Editor’s Letter: GPs push for deal-by-deal carry in record fundraising market

In today’s record-breaking fundraising market, GPs are negotiating hard to get terms they like.

One of those is to ensure they get paid after exiting each investment in their fund, rather than waiting until the LPs get paid back before they can start collecting profits. In other words, GPs are pushing for deal-by-deal carried-interest-distribution structures in their funds, even as LPs push to back-end carry to prevent unprofitable funds from falling into clawback situations.

GI Partners in its newest fund is asking for a switch to a profit-sharing structure that pays the GP carried interest after each exit in the portfolio. This is a change from the prior fund, which paid back LPs before the GP started to collect carry — a structure known as European-style carried interest.

The switch from European-style carry to deal-by-deal carry is fairly rare, several LPs told me in recent interviews. LPs prefer European-style carry because it eliminates the risk the GP will collect profits on early deals but have to pay back the LPs later if the fund ultimately ends up unprofitable. The agreed-upon profit-sharing split in a private equity fund is generally 80 percent of profits to the LPs and 20 percent to the GP, with a preferred-return hurdle usually around 8 percent.

An LP must be made whole at the end of a fund’s life by clawing back proceeds from the GP if it hasn’t reached its agreed-upon share.

A GP that makes such a switch in its new fund knows it will face pushback from LPs, especially those that committed to the firm’s prior fund.

Yet, in this strong fundraising environment, GPs are pushing for deal-by-deal carry structures. GPs like to get paid after each exit because they collect profits right away on strong exits and, depending on how profit flows through the organization, younger executives don’t have to wait until the end of the fund to collect their share of the proceeds.

Some GPs say they are less competitive for talent if they have European-style carried-interest structures. Young, talented executives might get fed up and head to firms where they can share in profits much more quickly.

Still, it’s a negotiation. LPs want to see carried interest collected on the back end of a fund’s life. And if a GP won’t offer a European-style structure on its new fund, LPs try and push for other concessions like fee breaks. One LP said such a switch is a “function of the market.”

“GPs would love to get deal-by-deal, pull out money earlier,” the LP said. “It’s the same thing with people messing with the [preferred returns].”

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky