Key Takeaways
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With allocation to private markets in Australia expected to follow the US and grow considerably, investors are eager to find ways to take advantage of this trend. In such context, some private capital investors are turning the spotlight on their industry peers as a way of accessing stable returns while maintaining an investment strategy based on long-term growth and value creation by establishing GP staking funds (GP Stake Fund).
What is it?
- A GP stake is a minority investment (typically 10% – 40%) by a GP Stake Fund in institutional capital managers (e.g., investment management company, asset managers and general partner of a private equity fund) across the full spectrum of asset classes such as venture capital, private equity, private credit, energy, real estate, distressed debt, infrastructure and others (GP Stake). In Australia, a GP Stake is usually made through a unit trust but can also be made in other structures familiar to growth private equity such as early-stage venture capital limited partnerships and venture capital limited partnerships. Like any equitable interest a GP Stake is a transferable security (although this secondary market may be limited).
- A GP Stake Fund is often established as an evergreen fund or a fund with a fixed investment period of 10 years or longer.
What are the returns?
- In return for its minority investment, a GP Stake will generate a pro-rata share of:
- management fee income (recurring net fee related income associated with managing the business of a general partner/management company);
- carried interest/performance fees (performance-based fees earned on profits of a fund above a preferred return); or
- balance sheet return associated with a GP commitment (i.e., for partnerships, typically GPs co-invest up to 5% of funds raised alongside the limited partners in the funds they manage).
- Returns associated with a GP Stake also include capital appreciation associated with the increase in value of the stake over time.
Why would a GP/management company want a minority investor?
From a GP/management company’s perspective, there can be numerous potential motivations for bringing in a sizeable minority investor, including:
- provide valuable funds that could be used for:
- financing growth initiatives, such as acquisitions, expansion into new markets, scaling existing products or launching new products;
- operational improvements such as investing in infrastructure and technology; and
- accessing greater scale and resources;
- funding a portion of its GP commitment (the size of which grows proportionate to any increase in new funds raised by private equity funds);
- liquidating some of the equitable ownership of existing owners and creating enduring equity recycling programs;
- alignment with a value-added strategic partner;
- expansion into new fund strategies that are within the experience and expertise of the management team of the GP Stake Fund; and
- access to invaluable networks.
What are the advantages and risks of investing in a GP Staking Fund?
- From an investor perspective, GP Staking presents an investor in a GP Staking Fund an opportunity to invest in the manager as opposed to the funds they manage. It has some unique aspects that distinguish it from other strategies. It offers a combination of short-term capital distributions and diversified downside protection over a longer period through:
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- management fees, which are usually not subject to fluctuation;
- carried interest/performance fees, that can offer growth opportunities based on existing and future fund performance;
- balance sheet return associated with a GPs commitment.
- capital appreciation associated with the increase in value of its stake over time;
- longer time horizon, often surpassing 10 years, enabling investors to minimise frequent reallocations.
- As with any investment, GP Staking has its own set of risks, including:
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- underperformance of the portfolio companies (or other assets) held by funds managed by the GP/management company;
- changes in carried interest/performance fee (or management fees);
- fundraising capabilities of the GP Staking Fund (impacts the size of investments it can make); and
- any changes in regulations or tax laws that impact the profitability of a GP Stake investment.
US foundations
GP Staking has gained considerable traction in the US over the last decade, raising more than US$50 billion from pension funds, endowments and high net worth investors. This is where the term “GP staking” has come from and is now also used in Australia, notwithstanding that most funds in Australia are structured as unit trusts with either outsourced or in-house trustees involved in the operation of the relevant funds. Several factors sit behind the expansion of the GP staking market in the US, including a need for external capital to fund increasing GP commitments brought about by the growth of overall value of assets in private markets and an increase in the average GP commitment size.
Leading market players in the global GP staking industry include Blue Owl (formerly Dyal Capital Partners), Blackstone and Petershill Partners.
Australian opportunities
The Australian market provides significant advantages and growth opportunities for this type of investment with the benefit of proven track records undertaken by firms such as Pinnacle Investment Management Group (ASX: PNI), Fidante and Bennelong. One new private equity firm that has recognised this opportunity and is looking to take advantage is Scarcity Partners.
Led by ex-Pinnacle founders Adrian Whittingham and Alex Ihlenfeldt, Scarcity Partners is looking to bring the GP Staking model to the investment management sector. With its Scarcity Partner GP Access Fund, Scarcity Partners is raising up to AU$300m to take minority stakes in asset managers. In January 2024, it made its maiden investment through a 30% stake in Sydney’s Evidentia Group (a business that provides asset management on $10 billion worth of portfolios to large wealth advisers), followed recently by its second investment in Dinimus, a long established, leading private credit fund manager focused on senior secured directly lending in Australia and New Zealand. Hamilton Locke advised Scarcity Partners on both transactions.
Scarcity Partners have identified a gap in the market and are of the view they can take full advantage, as noted by Mr. Whittingham, “Taking private equity stakes in investment management businesses, which is called general partner (GP) staking, has performed very strongly offshore. More than US$50 billion has been raised in such funds across the US and Europe in the past 10 years. Unfortunately, Australia and Asia have not seen the same rise of GP staking firms yet there are significant opportunities and first-mover advantages here. Scarcity Partners is built to take advantage of those opportunities in this region.” With a large addressable universe, Scarcity Partners sees plenty of appetite for the GP staking investment model for an appropriately sized GP Staking Fund such as itself.
How is a GP staking transaction structured?
GP Staking transactions are often heavily negotiated but typically involve a combination of a subscription for equity in the relevant management company and an acquisition of equity from shareholders (known as primary and secondary proceeds).
As a minority investor, a GP Staking Fund will need to be mindful of ensuring it has sufficient contractual protections in place across the transaction documents to safeguard its interests (e.g. anti-dilution clauses, restriction on transfer of shares, veto rights over strategic business decisions etc.). Investments are also typically conditioned upon key individuals entering into long term employment agreements with various forfeiture provisions to economically align such people to the long-term success of the business. Further, understanding the fund structure and fund governance that the GP/management company looks after is essential in ensuring the GP Staking investment aligns with expectations.
Hamilton Locke expertise in GP Staking
Although not yet widespread in the Australian private equity landscape, GP Staking presents an excellent opportunity for investors seeking stable growth opportunities in volatile economic times.
Having advised on numerous GP Staking transactions in Asia Pacific, at Hamilton Locke we are well aware of both the opportunities and challenges presented by this type of investment, and we work closely with our clients to navigate the hurdles encountered during the GP Staking process.
For more information, please contact Hamilton Locke, Partners Gordon McCann or Erik Seito.
