Investec: Increasing fund sizes do not help succession planning for GPs

The average GP commitment as a percentage of the fund was 4.8%, a more than 60% rise from two years ago, according to the latest GP Trends report.

Private equity managers are returning to market to raise new funds faster than ever, and with larger capital-raising targets. However, this is creating problems around the issue of succession planning, according to research from Investec.

In its GP Trends 2021 report, the firm found that the market norm for GP commitments is twice what it was several years ago. The average GP commitment in the latest survey was 4.8 percent. Historically, the typical expectation might have been 1-2 percent, the firm noted in the report.

Across strategies, the GP commitment ranges from 3 percent for secondaries vehicles to an average of 5.8 percent for large buyout funds.

“Succession in the industry is an issue regardless of the level of GP commitment,” said Jonathan Harvey, head of product, fund solutions at Investec, during a briefing about the report on Wednesday. “Higher GP commits certainly don’t help the issue… Rising commitments just make it harder for junior people to buy in.

“It’s an issue as funds get bigger, management fees get bigger, values of management companies get bigger. Therefore, the equity stake required to buy in becomes more and more significant.”

That said, successful PE firms are happy to invest more in their funds, according to Harvey: “There’s definitely more money flowing into alternatives and into PE; therefore there is probably more LP pressure [and] people looking for [a] higher degree of alignment. And this just leads to larger funds and larger and larger sums required for the GP commitment.”

According to Investec’s report, 62 percent of GPs are funding their commitments using existing resources, including re-investing carry rather than using external debt financing.

Harvey noted that the firm has seen clients invest up to 10 percent of their own money in a fund, especially if they have established track records.

Some mega-funds with sizeable GP commitments include Hellman & Friedman, which gathered $24.4 billion for its biggest-ever vehicle – to which it made a $1.8 billion GP commitment. KKR invested approximately $1.3 billion of its own capital, including through employee commitments, in its $15 billion Asian Fund IV, which closed in April. Nordic Capital made a 6.5 percent commitment – the largest by far across its vehicles – to its 10th flagship fund, which collected €6.1 billion last October.

On the plus side, Harvey said the market has become much more sophisticated in terms of how it looks at GPs: “Valuations are more understood than they used to be, there are finance providers that look to take stakes in GPs and there are an increasing number of banks that look to finance management companies.”

Public listings and GP stakes sales are also features of the market that may help in succession planning.

“Recapitalising the management company to keep a sensible level of debt and equity in the business may be a better option,” Harvey added. “It keeps the equity buy-in a little bit low, but some of these succession issues are just… inherent in a typical partnership model. It’s difficult to get value in and out and it’s difficult to buy in.”