First-time GPs should put ‘every dime you have’ in first fund: panelist

How much is enough to represent sufficient “skin in the game” as it relates to a new private equity manager’s monetary commitment to his or her own fund?

That was a question posed at Buyouts Insider’s Emerging Manager Connect conference in New York this week.

The answer? “Effectively, you should mortgage your house, you should put every dime you have into that fund,” said Andre Rice, president of Muller & Monroe Asset Management, who spoke on a panel at the conference.

“I’m not asking someone to impoverish themselves and risk their ability to feed their family [but] I have to believe that if this thing fails, I want you at home sobbing,” Rice said.

The ultimate question: “Is the team putting in enough money so I know … they’re really worried about the portfolio. We put in a lot of money and they put in a little, relatively speaking. We expect them to write big checks—relative to their net worth.”

GP commitment has long been a major concern of limited partners who invest money in private equity funds. GP commitments generally fall in a range from 1 to 5 percent of total commitments, according to Buyouts Insider’s PE/VC Partnership Agreements Study 2018/2019.

Only 7 percent of North American GP respondents made contributions of 5.1 to 10 percent, while 10 percent of such GPs made commitments of more than 10 percent, the study found.

GPs make such commitments either in cash or in a representative way by waiving management fees for LPs. The waiver converts management fees paid by LPs to be used to fund the GP commitment. This helps with a GP’s tax bill because management fees are taxed as regular income, while the GP commitment is treated at the lower capital gains rate.

Institutional Limited Partners Association doesn’t recommend a GP commitment size, but does advocate that GPs make their commitments in cash rather than through management fee waivers.

“I think the inability of young GPs to commit sizable dollar amounts to their funds is a major reason why people don’t commit to first-time funds,” Jim Bethea, chief investment officer at University of Iowa Center for Advancement, said in a separate email.

“Too many people are worried about “more than X%” rather than how much of the GP’s liquid net worth is committed. LPs have to remember that Fund I will probably not be paying [carried interest] to the GP when they have to raise Fund II as well. Don’t get me wrong, larger GP commits are better than smaller ones but if we are truly partners we need to have a more in-depth conversation than what percentage is the GP commit. If its below 1 percent, then you are probably raising too much money.”

The size of the check also varies depending on the amount of wealth a founder has amassed. Someone who has made millions working for years at a large established firm might put in a big GP commitment, but the concern then becomes that the fund is just a mechanism for wealth management, said Ed Powers, managing director at HarbourVest Partners who works with emerging managers. Powers also spoke on the panel at the conference.

“We want people on that edge who have that hunger,” Powers said.

Action Item: Read the ILPA principles here: