What is GP stakes investing?

GP stakes funds are unique among private equity strategies in their significant yield components, diversified downside protection and benefits when the underlying firms perform well. This blog post explores the GP stakes investing landscape and answers questions related to construction, allocation and GP and LP benefits.

What is a GP stakes investment?

GP stakes investing is the act of buying of passive, minority equity stakes in asset managers—often private equity firms—that are formed, in part, as general partners and receive funding from limited partners. Typically, the LP’s ownership position is non-strategic and non-voting, though it does provide access to the underlying business model and revenue from management fees.

Put another way, GPs typically raise capital to form funds via limited partners. Those funds are then used by the GPs to invest in private businesses of all stripes. In GP stakes, the GP uses LP-raised capital to buy shares of another general partner—as opposed to committing capital to their funds. Through GP stakes investments, LPs receive a minority ownership position in a GP’s underlying management company.
 

What is the history of GP stakes investing?

Though GP stakes investing has been around for some time, the environment as we know it today was heavily influenced by a handful of key events in recent history. From LPs and large asset managers making direct deals based on long-standing relationships to an explosion of new firms built around GP stakes investing, GP stakes’ recent evolution can be broken into three phases—2001-2007, 2007-2016, and 2016 to present.

What is the prevalence of GP stakes investing today?

When fundraising activity surged in the Q4 2021, more than $20 billion in capital was raised across GP stakes funds. The strategy became standard practice in the PE industry as more LPs made their first allocations and GPs considered selling equity stakes.

In 2023, as fundraising slows, private equity firms are taking stakes in their industry peers as a way to gain direct exposure to their fund returns and balance sheets, according to PitchBook News. At the same time, cash-strapped fund managers are happy to sell as they look for new ways to generate capital.
 

What's the relationship between a GP stakes investor and the GP they invest in?

The relationship between a GP staking firm and the GP in which they invest is akin to that between a typical GP and its portfolio company. As one GP stakes fund manager put it, “We are just a PE firm investing in and lending support to companies. The companies in which we invest just so happen to be alternative asset managers.”

What questions should a GP ask themselves before they sell a stake in their own firm via GP stakes?

GPs need to ask themselves some basic questions and seek expert advice, likely from a banker that has run these processes before, and an attorney well-versed in these types of deals. Questions to ask before and during the process include:
 

• Am I large enough to sell a stake in my firm?
• Do I have a succession plan in place?
• How will my LPs react?
• Why do I want to sell a stake in my business?
• What is the buyer's expertise?
• Is the equity I'm selling primary, secondary, or a mix of both?
• Do I or the next generation plan on buying this stake back?

For a full list of questions, including initial, strategic vs. financial, price and structure, and more, download our Analyst Note: Choosing Your GP Stakes Partner.

What are the market drivers of GP stake investing? 

High-yield components are one of the primary drivers of GP stakes investing. LP returns can reach anywhere from 7% to 10% and grow to the mid-teens in mature portfolios. Over the course of a decade, a PE fund can swell by more than three times its original size, increasing firm multiples and providing substantial returns. 

The GP stakes fund structure encompasses a ten-plus-year life cycle, allowing LPs to avoid reallocation to new funds in order to maintain target distribution, too.

Additionally, the capital firm’s annual management fee offers significant downside protection, while carried interest has the potential to ensure upside growth dependent on fund performance. For example, if a firm sells its stake and does not raise another fund, the stake investment will still recover 70% to 90% of its original cost. 

Do GPs engaged in stake investments prefer open-end or closed-end funds?

In the context of GP stakes, open-end funds refer to strategies in which periodic redemptions are possible—namely hedge funds and long-only equity strategies. In contrast, closed-end funds refer to investment vehicles that are not subject to investor redemptions such as buyout funds, VC, private credit, etc.

Currently, major GP stakes investors tend to invest primarily in GPs that favor closed-end funds, though preferences have changed over time. Initially, a lot of activity involved investments in closed-end funds—specifically hedge funds—that experienced mixed results. Today, firms look almost exclusively for closed-end funds. For instance, since 2016, more than 80% of Dyal Capital Partners’ deals have included closed-end GPs, while AIMS hasn’t invested in an open-end GP since 2015. Read more about these groups below.

Which types of firms typically receive this form of investing?

Firms receiving GP stakes investments are typically top performers with a proven track record. For example, the average capital raised for a firm that has received GP stakes investments is $23.4B, compared to a non-GP stakes average of $1B. This can include managers with varied strategies—from energy and real estate to credit and secondaries. Outside investors also favor firms that show growing assets under management.

Who are some of the players in GP stakes investing?

 

Why would a recipient of GP stake be interested the investment?

Selling a minority stake can provide liquidity to the recipient management company and allow them to back new business initiatives or otherwise build value. Further, GPs stand to benefit from an LP's operational expertise or specialized knowledge.

Why would an LP be interested in a GP stake investment?

In return for their GP stake investment, LPs receive greater access to the best performing managers, as well as a portion of future management fees—not to mention the potential for appreciation of their equity stake.

LPs also stand to forge close relationships with a core group of quality firms, potential co-investment and warehouse opportunities, the ability to seed new strategy launches, and possibly receive allocations to otherwise oversubscribed funds.

What kinds of  LPs are typically involved in GP stakes investing?

Most LPs that commit to GP stake funds are well-established PE investors that have been allocating capital to alternative assets for decades. This includes dedicated funds raised by groups like Dyal Capital Partners and Goldman Sachs’ AIMS group, but also includes publicly-traded conglomerates like Affiliated Managers Group (AMG), or large LPs such as the Alaska Permanent Fund Corporation.

What key factors do GP stake investors consider before investing?

Before making an investment, GP stakes investors will examine a firm’s business from every angle. This includes analyzing everything from LP-GP relationships and alignment of incentives, to understanding the nuances of how the GP management company generates revenue. Other important factors include the sustainability of the management company’s long-term revenue streams and its prospects for future funds.

Where do GP stakes exist within a private equity portfolio?

Although strategies vary, GP stakes investments are often placed in a growth equity portfolio, designed to deliver large and mid-cap growth stocks returns at a lower cost for LPs. Firms focused on equity growth invest in late-stage, high-performing companies to maintain their development.

What are some challenges and concerns regarding GP stakes investing?

A consistent complaint from publicly-traded PE firms is that traditional equity investors don’t know how to properly value their business, leading to persistent undervaluation.

From the investor side, there is some concern that the manager receiving a GP stakes investment may change their strategy in a way that maximizes income for the management company at the expense of underlying investments.

Additionally, the highly specialized nature of this strategy could mean that there’s only enough room for a handful of deep-pocketed managers.