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GP stakes deals are high stakes transactions – especially for the GP’s CFO, write experts from private equity consultancy Accordion.

This article was published in Private Funds CFO
on July 1, 2024.

GP stakes transactions – which involve the sale of an ownership interest in the general partner entity that manages the PE fund – can create significant value for both the investor and the selling sponsor. But they also create almost unparalleled complexity for the internal finance team.

That doesn’t seem to have impeded their rise in popularity. The LP Perspectives 2024 Study by our affiliate title Private Equity International found that 49% of respondents have either invested in GP stakes funds or intend to do so, up from 36% in 2023. But as firms rush to seize on an investing strategy that will produce outsized yields, they often overlook the significant complexity it creates as it relates to accounting and financial reporting, process and deal execution, and strategy and value creation.

Given that these challenges aren’t likely to dampen enthusiasm for GP stakes investing, it’s critical for the finance team to be aware of, and prepare, for potential complexities. To that end, we have created a 5-step checklist for GP CFOs who want to proactively mitigate unexpected pitfalls and costs:

Step 1: Focus on financial analysis/valuation

  • Financial statements: A simple step, but often overlooked – CFOs should start by conducting a comprehensive evaluation of all financial records to ensure they are both accurate and up to date.
  • Valuation: The next, but equally critical step is to value the GP interest. The CFO should consider valuation holistically, including the GP’s historical performance, future earning potential, and broader market conditions.

Step 2: Dig into due diligence

  • Reporting: It’s not about creating more reports, it’s about creating the right reports. In this case the right list includes comprehensive reports of the GP’s financial position (including capital commitments), fund performance, and carried interest potential.
  • Legal documentation: Legal documentation may seem to be outside of finance’s purview, but in this context, it’s an important part of the puzzle that the CFO must have a handle on. As a result, they’ll need to work with legal to gather and review all legal documents related to the GP and the funds it manages. This includes fund formation documents, Limited Partnership Agreements (LPAs), and contracts with portfolio companies.

Step 3: Start scenario planning

  • Modeling scenarios: A GP stakes investment may take many forms. It may involve the purchase of a percentage of the management company (and the future management fee income that comes along with it) and percentage of the GP entity (or multiple GPs). Alternatively, the investors may invest directly in the management company and GP entities, or a new Holding Company may be created that will wholly own the Management Company and GPs and sell a percentage of the Holding Company interests to the new investors. Transactions may also be structured as permanent capital, buying into income streams in perpetuity. The CFO must model different transaction structures to assess how they would impact the GP’s financial position and the interests of LPs.
  • Tax implications: These types of investments have wide-ranging and complicated tax implications. The CFO must be aware of all potential tax issues, perhaps engaging a tax advisor for more niche expertise.

Step 4: Consider the communication strategy

  • Communication plan: A GP stakes investment is an “inside baseball” type transaction. The CFO should work with the investor relations team and/or other professionals to carefully craft a plan to communicate the transaction to all stakeholders, including LPs and employees. This communication plan should include information on how the transaction will affect the GP’s management and the performance of the funds.
  • LP advisory: It may also be necessary to consult the LP Advisory Committee or seek LP consent for the transaction.

Step 4: Tackle the transition

  • Finance involvement: Sometimes finance is brought it on the later side of a transaction. CFOs should instead advocate for an early seat at the table. When CFOs are part of transaction structuring and negotiation processes, they can help ensure there is sufficient consideration of the impacts of the reporting requirements on the organization.  CFOs must make sure that the organization does not underestimate the importance of deal structuring to the finance team.
  • Management changes: If the transaction will result in changes to the GP’s management team, finance should be part of planning now for a smooth transition later. This includes ensuring that key personnel are retained, and that the GP can continue to fulfill its duties to the funds.
  • Structuring: Prior to negotiating the transaction with an external investor, CFOs would be wise to revisit the economic and voting/management rights within the existing business to ensure it is appropriately structured and formalized. This may present an opportunity for internal restructuring for generational planning purposes prior to the transaction.
  • Limited partners: When evaluating potential Investors, CFOs may want to weigh in on the impact of the potential investor LP base (i.e. international investors) as this may impact tax reporting.
  • Exit strategy: CFOs should also seek to understand the potential exit strategy for potential buyers – e.g. IPO vs. secondary – as it may impact the financial reporting requirements and accounting for future capital inflows.

Step 5: Partner with professionals

  • Legal counsel: Engage legal counsel to review the transaction documents and advise on legal risks.
  • Valuation experts: Consider hiring financial advisors to assist with the valuation of the transaction.
  • Financial/accounting experts: These experts will be important throughout the process, but they will play a critical role in nuanced post-transaction considerations, including technical accounting (carried interest, deferred waver, revenue recognition, lease accounting, etc.) and financial statement presentation (consolidation and considerations of period presented).

GP stakes investments can create outsized value for both the investor and the selling sponsor as well as significant complexity for the finance team. CFOs who use these five steps to prepare properly and proactively can minimize complexity and unexpected risks/costs.

GP stakes investing means higher stakes for CFOs

GP stakes deals are high stakes transactions – especially for the GP’s CFO, write experts from private equity consultancy Accordion.

privatefundscfo.com

Meet the Authors

Pamela Stern
Pamela Stern
Managing Director, Head of Operational & Technical Accounting Advisory

Pamela is a Managing Director and Head of Accordion’s Operational & Technical Accounting Advisory Practice. She has two decades of experience stemming from roles at the Big 4, private equity, public and privately held companies. A certified public accountant, Pamela provides execution leadership and project execution for merger integration, business process improvement, financial close acceleration, and visibility reporting.  Read more

Mindy Dominek
Mindy Dominek
Managing Director

Mindy is a Managing Director with nearly three decades of experience in public accounting. She has extensive experience working with companies in regulated businesses and has deep technical expertise in both accounting and auditing.  Read more

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