LPs demand more ‘skin in the game’

Investors are requiring fund managers to increase their personal commitment levels but many GPs are struggling find the cash, the Investec Fund Finance General Partner Trends 2014 survey said.

A total of 21 percent, of the more than 80 GP respondents, said they expect their team to have to make personal commitments of more than 3 percent, compared with the traditional 1 to 2 percent. But, 75 percent of the GPs said they would need “resources” other than carried interest to fund their next round of ‘skin in the game’.

“As the industry adapts to the post-crisis environment, it is clear that investors want greater alignment with the GPs who manage their money,” said in a statement Simon Hamilton, global head of Investec Fund Finance. “One of the biggest issues is how they fund this commitment, not just at a senior partner level, but throughout the firm.”

Causing this problem for many fund managers is simply the struggle to get their hands on carry early in their careers. Three-quarters of respondents said they expect to receive carry from their current fund, only 38 percent said they did not expect such a payout for at least another three years.

One method that fund managers rely on when carry has been hard to come by is a loan program with a bank and Hamilton said that he has seen significantly more GPs asking about these financing options.

The lack of carry for junior partners is also impeding succession plans at private equity firms, the research revealed. A common approach is usually for the original founders of the firm to sell to the next generation.

“[But] the younger investment partners may not yet have the wealth, especially if historically carry has not been well spread, to buy out the founders at a value they see as fair,” says Mark Ligertwood, a partner at UK-based buyout firm Dunedin. “If the founding partners are too greedy, then that can fracture the whole relationship which would make a buyout very difficult to achieve. That heady cocktail of greed and success can make for a very challenging succession plan.”