- Sales of minority stakes are rarely truly “passive”
- There’s always implicit or explicit pressure to grow
- Funds are getting too big too quickly
Sales of minority stakes by general partners almost always cause PE firms to lose an element of control, according to Maurice Gordon, managing director and head of private equity for Guardian Insurance Co of America.
Gordon, speaking at PartnerConnect Midwest in Chicago on June 28, suggested that managers almost can’t avoid being pressured by firms buying minority stakes in their funds. Despite the notion that these are “passive” investments, GPs make more money by raising bigger funds, and so there’s always explicit or implicit pressure to grow, the limited insurance partner said.
“I think you’ve always got that pressure,” Gordon said. “If you’ve got even a 20 percent owner who swears he’s completely passive, I think the reality is that isn’t true.”
The increasing number of funds isn’t a problem, but the idea that existing funds are doubling in size in a couple years or so is an issue, according to Gordon: “They’re just getting too big too fast.”
“All of the sudden they move out of the strike zone,” Gordon said. “They’re not doing what they did to make money initially. And you’ve seen this movie 100 times. The returns just go down, down, down. It’s a very, very rare occasion where returns go up.”
Gordon’s comments come after Dyal Capital Partners’ head, Michael Rees, spoke at the conference a day earlier.
Rees during his fireside chat argued that because these stakes are passive, the firm has no decision-making authority. Dyal, among the most active buyers of minority stakes in PE groups, invests with firms that want to grow for years to come, but it doesn’t force managers to grow, Rees said.
Gordon on Wednesday did say that if the stake sales are done correctly — that is, if they are truly passive — the money raised can be put to work for good use. For instance, the capital coming in can be used to help cash out older founders and bring in newly energized operating partners to grow the firm, he said.
The idea that these deals are done to cash out older founders is a “myth,” Dyal’s Rees said on Tuesday.
Guardian Insurance is an LP in a few firms that have sold stakes, Gordon said. In these cases, his firm believed there was no pressure on a fund to do “unnatural acts,” he said.
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