LPs throw up caution flag on minority-stake sales

  • Fees, carry should go to people earning return: Mitimco’s Rainey
  • Minority-stake sales “raise flag” in diligence: LP
  • Market booms as firms, LPs raise money for stakes

Selling a minority stake in a private equity firm’s management company can be a useful tool for firms looking to expand their investment teams or transition to a newer generation of leadership.

They can also be a red flag, said LPs at Massachusetts Institute of Technology’s Venture Capital and Innovation Conference on Feb. 9.

“The partnership needs to own the firm,” said Michael Rainey, who manages private investments at Massachusetts Institute of Technology Investment Management Co.

Rainey, along with Mercer CIO Ken Shimberg and Boston Children’s Hospital CIO Philip Rotner, discussed his concerns with such deals while speaking on a panel at the conference.

Stake sales

While the terms of each deal are unique, stake sales often entitle the minority investor to a share of the fees or proceeds generated by fund investments.

For some LPs, that arrangement raises the possibility that their interests as fund investors are misaligned with those of the team managing the investments.

“We like the fees and the carry that we’re paying to go to the people earning the returns,” Rainey said.

Separately, another LP at the event said minority-stake sales “raise a flag” in due diligence. While partners might pitch sales as a way to expand the firm’s investment platform or bolster its bench of investment talent, they also throw the partnership’s long-term prospects into question, he said.

A growing number of PE firms have sold stakes in their management companies to third parties, including to other PE firms like Blackstone Group and Neuberger Berman’s Dyal Capital.

LPs have entered the market as well. Buyouts reported Aea Investors sold a portion of its management company to RDV, which manages the DeVos family fortune. Riverside Co sold a 10 percent stake to the Cleveland multifamily office Parkwood LLC in 2017.

The rush of capital dedicated to acquiring management-company stakes has driven up valuations, effectively encouraging more firms to explore partial sales.

Speaking late last year at a Buyouts Insider PartnerConnect conference, TorreyCove Capital Partners President and CEO David Fann characterized the market as a “land grab.”

Action Item: More on MIT’s conference: www.mitvcconference.com/

The Samberg Conference Center hosted the MIT VC + Innovation Conference on Feb. 9, 2018, in Boston. Photo by Sam Sutton, Buyouts.