An introduction to GP stakes

General Partner (GP) stakes have continued to capture headlines over the past several months and has seen a gradual rise in sentiment based on several factors. But to understand why GP stakes have continued to garner attention, and have drawn a growing number of alternative managers to the space it’s important to understand what GP stakes are, and the potential opportunities at play. 

In this piece we’ll dive into defining GP stakes, the mechanics behind these investments, and what may be at stake looking ahead. 

What are GP Stakes? 

GP stakes involve the acquisition of minority equity interests in the management companies of established private market alternative asset managers¹. This investment approach allows investors to secure an investment in a piece of the private asset management industry without taking on a controlling role. 

More specifically, GP stakes are direct equity investments that represent a minority ownership position, typically less than 25%, in a general partnership's underlying management company.² These stakes are usually non-controlling and non-voting, indicating a passive investment approach. 

Stakes can be held in various segments of the alternative asset market controlled by GPs, such as in asset classes like private equity, private credit, real estate, infrastructure, and venture capital. Like any equity interest in a private or public company, a GP stake is often a perpetual and transferable security, meaning it can, in certain circumstances, be financed, recapitalized, or sold. 

Investment Mechanics and Performance 

Investments in GP stakes seek to generate returns through multiple streams, including management fees on LP commitments in the GP, carried interest, balance sheet returns, and capital appreciation.³ These investments seek returns that can resemble private equity-like multiples of invested capital with ongoing cash flows similar to private credit or mezzanine financing.⁴ 

One of the main attractions of GP stakes is their high-yield potential. GP stakes investments seek returns ranging from 7% to potentially mid-teens over time, with mature portfolios potentially increasing in value1. The GP stakes fund structure is designed for a longer time horizon, typically exceeding ten years, allowing investors to avoid frequent reallocations. GP stakes investments seek stable returns achieved through the collection of management fees, which are usually not subject to fluctuation, which may also provide downside protection. Carried interest can offer growth opportunities based on a GPs existing and future fund performance. 

A diversified portfolio of GP stakes may further enhance this approach, offering numerous layers of potential downside protection. Diversification can be achieved across different strategies, vintages, geographies, and the sizes of the firms involved. This not only has the potential to smoothe out the investors' cash flows but may also align them with the broader growth trends in the private markets. 

Driving forces behind GP staking 

Several factors contribute to the popularity of GP staking: 

Secular growth trend

There is a notable growth in assets under management and fundraising within private markets,⁵ making GP stakes a strategic play on this expansion.

Consistent capital demand

GPs may frequently require capital for various financial and strategic enhancements to their businesses.

Financial

Minority stakes can enable GPs to engage in larger commitments to support fundraising, seed capital deployment in new products, or pursuing geographic expansion through mergers and acquisitions.

Strategic

Investment from larger and more reputable buyers can enable GPs access to greater scale and resources, from counsel and business support, to global distribution networks.

Changing value creation dynamics

Operational improvements in private equity are increasingly becoming a majority source of value creation in private equity, which differs greatly from years previously dominated by leverage and multiple expansion.⁶

Risks of GP stakes 

Like most private capital strategies, the main risk, among others, involves portfolio companies significantly underperforming in growth and profitability. Investors in GP Stakes need to closely monitor fundraising capabilities, fee structures, and market competition. GP stakes are also generally illiquid, and the secondary market for these investments may be considerably limited. 

The bottom line 

Investing in GP stakes presents a potential opportunity for those looking to benefit from the growth of the private markets while seeking to manage risks through a diversified, long-term investment strategy.