Research Report: GP Stakes Strategies: Investing in the Firm not the Fund
Over the last five years, assets under management for private capital have grown 8% annually to reach about $13.3 trillion[1]. The largest firms have been the greatest beneficiaries, achieving double-digit growth over this period. This is the bar bell nature of the industry today – a mass of small, single strategy firms at one end and a small but growing number of mega, multi-strategy players at the other.
As the multi-strategy firms look to grow further and the larger of the single strategy firms look to branch out into new product areas, they typically execute in one of two ways. They will either grow their own new business lines by shifting resources and hiring piecemeal. Or they will acquire new teams or businesses with the necessary expertise and create a fully-fledged product from day one. Both are capital and resource intensive and GPs are increasingly on the look-out to attract investment to support their own business development.
At the same time, certain LPs are looking creatively at new investment opportunities within the private markets ecosystem as the asset class has seen very profitable growth. Together these trends have encouraged the rise in GP stakes transactions – involving the acquisition of an ownership interest in the private capital firm itself, rather than a commitment to the funds they manage. It’s not a new concept, but it’s one that’s been steadily gaining momentum in a constrained cash, deal and exit environment. And it can be a win-win for both GPs and LPs.
An evolving buyer universe
Just a decade ago, the number of players in the GP stakes market could be counted on one hand. Since then, the strategy has built credibility as both a viable and durable one. Investors have warmed to the market – particularly those seeking greater alignment and collaboration with their managers, not to mention the opportunity to share in the enterprise value they are helping to build. The Private Equity International LP Perspectives 2024 Study found that almost half of respondents have either invested in GP stakes funds or plan to do so, up from 36% just a year earlier.
GP stakes investing has primarily been the preserve of large, institutional players, with sovereign wealth funds and other significant LPs leveraging their relationships with large GPs to take a minority stake in the firm and become strategic partners. There are also funds exclusively dedicated to taking GP stakes. Investors in such funds can participate in the earnings of multiple private capital managers, through a diversified exposure to asset classes, strategies, market segments, geographies and vintages. There are reportedly 15 such vehicles in the market seeking over $30 billion, up from $17 billion of fundraising through 2022-3[2].
In an environment of slow asset realisations and distributions, the strategy’s unique return profile, in the form of a steady income stream that mitigates the “J-curve” effect, is a seductive selling point. Income sources for GP stakes investors include locked-in contractual management fees that offer downside protection; with carried interest, capturing potential growth upside; and value appreciation for the stake itself if the GP successfully grows the business. Most GP stakes funds are estimated to be targeting 8-12% annual net cash on cash yields, comparable to senior secured private credit strategies[3].
As LPs increasingly hunt for routes to DPI that aren’t contingent on asset realizations, the buyer universe for this defensive business model continues to expand with some estimating that the total market for GP stakes could exceed $50 billion annually[4]. Private wealth investors are one such group. Historically under-exposed to private markets, they are developing a taste for the visibility on cashflows as well as the diversified access to private markets – but without the burdensome costs and complexities typically associated with accessing such a broad array of alternative investments.
Ripe in the middle
The pipeline for GP stakes is ripe, and it’s not just the mega-funds. Research from Wafra[5] suggests there are over 2,500 GPs available to be bought into. And with just 3.6% of mid-cap firms having sold stakes[6], the middle market represents an untapped opportunity. With lower entry multiples there is the potential for outsized returns.
For the GP stakes investor, there is more room to add value beyond just financial capital. Whether it’s providing a lower middle-market manager in need of fundraising support with access to distribution channels or guiding an upper-middle-market manager at an inflection point in their development. The intellectual capital they can offer varies from sector know-how for GPs exploring new strategies or business lines, to help with reaching the private wealth market among other value creation levers.
Smaller and emerging managers are also well-placed to benefit from the strategy – indeed, many GP stakes funds have emerging manager capabilities. This is all the more valuable in the tough fundraising landscape where investors are gravitating towards managers with a long track record in a “flight to familiarity”. A GP stakes investor can provide much-needed capital to fledgling managers, along with HR and operational assistance to support, for instance, strategic hires, ESG, cybersecurity and AI-deployment capabilities.
One pocket of growing interest across both emerging and established managers has been “seed and stake” deals, where the stake in the GP is linked to substantial fund commitments. The seeder receives returns from the fund investment while also sharing in the fund manager’s economics – typically through revenue sharing or profit participation. However, such arrangements are complex, requiring careful consideration of legal and structural factors.
No longer small beginnings, but still early days
Market sentiment has shifted from scepticism to appreciation of the GP stakes strategy as a solutions provider. While there is a proliferation of activity, it’s important to recognize that it is still relatively early days. For the traditional fund LP, ownership and debt financing at the GP level will remain a key point for due diligence. Other things to consider are potential conflicts of interest – while GP stakes investors will want to see a rise in assets under management, LPs are more focused on returns and often wary of accelerated AUM growth. Still, with strong correlation between LP returns, carry and GP value, this clash in interests need not translate to misalignment.
The rise of GP stakes investing signals a maturing private equity landscape where both GPs and LPs are rethinking traditional boundaries. As performance data builds, more investors will be encouraged to dip their toes in the GP stakes pool to diversify their exposure to the asset class and potentially benefit from a differentiated return profile. Meanwhile, GPs willing to embrace the model could unlock new opportunities to raise capital, grow strategically, and set a foundation for long-term succession. For both buyers and sellers, understanding the nuances of these deals will be critical to unlocking their full potential. As private markets enter a new era of accessibility and innovation, GP stakes will certainly be a space to watch.
[1] https://www.pwc.com/gx/en/services/deals/trends/private-capital.html
[2] https://www.bfinance.com/insights/gp-stakes-funds-seek-us-30bn-with-promise-of-private-equity-plus-yield
[3] https://www.investcorp.com/wp-content/uploads/2023/10/GP-Stakes-Whitepaper-Oct-2023-vF3.pdf
[4] https://gunungcapital.com/strategic-insights-on-private-credit-secondaries-and-gp-stakes/
[5] https://www.privateequityinternational.com/why-gp-stakes-is-the-strategy-of-the-moment/
[6] https://altgoesmainstream.substack.com/p/when-funds-become-firms-our-partnership
