EM Pro Tips: GP Commitment
Emerging Manager Fundraising Pro Tips: GP Commitment
This is a series of posts focused to assist emerging managers raise capital, especially in this difficult environment sans private credit fund managers. In the world of private funds, "GP commitment" often stands as a critical topic in fund formation discussions. But what exactly does it mean, and why is it so significant? Let’s break it down and provide some pro tips on how to navigate this topic with investors.
What is GP Commitment?
GP commitment refers to the amount of capital that the General Partner (GP) contributes to the fund alongside Limited Partners (LPs). This contribution signals the GP’s confidence in the fund’s strategy and alignment of interests with the LPs. Typically, GP commitments range from 1% to 5% of the total fund size, though larger commitments are not uncommon.
Beyond the GP’s own contribution, the definition of GP commitment can also extend to include contributions from advisors or key individuals associated with the fund. These advisors, often integral to the fund’s operations and strategy, can further strengthen alignment with investors.
Why is GP Commitment Important?
Alignment of Interests: LPs want assurance that GPs have "skin in the game." By investing their own capital, GPs demonstrate that they are equally incentivized to maximize the fund’s returns (or at least preserve their capital).
Market Signaling: A substantial GP commitment signals confidence in the fund’s success. It reassures LPs that the GP genuinely believes in the investment thesis.
Negotiation Tool: For emerging managers, a higher GP commitment can serve as a differentiator when seeking capital from investors. It can help offset perceived risks associated with limited track records.
Pro Tips for Emerging Managers on Structuring GP Commitment
Personal Capital: Using personal wealth is the most straightforward source but may not be feasible for all GPs. To the extent the headline number of the GP commitment is not large, fund managers should explain to investors the reason and emphasize that the amount being committed is a significant portion of the GP’s personal wealth. Ultimately, investors want to ensure that the GP has "skin in the game."
Management Fee Offset: If the GP commitment is not large enough, consider a management fee offset, where the GP offsets a portion of the management fee for the GP commitments. This is a fairly common strategy, even among experienced managers, so emerging managers should not be hesitant to make this request. However, it is important to ensure that the offset percentage does not disrupt operations, as investors will also scrutinize the extent of the management fee offset. Investors do not want a GP that is cash-constrained and sacrifices management fund duties.
Debt Financing: Certain GPs may secure loans to finance their commitments. This can work in specific scenarios but may raise questions about financial stability. Transparency with LPs is crucial if this option is pursued.
Involve Advisors: Expanding the definition of GP commitment to include contributions from trusted advisors or other key team members can signal a collaborative, well-rounded team to LPs. However, this approach has its limits and should not be overly relied upon.
Seed Investment: Soliciting capital to seed the GP can be an effective strategy. This can take the form of a "GP stake" transaction, i.e., the investor takes an ownership interest in the GP, or a revenue-sharing arrangement, where, in each instance, the investor gains a right to a portion of the GP's management fees and carry. Although a seed arrangement will dilute the GP’s receipt of carry and management fees, it can create a long-term partnership with an investor and provide cachet (or at least a glowing reference) when soliciting capital from other investors, especially if the seed investor is a blue-chip investor with a strong reputation. To the extent possible, such arrangements can be limited to the fund being raised, successor funds of the fund, a specific investment strategy or capped at a certain dollar figure (or return multiple) so that the dilution does not extend for an indefinite period. Seed arrangements have gained significant popularity in recent years, making them an important strategy for emerging managers to explore as part of their overall fundraising efforts.
Final Thoughts
GP commitment is more than just a financial contribution; it’s a cornerstone of trust between fund managers and investors. For fund managers, understanding how to structure and present this commitment effectively can make a substantial difference in fundraising success.
