GP LP Structure


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GP LP Structure

  1. 1. GP/LP STRUCTURE How Private Equity Firms are Formed
  2. 2. GP / LP Presenters <ul><li>June Dutta formerly of AIG Investments </li></ul><ul><li>Justin Dupere formerly of GTCR Golder Rauner, LLC </li></ul><ul><li>John Hennegan formerly of Henry Crown & Co. </li></ul>
  3. 3. Legal Structure of a Fund <ul><li>The Fund: This is the Limited Partnership formed for the specific purpose of investing money (eg. Blackstone Capital Partners VII, L.P.) </li></ul><ul><li>The Manager: This is the Firm that structures the Partnership and is responsible for managing the fund being raised. (eg. Blackstone Capital Partners, LLC). </li></ul><ul><li>The General Partner: The general partners of a fund will be organized as a limited partnership controlled by the fund Manager. The General Partner of each Fund will make all investment decisions for the Fund. </li></ul><ul><li>Term of a Private Equity Fund: Typically 10 years, with 2-3 year extensions with the approval of the Limited Partners. </li></ul><ul><li>Investment Period: Typically 5-6 years. </li></ul>
  4. 4. General Partner / Limited Partner <ul><li>A Private Equity Fund comprises two parties: the General Partner and the Limited Partner </li></ul><ul><li>General Partner: The partner in a limited partnership responsible for all management decisions of the partnership. The GP has a fiduciary responsibility to act for the benefit of the limited partners (LPs), and is fully liable for its actions. </li></ul><ul><li>Limited Partner: An investor in a limited partnership. LP's have limited liability and usually have priority over GP's upon liquidation of the partnership. However, they have no control over the daily management of the Fund. </li></ul>
  5. 5. Types of LP’s <ul><li>Institutional Investors: Professional entities that invest capital on behalf of companies or individuals. </li></ul><ul><ul><li>Insurance Companies </li></ul></ul><ul><ul><li>Pension Funds </li></ul></ul><ul><ul><li>University Endowments </li></ul></ul><ul><li>High Net-Worth Investors </li></ul><ul><li>Fund-of-Funds: A fund created to invest in private equity funds. Typically, individual investors and relatively small institutional investors participate in a fund-of-funds to minimize their portfolio management efforts </li></ul>
  6. 6. Criteria Required to Raise a Fund <ul><li>General Partner’s Track Record: </li></ul><ul><ul><li>Top-down analysis at the Fund level: quality of the fund manager, size of the commitment, percentage drawn, percentage undrawn and general profile of the underlying deals </li></ul></ul><ul><ul><li>A bottom-up analysis employed to ascertain the risk-return profile of the fund’s underlying investments. Items include financials of the underlying portfolio companies, valuation of the companies at the time of acquisition vis-à-vis their valuations in the current market, companies’ capital structure and assumptions of follow-on financing, industry exposure, and exit horizons. </li></ul></ul>
  7. 7. Criteria Required to Raise a Fund <ul><li>Investment Strategy: Investment criteria, industry focus, control/minority position, consistency of investment strategy, sources of deal flow, deal exits </li></ul><ul><li>Management Team: Management team bios, industry expertise of the Partners, industry Rolodex, deal sourcing and execution capabilities, number of board seats, performance of deals, key-man clause. </li></ul><ul><li>Consistency in Terms and Conditions: Changes in legal terms of the Fund, including management fees, carried interest, key-man etc. over time. </li></ul><ul><li>Other investors: Ability of the General Partner to source other reputable investors </li></ul>
  8. 8. General Terminology <ul><li>Target IRR: This is the return that the General Partner hopes to achieve over the life of its fund. </li></ul><ul><li>Hurdle Rate: The internal rate of return (IRR) that a fund must achieve before its general partners or managers may receive an increased interest in the proceeds of the fund. </li></ul><ul><li>Carried Interest: It is a share in the profits of a private equity fund. Typically, a fund must return the capital given to it by limited partners plus any preferred return before the general partner can share in the profits of the fund. </li></ul><ul><li>Key Man Clause: If a specified number of key named executives cease to devote a specified amount of time to the Partnership, the manager of the fund is temporarily suspended from making any further new investments. </li></ul>
