Analysis: GPs putting more ‘skin in the game’

When Stirling Square Capital Partners, a London-headquartered midmarket private equity firm, closed its second fund on €375 million last year, one particular element stood out: the GP commitment.

The investment team at the firm accounted for €28 million, or 7.5 percent, of the fund’s total capital. According to an LP source, if you include commitments from a separate, “associated” vehicle, the management exposure to the fund accounts for more like 15 percent. This is far in excess of what you might expect. The GP commitment to a fund does vary, but will normally sit in the 1 percent to 2.5 percent region depending on the size of fund and the liquid net worth of the partners.

Stirling Square declined to comment on the separate entity that apparently boosts the team’s exposure to the fund, but on the topic of GP commitment, investor relations director Robert Swift says, “Feedback from LPs on our approach has been extremely encouraging and it undoubtedly helped in our fundraising exercise.”

This size of contribution is by no means inconsequential. Being able to demonstrate that the individuals in control of the fund have much to lose as well as gain – they have their own “skin in the game” – is compelling for limited partners. One LP in Stirling Square’s fund said the GP commitment was certainly the deciding factor in his backing the fund. The fact that Stirling Square raised €375 million – 50 percent more than for its predecessor fund – in the fundraising down-market of 2009-2010, suggests that other LPs were also impressed.

For Axcel Partners, a Danish midmarket firm, a hugely successful investment from its third fund prompted it to increase the manager commitment to its latest vehicle to 6 percent from 1 percent. The partial exit which spurred the increased GP commitment was Axcel’s investment in Danish jewellery retailer Pandora, which generated venture-like returns of 30x for the firm and its limited partners. The phenomenal success of the Pandora exit has made the individuals at Axcel, led by managing partner Christian Frigast, a considerable amount of money. As a result of the partners increasing their individual net worth, the team has increased its own commitment to Fund IV. The fundraising effort is – perhaps unsurprisingly – understood to be progressing well. As of February this year the firm raised around DKK3 billion (€402 million; $530 million) – surpassing its target – and is likely to pull in another DKK500 million, said a source with knowledge of the process.

One European firm to really “go long” on its own funds is Amsterdam-based mid-market player Egeria. The investment team of the firm contributed an eyebrow-raising 20 percent to their most recent fund, which closed towards the end of 2008, heavily over-subscribed, on €500 million.

Caroline Huyskes, a partner with Egeria, says limited partners undoubtedly appreciated the large commitment. “The fact that we put most of our own net worth into our own fund shows LPs a good sign of confidence. We feel that the best place to invest our own money is in our own funds. We know exactly where the money goes.”

While the GP commitment to the next Egeria fund may not be quite at the 20 percent level, the team will always make up at least 10 percent, says Huyskes.

The reasons behind an out-sized GP commitment can vary. The most straightforward reason is to demonstrate to LPs that you have faith in your own ability to invest the capital and make better returns than you could make elsewhere. It is a selling point for the fund: LPs are reassured by your self-belief and the genuine alignment of interest. The liquid net worth of the management team plays a major role in deciding the commitment size. LPs are keen to ensure that the investment team will feel an investment loss in relative, as well as absolute terms.

“Six percent is a very high number for an independent fund and will certainly make LPs sit up and take note,” said Bruce Chaman, a London-based placement agent with Threadmark, in a prior discussion about the Axcel fundraise. Chapman noted that it would be very difficult for any obviously wealthy manager to raise a fund in this environment without committing a substantial amount.

A check on the personal financial situation of investment team members is not uncommon, says Dermot Crean, managing partner at placement agent Acanthus Advisers. “There is certainly more probing by limited partners on this than there used to be… although there always was a certain amount, especially in the mid-market.”

Whether or not these instances represent a wider trend toward increased GP commitment is debatable. What is an undeniable fact, however, is that for at least two years GPs have been facing an incredibly tough fundraising market. Much has been written about the “pendulum of power” swinging towards the LPs, who – during a period of fundraising difficulty – have been able to push for more advantageous terms and conditions. The creation of the Institutional Limited Partners Association’s Private Equity Principles, which codified a number of LP-friendly fund terms in 2009, was evidence of the perceived shift in negotiating power.

LP demands to date, however, have focused more on fee structures and the payment of carry, rather than GP fund commitments. Nevertheless, a poll conducted among attendees at PEI’s annual CFOs and COOs Forum in New York in January suggested that the size of GP commitment is indeed trending upwards.

According to the survey, 35 percent of the audience believed GPs in future would contribute between 2 percent and 5 percent to their own funds; a further 16 percent of those surveyed said contributions would be more than 5 percent. 28 percent predicted the GP commitment would come in at between 1 percent and 2 percent; 21 percent said GP commitments would be less than 1 percent.

Anecdotal evidence from fundraisers backs this up. Kelly Deponte, a partner with placement and advisory firm Probitas Partners, says that for a lot of investors, “1 percent is just not enough anymore”. “Certainly among the funds we are seeing,” he says, “GP commitments are being raised. LPs want to see managers prepared to eat their own cooking.”