By David Stevenson, a London-based financial writer for PitchBook News, covering private equity.
When KKR closed its sixth European buyout vehicle on $8 billion, it did so with around $1 billion of its own capital contributing to the fund corpus. The New York-based firm is one of many GPs pumping more of their own money into their funds.
PE firms have always invested in their own funds to reassure their limited partners that their interests are aligned. But KKR’s 12.5% commitment is far beyond the industry standard, which has traditionally been around 1% to 2% but, according to financial services group Investec, is now closer to 5%.
Jonathan Harvey, a member of Investec’s fund solutions team, said that formal GP commitments have been on the rise out of a desire among many PE firms to demonstrate to their investors that they bear the same level of risk. When informal commitments are included, a GP contribution can rise beyond 10%, Harvey added.
"I talk to hundreds of investors every year, and that's an issue they're very focused on, ‘How much is your GP commitment?'" said Michael Ward, CFO and COO at Bain Capital.
However, it is not always clear how managers intend to finance these commitments. According to a forthcoming GP trends survey set to be issued by Investec, a third of industry respondents admitted that they did not know where their commitments were coming from.
“A lot of GPs would be expecting money to come from exits and carried paid interest, etc., which has just slowed down in this environment. So, one-third of people not knowing how they’re going to fund commitments is significant. If that trend was widening, it would probably be a bit of a concern for LPs,” Harvey said.
Some of these capital commitments will come directly from the partners. Various firms have even offered more junior partners lines of credit so they can participate. But the subject is contentious: One managing partner would only discuss it off the record, while others openly acknowledge the process.
Frank Angella, managing partner at middle-market-focused GroveStreet, said firms allowing employees to access lucrative deals is a growing trend.
"[Employee commitments are] increasingly typical. The company will give loans to younger people to allow them to invest more than they could otherwise afford,” Angella said.
However, Bain’s Ward noted that GPs must sometimes temper the exuberance of their employees when it comes to committing their own money to funds, partly as a way of ensuring no one person is taking on more risk than they can handle.
Different asset managers may have additional funding options available for GP commitments, which may impact how an LP views the attempt to align their interests.
“Is that capital [for a GP commitment] coming from the people doing the investing or is it coming in part from the very senior people who are overseeing it?” said Angella, highlighting some the questions investors might have. “Or is that capital coming from the balance sheet, where instead of paying dividends are they taking realizations they’ve had or fees and investing those?”
The latter point is in reference to listed PE firms such as KKR, which have additional funding options available because they have gone public.
However, while some GPs make larger commitments than others, the size of a GP commitment as a proportion of the entire fund corpus is not necessarily an accurate way to determine the extent of alignment between an LP and a GP.
Angella added that while a single percentage point GP commitment might not be seen as particularly meaningful for a well-established PE shop like KKR or The Carlyle Group, for new firms that have to invest in hiring and renting offices, it can be very significant.
Kevin Callaghan, managing director at Berkshire Partners, noted that increased GP commitments are also a good way to help a firm win a bid for a target company.
“Successful GPs, when they’re interacting with a portfolio company management to try and win a deal will say, ‘It’s not just your money and your company going into this, but I, my partners and our full team will be investing very meaningfully in the equity,’” Callaghan said.
However, the growing GP commitments trend may have a potential downside. Investec’s Harvey notes that as conditions get tougher, investors will continue to expect GPs to invest significant amounts of their own capital, even if securing that capital gets harder.
Since LPs are highly selective, alignment is most certainly a bonus, but when all is said and done, a well-established track record of solid returns and timely distributions remains paramount.
“Aligning with LPs is not in itself a decision maker, but inadequate co-investment can certainly be a detractor for an LP,” Ward said.
About the Author:
David Stevenson started his journalism career at Euromoney, covering the tax aspects of major corporate M&A deals including private equity in 2008. He has written for institutional investor-focused Funds Europe, wealth management and private bank-aimed PAM Insight as well as private markets data provider PitchBook among many others.
