GPs Are Making Larger Fund Commitments—Just Not for the Reason You Think

These firms want employees to have more skin in the game. So do investors.

Luke MacGregor/Bloomberg

Luke MacGregor/Bloomberg

Employees and partners at private equity firms are making bigger investment commitments to their funds — but the reason for the upsizing may be unexpected.

October data from MJ Hudson shows that 80 percent of private equity and venture capital firms committed more than 2 percent to funds raised in 2021. Over the three prior years, 75 percent had done the same.

Research from Investec published in June showed an even higher number. As Institutional Investor previously reported, that data indicated that the average GP commitment reached 4.8 percent in 2021. The typical expected commitment is between 1 and 2 percent.

Why the increase? According to attorneys at Ropes & Gray, it’s not due to larger fundraises or even the impending market downturn. “I don’t know that investors are actively pushing for higher commitments at this point in time,” said Justin Kliger, a partner in the law firm’s asset management practice.

Instead, it’s about employee compensation.

“In my experience, a lot of the interest comes from the employees themselves,” said Marc Biamonte, another partner in Ropes & Gray’s asset management group. “It’s a great opportunity for them. When they have high conviction in the firm at which they work, then they can get the opportunity to put that money to work in a favorable fee arrangement.”

Employers looking to share their profits with a greater pool of workers are more frequently setting up GP commitment structures that include mid-level and even junior employees. But according to Kliger and Biamonte, private equity firms setting up these structures first need to consider the consequences.

“It’s important for the GP to understand where it’s putting its funds based on the underlying employee base,” Biamonte said. “If it’s a very large investor, they need to consider the jurisdiction and the tax ramifications and make that commitment through its appropriate fund sleeves. The tax matters help determine the fund structure.”

According to Biamonte, due to asset owner preference, these commitments were often previously made in cash. Historically, GPs were able to waive management fees, then use those waived fees to commit capital to the fund. However, recent tax law changes have made this a more difficult process, according to Biamonte, so he’s seeing fewer GPs implementing this strategy.

As they look to bring in employees, GPs have a few options. In addition to direct investments, they may have employees invest in the firm itself, a sort of GP-stakes style investment, according to Biamonte and Kliger. They may also simply set up a completely separate fund sleeve for employees, rather them including them in a commingled structure.

Regardless of the structure itself, Kliger noted that alternatives firms need to consider whether it even makes sense to bring in junior employees, who may be more mobile earlier in their careers.

“They sometimes look for more flexibility to handle employees who are coming and going over the course of the life of the fund,” Kliger said. This means, particularly for evergreen funds, that it may be worth keeping junior employees out.

“It really comes down to the alignment of interests,” Biamonte said. And that’s not just with employees — it’s with limited partners, too.