- Management Fee
- Carried Interest Overview
- Carried Interest – Preferred Return and GP Catchup
- GP Clawback
- Management Fee Offsets
- Key Person Clauses
- No Fault Divorce
- For Cause Actions
- Should Venture Capital Funds have a Preferred Return Hurdle?
Private equity funds (buyout, venture capital and growth equity funds) are typically structured as limited partnerships, which have two types of partners: limited partners, or LPs, which are passive investors in the fund; and a general partner, or GP, which is the manager of the fund. As I evaluate funds, one of the fund terms that receives special attention is the amount of money the GP will commit to the fund - which is called "GP Commitment", "GP Capital Commitment" or "GP Commit."
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To understand why GP commitment is so important, a little background on agency theory is in order. Agency theory explores the relationship between a principals and agents in an enterprise, and the problems that can arise. In private equity, the LPs are the principals and the GP is the agent. In private equity funds, the GP has pretty much unfettered control over the management of the fund, and LPs have limited visibility into the management of the fund. In fact, by law, LPs must be passive investors in the fund and cannot be active participants in the management of the fund, or there may be some very unhappy tax and legal consequences. Because of the control GPs have in the fund, they will be incentivized to maximize the cash flows the GP will receive, often at the expense of the LPs. If however, the GP (and the owners of the GP) invest a meaningful amount of
their own personal capital into the fund, their interests are more aligned with those of the LPs, which is very important.
How much should the GP commitment be? As mentioned above, it was historically 1% of the committed capital of the fund. However, to me the GP commitment must be a "meaningful amount of the investable assets of the owners of the GP." Let's look at two examples to put this in perspective.
Example 1. Fund 1 is raising $100 million. The fund will be managed by two partners, who own the GP of the fund. The GP commit will be 2% of the fund, or $2 million. These partners are young, capable and smart, but they don't have a lot of money. Partner A has investable assets (think of net worth less primary residence and other illiquid assets) of $3 million. Partner B also has investable assets of $3 million. Each will be responsible for $1 million of the GP commit. In this case, the GP commitment represents 33% of each partner's investable assets. That's meaningful.
Example 2. Fund 2 is also raising $100 million, and the fund is also managed by two partners who own the GP. The GP commit will be 2% of the fund, or $2 million. The partners are also young, but both have become billionaires from an early venture capital company they founded and took public. Each partner is responsible for $1 million of the GP commit. As both GPs are billionaires, a $1 million share of the GP commit represents 0.1% of their net worth. That's not meaningful.
Each fund will be different, and so the amount of the GP commit must be evaluated on a case-by-case basis.
Who is the GP? An additional consideration is "who is the GP" for purposes of the GP commit. Some private equity groups allow investment personnel and/or staff to participate in the GP commit. When I evaluate GP commit, I look at the contributions from the core investment team of the fund, and expect the contribution from these individuals to be meaningful. A 5% GP commit from 3 investing partners is better than a 5% GP commit from 3 investing partners, 15 junior investment team members, operations team members and staff.
How is the GP Commit Paid? I expect to see this as a cash contribution from the GP, not as a management fee waiver or a loan from the fund to the GP. In my view, the GP commitment should come out of the partner's pocket for it to be meaningful. In this way, the GP is acting like an LP in the fund - writing the same check (so to speak) to fund capital calls. In my view, a management fee waiver defeats the purpose of the GP commitment.