EM Pro Tips: Stretching GP Dollars

Pro Tips for Emerging Managers: Stretching GP Dollars

For emerging fund managers, stretching every fund dollar is essential to ensure the fund operates efficiently while the General Partner (GP) builds a foundation for long-term success. While management fees and carried interest (carry) are the obvious financial lifelines for GPs, there are additional strategies to maximize resources and create supplementary revenue streams. Below are key strategies GPs should consider when structuring their fund terms with investors:

1. Protecting Management Fees and Carry

Reducing management fees or carried interest for anchor investors or early LPs can significantly impact a fund’s ability to operate effectively. Emerging managers should strive to protect these critical revenue streams by offering non-economic tradeoffs or delaying economic concessions to ensure the manager’s immediate needs are met.

Management Fees

Management fees are essential for covering operational expenses. Instead of agreeing to discounts, managers can offer non-economic accommodations, such as:

• Providing additional reporting.

• Scheduling quarterly update meetings.

• Granting LPs advisory board seats to enhance transparency.

If non-economic trade-offs are not feasible, the GP may consider offering a commitment-based MFN to reassure the LP that no better economic terms will be provided to any other investor. Alternatively, the GP could offer a no-fee, no-carry co-investment opportunity, which is common in the market and defers the economic trade-off to the future. Another option is to structure discounts based on the fund’s size, allowing the discount to scale as the fund grows. This approach protects the GP’s ability to operate early on or if the fund does not reach its target size.

Carried Interest

Carry should also be structured thoughtfully. If a fee break is unavoidable, a carry discount is often preferable to a management fee reduction if the GP is cash-strapped. Although a carry discount might seem greater in magnitude, it impacts the fund’s backend distribution rather than the operational budget, making it less disruptive in the short term. Managers can also consider a deal-by-deal carry structure, allowing carry distributions as deals are realized, rather than waiting for the entire fund to return LP capital. This approach provides earlier payouts and eases cash flow pressures.

2. Optimizing Expense Allocations to Reduce GP Burden

Carefully allocating expenses between the fund and the manager ensures that the fund bears appropriate costs, reducing the GP’s financial burden. Organizational and partnership expenses can often be allocated to the fund.

Organizational Expenses

Organizational expenses, typically associated with setting up the fund and its entities, can include:

• Legal, accounting, and compliance costs for fund formation, including the formation of the GP and its carry structure.

• Travel expenses for fundraising, attending conferences, and networking with potential LPs.

• Filing fees.

• Placement agent fees, which can often be offset against management fees.

Partnership Expenses

Partnership expenses related to ongoing fund operations should also be reviewed and allocated carefully. Examples include:

• Travel expenses for deal-related activities, such as diligence and portfolio oversight.

• Administrative expenses, such as portfolio monitoring, reporting, and fund compliance systems.

• Costs for consultants and specialists brought in to address specific fund or portfolio needs.

• Advisory services or external experts assisting with fund operations.

• Software tools for fund management, reporting, and data analysis, including AI tools that improve efficiency.

• Web portals for investor reports, document distribution, and communication.

Recent media scrutiny has raised concerns about funds including overly broad or ambiguous expense lists. Some GPs have used these lists to shift costs—traditionally part of the management fee—onto the fund. To address these concerns, transparency is key. Clearly define allowable expenses and ensure they align with industry norms. This helps avoid investor backlash and preserves credibility with LPs.

3. Transaction Fees: An Underutilized Opportunity

Transaction fees, such as board fees, broker fees, and other deal-related charges, can provide a valuable supplementary revenue stream for the GP. While these fees typically offset management fees on a 100% basis, there is room for negotiation. Emerging managers can often negotiate a reduction of the offset from 20% to 40%, allowing the GP to retain a portion of the transaction fees. To justify retaining part of these fees, GPs should highlight additional costs incurred, such as operational support, due diligence, or maintaining a strong deal flow network.

GPs can offer regular reports detailing transaction fees received and their allocation to provide LPs with greater comfort. These reports can include information on fees generated, how they are allocated, and any associated expenses, helping to build trust with investors and ensure alignment of interests.

4. Key Person Time Commitments

LPs typically expect key persons to dedicate all or substantially all of their time to the fund during the investment period and a reasonable amount of time thereafter. To provide flexibility, fund documents should broaden this definition to include time spent on the management company, not just the fund itself. This allows key persons to allocate time to other GP revenue streams, such as managed accounts, co-investment vehicles, and other investment strategies.

Restrictive definitions tying key persons solely to the fund can limit their ability to grow the business and develop additional revenue sources. By including time commitments to the management company, GPs can retain flexibility while ensuring LPs receive the dedicated focus they expect.

5. Distribution Policy

Where possible, GPs should negotiate for a flexible distribution policy that allows discretion to maintain sufficient cash reserves in the fund for timely payment of management fees and other expenses. Investors may push for timing requirements or caps on cash reserves, so GPs should carefully model their cashflows. This ensures that any agreed timing or cash reserve cap provides adequate protection for covering operational expenses on time.

Conclusion

By implementing these strategies, emerging managers can better manage cash flows, preserve critical revenue streams and position themselves for long-term success while maintaining alignment with LP interests.