What is the path to exit for firms that buy minority stakes in GP management companies? Industry sources are asking the question, and it doesn’t seem to have a great answer.
The obvious exit is the public markets. The investors get paid when the firm goes public. But realistically, how many PE firms are going to go public? After the wave of mega-firm IPOs a few years back, firms don’t seem to be rushing to go public.
Sales on the secondary market have also been mentioned as an exit route, as have sales to strategic purchasers and even recapitalizations.
So there are a few options, but each comes with its own challenges. “The exit strategies aren’t perfected yet, but there are lots of smart people around the table and … they will figure it out,” said one market source.
Earlier this year New Mexico State Investment Council rejected making a commitment to Dyal Capital’s third fund, which buys stakes in private equity firms. Concerns mentioned by council members included unclear paths to exit.
Goldman Sachs, which buys minority stakes in hedge funds and PE firms through its Petershill funds, achieved an exit for this type of holding earlier this year. The investment bank sold minority stakes in five hedge funds to Affiliated Managers Group for about $800 million in June, according to Bloomberg. AMG owns hedge funds and private equity firms, including Pantheon.
I bring this up because this week Littlejohn & Co said it was selling a minority stake in its management company to Goldman. The announcement follows several others this year that taken together point to a trend in the PE industry.
The trend is this: GPs selling nonvoting minority stakes in their management companies. Other firms that have sold stakes include H.I.G. Capital, Vista Equity Partners, Providence Equity and Silver Lake.
This type of deal is likely to continue, sources tell me, in part because several firms are raising capital for the strategy. Dyal is targeting $2.5 billion for these types of investments. Hycroft wants to raise $750 million for the strategy, and Goldman raised $1.5 billion for its Petershill II fund.
Also driving this type of transaction is GPs’ constant need for capital to expand their businesses, said an industry consultant. Rather than following the rigorous path of raising a fund to expand into a new strategy, which can take more than a year and comes with no guarantee of success, selling a small stake is a quick way to bring in capital for expansion without giving up control.
The key word in describing these types of transactions seems to be “nonvoting.” The buyer takes a non-voting minority interest in the management company.
Non-voting is important because this way the GP gets an influx of capital without giving up control of the operation or the direction of the firm.
“GPs are more than happy to take in a minority, 10 percent owner who has no rights and do so at a high valuation,” said a limited partner.
The LP continued: “You have an industry … that needs capital for various things: partner movements, GP investments, product proliferation. That industry has a high rate of return on equity and so owning pieces of these firms has generated good cash-flow returns. That is a good dynamic for investors and investees.”
Photo: Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky