them to think about how they will be adding value to the fund in which you are invested and maximising returns. 
 
“If you were to take a straw poll on which one LPs would prefer – GP ownership in public markets versus GP ownership in private markets – I think they’d vote for private market ownership,” concludes Goodlad.

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