GI Partners frustrates LPs by switching to deal-by-deal profit sharing

The switch by GI Partners, the Menlo Park, California, private equity firm, to deal-by-deal profit sharing on its newest fund has so frustrated some limited partners that they have passed on investing, Buyouts has learned.

At least two LPs told Buyouts they are passing on Fund V in part because of the carry-distribution shift.

The so called deal-by-deal distribution waterfall lets a general partner get paid carried interest after each exit so long as it meets a preferred return for investors. GI Partners has proposed the term on its Fund V, in the market targeting $2.3 billion.

Under terms of the prior fund, a $2 billion pool closed in 2014, the GP first had to pay back LPs committed capital before sharing in profits, a method known as a European-style distribution waterfall, three sources told Buyouts.

GI Partners did not respond to questions for comment. It’s unclear whether the deal-by-deal carry structure is being proposed across the investor base, or whether those making larger commitments would be offered something more LP-friendly.

Also unclear is whether GI Partners has held any closes on the fund. If not, the firm could potentially modify the terms offered.

Waterfalls

LPs are generally happier with European-style waterfall distributions. This is because these eliminate the risk that the GP collects profits on early deals only to have to pay a clawback obligation later because the fund as a whole fell short of anticipated returns.

In a strong fundraising environment, however, more GPs are pushing to collect profits after they exit each investment in a fund. GPs like this model because it pays them right away for strong exits and, depending on how carried interest flows through the organization, younger executives don’t have to wait until the end of the fund to collect their share of profits.

Some GPs say that having a European-style waterfall distribution, also known as back-ended carried interest, makes them less competitive for talent, sources told Buyouts.

“It’s surprising to me that more firms aren’t [switching to deal-by-deal carry] just because there’s so much demand for access,” said a pension LP who has talked to GPs about various profit distribution structures. “What you hear … from managers with European waterfalls is … it’s harder for them to compete for talent.”

LPs that talked with Buyouts for this article said firms don’t often move from an LP-friendly distribution waterfall. Since it launched in 2001, GI Partners has had a strategic relationship with California Public Employees’ Retirement System, with CalPERS providing $500 million to the firm’s initial $526 million fund. Over time, CalPERS provided anchor commitments to subsequent funds as the firm expanded its LP base. It’s possible that GI Partners struck the LP-friendly carry-distribution structure under its partnership with CalPERS but is making the change now in this strong fundraising environment.

A spokesman for CalPERS declined to comment.

About 53 percent of North American buyout funds require all contributed capital to be returned to LPs before GPs start to collect carried interest, according to Buyout Insider’s 2016/2017 PE/VC Partnership Agreement Study. Thirty North American buyout funds responded to the survey. Of those, about 33 percent of North American buyout funds use deal-by-deal carry structure, the study said. Participants in the study held final closings on their funds from 2008 to 2015.

Around 13 percent of North American buyout respondents require all committed capital to be returned before the GP starts to collect carry, the study said.

Fund Performance

The firm, led by Executive Managing Director and Founder Rick Magnuson, invests in tech, media and telecom, healthcare, retail and leisure and business and financial services.

GI has about $10.7 billion of discretionary and non-discretionary assets under management, according to the firm’s Form ADV.

GI Partners closed its third fund on $1.9 billion in 2009; its second fund on $1.45 billion in 2006; and its debut fund on $526 million in 2001, according to data provider Pitchbook.

Fund IV was generating an 11.25 percent net internal rate of return and a 1.2x total value multiple as of Dec. 31, 2016, performance information from Washington State Investment Board shows.

Fund III was producing a 12.8 percent IRR and a 1.53x multiple as of that date, Florida State Board of Administration data shows.

Fund II was producing a 7.5 percent IRR and 1.58x multiple while the first fund had a 31.6 percent IRR and a 1.94x multiple as of the third quarter of last year, Pitchbook said.

Action Item: Check out GI’s Form ADV here: http://bit.ly/2fPzc7b

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