  9. 9. Committed vs. Invested Capital <ul><li>Committed Capital: Committed Capital is the total dollar amount that an individual LP agrees to commit to a fund over the life of the fund. The committed capital is not drawn at once. </li></ul><ul><li>Invested Capital: Commitments allocated to a Fund are drawn down pro rata (based on such Commitments) on an as needed basis (to make investments, pay management fees etc.) The General Partners typically give Investors a minimum of 10 business days’ notice of a drawdown. </li></ul>
  10. 10. Committed Capital <ul><li>Committed Capital is the total dollar amount that an individual LP agrees to commit to a fund over the life of the fund </li></ul><ul><li>Depending on the size of the fund, most funds have a targeted minimum and maximum amount of capital that each LP can commit </li></ul><ul><li>Different LP’s can commit different amounts of capital to a fund </li></ul><ul><li>Committed Capital is a legally binding commitment that is made during the fundraising process; the amount generally cannot change once a fund has been launched </li></ul><ul><li>Committed Capital is not paid by the LP’s when the fund is created; it is drawn dawn over time as the fund makes investments </li></ul>
  11. 11. Capital Call / Drawdown <ul><li>When an investment is made, a GP makes a Capital Call to its LP’s in order to receive the capital required to make the investment </li></ul><ul><li>Capital Calls are made as a % of total committed Capital (i.e. a fund may call 10% of total Committed Capital from all LP’s) based on how much money is required for a particular investment </li></ul><ul><li>Capital Calls are typically made during specified periods throughout the year (i.e. quarterly) during which investments are made </li></ul><ul><li>Funds can often draw down on a bank facility (or similar arrangement) to bridge the funding of an investment until a Capital Call is made and money is received from LP’s </li></ul>
  12. 12. 2/20 Fee Structure <ul><li>The GP is paid primarily through two types of fees: a Management Fee and a Carried Interest Fee </li></ul><ul><li>The Management Fee is paid annually to the GP and is calculated as a percent of total Committed Capital </li></ul><ul><ul><li>The most common Management Fee is 2% of Committed Capital, paid annually </li></ul></ul><ul><ul><li>Management Fees are typically used to pay GP salaries and overhead costs </li></ul></ul><ul><li>The Carried Interest Fee is the GP’s share of the profits generated by the fund’s investments </li></ul><ul><ul><li>20% is the most common, however it can vary across funds </li></ul></ul><ul><ul><li>The GP does not have to commit capital to earn its Carried Interest </li></ul></ul>
  13. 13. Distributed Capital <ul><li>Each investor’s proportionate share in the net proceeds received by the Partnership Fund is distributed in the following order of priority: </li></ul><ul><ul><li>First, 100% to each Limited Partner in proportion to its respective capital contributions to such Fund, including their capital contributions for investments, management fees, and a preferred return of typically 8% per annum, compounded annually. </li></ul></ul><ul><ul><li>Second, 100% to the General Partner until the General Partner has received a percentage equal to the Carried Interest Percentage of the sum of the aggregate amounts distributed </li></ul></ul><ul><ul><li>Thereafter, the Carried Interest Percentage to the General Partner and the remainder to each Limited Partner in proportion to its respective capital contributions to the Fund </li></ul></ul>
  14. 14. Closing a Deal <ul><li>LP’s typically do not have any approval rights over investments; that decision lies with the GP </li></ul><ul><li>In some instances, funds may employ an LP Board which is used to screen deals prior to the final investment decisions </li></ul><ul><li>After an investment decision is made, GP’s often prepare a press release for their LP’s followed by a memorandum which describes the investment </li></ul><ul><ul><li>Topics covered include a description of the business, investment thesis, risks, financing arrangements, ownership structure, financial metrics, and valuation metrics </li></ul></ul>
  15. 15. Deal Fees <ul><li>Funds often charge a deal fee (aka Closing Fee or Transaction Fee) at the time of an investment </li></ul><ul><li>Treatment of these fees vary across funds </li></ul><ul><ul><li>For some funds, the fees accrue to the benefit of the GP (and in some instances, even specific Principles who work on the investment) </li></ul></ul><ul><ul><li>For other funds, the fees (or some portion of the fees) may offset the Management Fees paid by annually by the LP’s, which effectively raises the IRR for the LP’s </li></ul></ul><ul><li>Following an investment, funds may also charge their portfolio company an ongoing annual management fee </li></ul>
