PE Principals & Partners of WSO - I find myself in what I think is a fairly unique scenario. I'm going to have to be frustratingly opaque to maintain any confidentiality, but I'll do my best to get at the heart of the issue.
My firm has advised a group of family offices for many years. Started out on M&A work and have gradually worked into more ongoing portfolio company oversight and investment strategy. The group of offices is related but independent and so they have different personalities and investment styles, which we have worked to accommodate. (Should also mention that they each have a CIO of sorts and investments in a variety of public and private asset classes, and our work has been focused on whatever their direct private equity allocation has been.)
One of them has proposed a formalization of the structure, that codifies us as a GP and them as LPs and irons out roles and responsibilities and economics. I love the idea in concept, as I've never been totally comfortable with the informality of the arrangement and this would enable us to "lock up" the relationships and staff appropriately.
The devil is in the details, though. We're not talking about just spinning up a PE fund with a group of anchor investors; we're talking about these groups contributing a mix of cash and existing ownership interests in operating companies (not all of which are 100% owned by these groups) that would constitute our "fund." My concerns are:
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Relative valuations of contributions will be a mess. Everyone always thinks their portion is worth more than someone else's.
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Not all of the assets are ones we would have invested in, and I don't think we can cherry-pick the best ones for inclusion in the "fund" and leave out the rest. Any economic mechanics will have to account for the heavy lifting required on the "dogs."
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I don't have a great idea as to how to structure our economics off of this kind of vehicle - it's envisioned as an evergreen investment vehicle, and the ability to grow AUM is likely more a function of cash generation from inside the fund than additional external contributions. It seems like it lends itself more to a heavy management fee and less of a promote/carry mechanism, but at the same time that seems like a less healthy way to align incentives.
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Governance is going to be tricky. I would love to hear how others have navigated LP relationships that want to be ultimate decision-makers on an IC but still want someone else to do the work. I'm leaning towards the tough conversation of "look, if you want us to truly be principals, then we need to be principals, and that means having authority and matching the economic incentives appropriately" but I'm open to ideas.
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They're all a bit different. They all like working with us and are supportive of the idea of us taking a larger role but are unsure how their own idiosyncracies will be preserved. I also don't know, short of building in sidecars / sleeves, which then opens up the risk of the perception of not treating each member equally / fairly / with equivalent attention. (They're a range of sizes, of course.)
Figured I'd throw this out into the WSO ether and see what others' experiences have been. Would be glad to chat over DM as well if it helps keep things under the radar. Thanks in advance for your thoughts.
Should have thrown up the bat-signals in the body. APAE, m_1, Whiskey5, CompBanker. All thoughts welcome.
Given what you mentioned, I don’t think letting everyone use their existing companies as LP commits makes sense, especially if you do not believe their companies meet your investment criteria. Otherwise you're going to be starting on a bad note, which makes your job less enjoyable and it will be harder to recruit/build out this PE function down the road.
I spent quite a bit of time doing research on evergreen economics, but couldn’t find anything “great” in the LMM size range. There’s some material floating around on larger MM+ size funds…but nothing for LMM really, unfortunately. Maybe worth speaking to the Permanent Equity guys to see how they structured things?
My main concern if I was in your shoes is that I would end up with a ton of responsibility, but no power to make the decisions I feel would generate the highest quality returns possible. Depending on how much involvement these family offices want, the other concern would be speed + flexibility. As you know, speed is a big differentiator that can help you win deals as is flexibility. Family offices are often too slow and have weird issues with certain ideas.
Tangential sidenote…
To me, this is almost a question about the fundamental business itself that you are in.
This is one of the huge advantages of running on something like EOS or Verne Harnish’s Scaling Up. It simplifies decision making across every aspect of running a company. I didn’t realize how much faster we could move with a strong vision. I used to think people that went on and on about vision were nutty guys with too much money until I saw it in action. I know this is kind of weird/useless feedback though lol 😊
Line-by-line responses are my favorite! Here we go:
Generally agree. The good part is that for say 90% of the assets, the existing companies would be great businesses to manage from this point forward. It's that last ~10% that would be a headache until we could divest them (part of why the autonomy over fund decisions matters so much).
Mad I didn't think of this first. They aren't a true evergreen fund per se, since their fund is a 25-year fund with two one-year extensions, so there has to be some way for them to earn from the outset. I'll ask.
What's your familiarity with EOS? I had never heard of it before a few years ago, and now I've seen it mentioned in a few places. I've always been big on some kind of "management system," a somewhat rigid management framework that forces attention on things that actually move the needle. I was exposed to the A3 management process early on and have rabbit-holed into other management and problem-solving frameworks over time.
Anything that cuts down meeting time is big for me. Especially boards. Listening to boards talk in circles drives me nuts.
I don’t have much to add, but think like an owner is a podcast that has had some permanent capital episodes.
Come across a similar situation as yours quite a while ago. The plan was to roll in the assets into a fund, and GP would go raise on the back of that. Our mandate was to advise on appropriate consideration/economics and governance to the contributing party.
Fell apart on exactly the points you mentioned, (a) "seller" had an all or nothing approach of either take all the assets (with some absolute writeoffs in there) or walking , (b) parties were worlds apart on value, like not even close, and (c) could not agree on a governance structure where the GP could be fairly independent, or at least unburdened in decision making.
We tried a bunch of avenues, including giving the seller a combination of GP and LP units, but just could not get around the above three issues without unreasonably complex structures and mechanisms. It's one of those mandates that still bothers me because it felt like there was a workable solution somewhere but we just couldn't get to it.
Would be very curious to see where you land up if you are able to share.
Appreciate the thoughts - your comments are both encouraging (because this has been attempted before) and discouraging (because it failed). I'm probably least worried about the health of the portfolio of assets - the poor-outlook ones are enough in the minority that I don't think we'd have much trouble divesting them and limiting exposure. It's just more of a headache to have to do that then to just not contribute them in the first place.
m_1 brought up a good point - the value creation is much heavier on the ability to oversee and optimize the portfolio than it is finding and executing deals. It's more like being the corporate strategy and corporate development arm over a conglomerate than it is being a private equity firm ... although I guess depending on the velocity of deals and the economics, those lines start to blur.
All of that to say that we'd probably trade high-level independence (making big moves unilaterally) for oversight/approval for the big stuff (major acquisitions and divestitures) and hands-off for the smaller stuff (implementing strategic plans and management systems at the portcos, hiring management, comping according to plan, capex approval, financing at portco level, etc.).
I'm hopeful we can come to some resolution on this but I suspect it will evolve over time. These organizations are not known for moving quickly.
Interesting the valuations were so far apart. Was the GP being completely unrealistic or the LPs?
I too am still considering rolling our existing portfolio companies in as our GP commit, but based on feedback I received from this forum, it seemed like I was better off holding the asset on my own or selling it and doing my commit in cash. So now our plan is dividend recap -> gp commit in cash & keep the asset ourselves.
Mainly wanted to use that portfolio as commit because I have been running it since 2019 and know it will outperform -> help us ensure our track record is awesome for a larger subsequent fund. :)
Was a corporate portfolio that was basically punted down through a bunch of managers with different approaches, so a really really eclectic mix of assets to put it politely. Part of why "seller" had an all or nothing approach to the commit, trying to squeeze out whatever they could get. Likely a very different outcome if they were frankly, better assets.
I didn't really (and honestly still don't) grasp the GP's rationale other than having a portfolio and partner to raise on the back of. It's the only time I've worked on something of this kind, very out of my wheelhouse. Your post was super insightful, thanks for sharing.
Hey man. Love seeing you back on here.
My advice: don't straddle the middle, either do a fund (where you are an autonomous GP) or don't accept the headache.
This sounds rife with difficulty.
If for some insane reason you're committed to doing this because you are both a glutton for punishment and interested in fostering these longstanding relationships even further, a way better structure is to do this as an investment corporation.
The immediate objection is "Oh my god, double taxation!", but not only is there all kinds of tax optimization you can do, but the whole idea is that you don't actually issue distributions, you use them to fund further growth initiatives and make new investments.
This solves a lot of your issues.
This structure really works for your circumstance. You get paid for all the work you do. Instead of a management fee, you negotiate an executive compensation program that the board approves. Your shares are your long-term incentive, and because the operating distributions provide you the cash basis for further acquisitions or investments, you actually get to skip the fundraising timesuck of the fund business model. If you decide you need more capital than that path offers, you can do an equity raise at the holdco level. The easiest audience is that same set of families. The broader audience is the entire institutional investor universe.
You can run this as long as you want. If it's your forever thing, congrats. If it's for five, eight, whatever time it takes to monetize either the entire holdco or just your personal position, perhaps as part of a transaction with the first external investor joining the company, that's great and you just earned both the GP commit and track record to set you up for a traditional fund unencumbered with all the idiosyncrasies your original idea here presents.
I promise I'm not as dumb as I look (not that any of you know how I look). There obviously must be some major incentive for me to do this that makes it attractive enough to consider ways to mitigate the main pain points. You're not wrong in your assessment of the challenges - and I agree that on the surface, going the route of a traditional fundraise is much, much cleaner - but I can't share all the specifics.
I can say that the contemplated assets would immediately make this a meaningfully larger fund than I could raise.
The purpose of this is to be a forever thing. Whether it's my forever thing is a different question, but this entity will be hard to unwind once it's rolling. I like the idea of owning shares and being paid a management comp plan as an alternative to a classic management fee / carry setup.
"My advice: don't straddle the middle, either do a fund (where you are an autonomous GP) or don't accept the headache."
100%
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