Having Skin in the Game Isn’t So Easy Anymore for Private Equity Managers

Investors want their general partners to invest alongside them, but it’s becoming increasingly difficult for GPs to have stakes in line with their massive funds.

Illustration by II

Illustration by II

The private equity industry has been raising record amounts of cash from investors. Now it’s the general partners’ turn to pony up.

General partners are expected to personally invest an average of $55 million in their next funds as they attempt to keep up with increasing fund sizes, according to results of Investec’s 2018-2019 GP trend survey.

This is an absolute increase from past years, due to the larger fund sizes as well as limited partner demands for GPs to invest more money alongside them. Investec’s forecast of a $55 million average commitment is based on Preqin data showing that GPs are targeting an average fund size of $1.9 billion.

The need to finance these GP stakes has fueled businesses such as Neuberger Berman’s Dyal and Goldman Sachs’ Petershill, which buy stakes in alternatives firms.

According to Antoine Drean, chairman of fund advisory Triago, whether or not managers had “skin in the game” became a “deal-breaking issue” for many investors following the financial crisis.

“Indeed, many LPs see it as the essential counterpart to carry,” he said. “The assumption of these investors is that the best protection against losses, particularly in difficult markets, is making sure a fund manager has enough invested in a fund so that a loss hurts.”


Drean explained that many LPs look at a fund manager’s previous fund and how much was pulled out in carry to determine what might qualify as a meaningful amount for the manager to invest in the next fund. In general, he said the expected amount has risen from about 1 percent of capital before 2008 to 3 percent or more now.

“The GP team in the latest Brookfield infrastructure fund is actually planning to commit 30 percent of the capital raised,” Drean noted. Brookfield Asset Management said it would invest about $3 billion of its fundraising target of approximately $9 billion.

The survey, which included the responses of 289 global private equity professionals, found that GPs expect to commit an average of 2.9 percent to their next fund. That’s down from 3.3 percent last year, even as manager commitments have increased in absolute terms due to the larger fund sizes.

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Investec reports that GPs’ commitments will continue to rise. Fifty-five percent of the respondents to Investec’s survey said their next fund would be 25 percent larger than its predecessor, and 12 percent expect their next fund to be twice as large.

For newer general partners especially, funding personal commitments can be tough. Thirteen percent of GPs in the Investec survey said they didn’t know how they would finance commitments to the next fund, up five percentage points from a year ago. Among the private equity professionals who were not partners, 23 percent weren’t sure of fund commitment financing. However, 39 percent said they planned to reinvest carry or proceeds from co-investments. Fourteen percent said they would borrow money for commitments. (Investec, a banking and asset management firm, is a speciality finance provider for funds and fund management teams.)

The need to finance GP fund commitments is one of the top three reasons why private equity firms sell stakes to fund-of-fund-stakes like Neuberger Berman’s Dyal Capital or Goldman Sachs’ Petershill, according to a senior official familiar with the industry.

When GPs sell stakes, the official said, the proceeds are often invested back into the business to finance general partner commitments or other strategic activities.

According to Drean, it has become increasingly common for GP teams to fund their entire commitment by selling a stake in the firm to managers like Dyal Capital and Petershill. “The need to have major skin in the game is generating good business for these funds and similar ones,” he said.

According to data Investec provided to Institutional Investor, the average commitment for North American general partners – excluding the highest 10 percent and lowest 10 percent of responses – was 2.8 percent. North American respondents were the most likely to say that they didn’t know how they would personally fund their commitment, with 19.6 percent unsure of financing.

Fifty-five of the survey’s total respondents were based in North America.

“Financing, particularly for newly independent managers or new partners and those junior to them, can be challenging, but that’s what LPs want,” Drean said. “This can lead newly independent managers and the more junior members of a team to take out significant loans.”