  16. 16. Ongoing Communication with LP’s <ul><li>The GP will provide the LP with regular reporting packages (quarterly, semi-annually) throughout the year to provide updates on the performance of the fund’s investment </li></ul><ul><ul><li>The GP provides valuations, or Carrying Values, for each investment in the fund. Carrying Values can be based on cost, FMV of securities (if publicly traded), comparable multiples, or can reflect impairments in the business relative to the original investment </li></ul></ul><ul><li>Funds host LP meetings at least once a year in which representatives from the various LP’s can gather in person and listen to presentations from the GP and portfolio company executives regarding the performance of the fund and its specific investments </li></ul>
  17. 17. LP Co-Invest <ul><li>In some instances, the amount of capital required to make an investment may be larger than a fund is comfortable committing to a single investment </li></ul><ul><li>LP’s are often utilized as potential co-investors in such instances, where the LP will invest side-by-side with the fund in a deal </li></ul><ul><ul><li>LP’s will have access to more detailed information regarding a potential investment if they are considering a co-investment </li></ul></ul><ul><li>LP Co-Investment does not count toward the LP’s Committed Capital; it is made outside of the commitment </li></ul><ul><li>LP Co-Investment allows the LP to earn returns that are not subject to the Carried Interest Fee, however the risk is more concentrated than investing in the fund as a whole </li></ul>
  18. 18. Exiting Deals <ul><li>Funds will distribute proceeds to LP’s following a liquidity event </li></ul><ul><ul><li>Dividends </li></ul></ul><ul><ul><li>Recapitalization (debt or equity) </li></ul></ul><ul><ul><li>Public offering </li></ul></ul><ul><ul><li>Sale of the company </li></ul></ul><ul><li>Proceeds are distributed to the LP net of the GP Carried Interest, if applicable (i.e. if a gain is realized) </li></ul><ul><li>Funds will most often distribute cash to LP’s, however occasionally the fund will distribute securities (i.e. shares in a publicly traded stock) if a cash distribution is less feasible </li></ul>
  19. 19. Raising the Next Fund <ul><li>Although the exact timing varies by firm and market conditions, it is important to always have dry powder </li></ul><ul><li>In general terms, a firm will begin discussing the next fund after the current fund is 50% invested and </li></ul><ul><li>Fund raising typically begins when there is enough remaining “dry powder” for 3-4 deals </li></ul><ul><ul><li>Typically, this is approximately 15% of committed capital, and allows the fund to invest in add-on acquisitions to existing platform deals </li></ul></ul><ul><li>When raising the next fund, LPs will most heavily weight the prior fund’s exits when determining past performance </li></ul><ul><ul><li>While the fund will mark-to-market remaining portfolio companies, LPs prefer to see external market validation of fund performance </li></ul></ul>
  20. 20. Raising the Next Fund (cont’d) <ul><li>When going back to LPs for the next fund: </li></ul><ul><ul><li>Returns must match those promised in fund docs </li></ul></ul><ul><ul><li>Quartiles, Deciles </li></ul></ul><ul><ul><li>“ We’re top quartile, just like everyone else…” </li></ul></ul>
  21. 21. Ongoing Valuation <ul><li>Important to keep LPs aware of current performance </li></ul><ul><li>LP updates vary by firm but general methods include: </li></ul><ul><ul><li>Annual LP meetings and reports </li></ul></ul><ul><ul><li>Quarterly performance updates </li></ul></ul><ul><li>Investment valuations and LP updates often outsourced to specific groups within the firm or outside parties </li></ul><ul><ul><li>In a post-MBA role you’ll most likely answer questions / provide brief write-ups on current events etc. </li></ul></ul><ul><li>Impact of FAS 157 </li></ul><ul><ul><li>No longer allowed to carry investments at cost </li></ul></ul><ul><ul><li>Limited (or no) liquidity for PE investments </li></ul></ul><ul><ul><ul><li>Secondary market is growing (recent WSJ article on Goldman secondary markets) </li></ul></ul></ul><ul><ul><li>Requires conservative valuations (see Blackstone) </li></ul></ul>
  22. 22. Ongoing Valuation (cont’d) <ul><li>Impact of FAS 157 </li></ul><ul><ul><li>No longer allowed to carry investments at cost </li></ul></ul><ul><ul><li>Limited (or no) liquidity for PE investments </li></ul></ul><ul><ul><ul><li>Secondary market is growing (recent WSJ article on Goldman secondary markets) </li></ul></ul></ul><ul><ul><li>Requires conservative valuations (see Blackstone and recent Sam Zell discussion) </li></ul></ul>