Private Equity Interviews - Part 2: Know Your GP From Your LP
This is my second post about information that you should be familiar with if interviewing for a role in Private Equity (the first was on valuation). The objective is to arm the uninitiated with information that will make you able to talk, if not like an expert, then at least like someone who is not a complete newcomer to the subject.Like most financial topics, PE is rife with acronyms which often seem designed to close the subject to outsiders. If you are interviewing for a first job in the sector, you can get away with not knowing them all, but a bit of knowledge should prevent you from making unnecessary and potentially embarrassing mistakes and may help you stand out from the crowd.Two related acronyms that you will hear all the time in relation to private equity are GP and LP, which stand for General Partner and Limited Partner. Most (not all, but the vast majority) of PE funds are structured as Limited Partnerships for reasons that I have covered in previous posts. The distinction between GP and LP is an important one.Limited partners are usually institutional or high net worth investors interested in receiving the income and capital gains associated with investing in the fund (these are not products designed for retail investors). They do not take part in the fund's active management and they are protected from losses beyond their original investment as well as any legal actions taken against the fund. When they agree to invest in the fund, they make a commitment to provide capital up to a fixed amount, as and when it is required (this is an important point – they do not pay in the whole amount on day one). Requests for capital are made when the fund is ready to make an investment – these are called draw-downs and will be made to all the funds LPs pro-rata to their commitment. A failure to pay up when a draw down is requested usually has serious consequences, so the LP has to ensure that they have cash or cash equivalents on hand to respond when required.The general partners on the other hand are responsible for managing the investments within the fund (they may also be referred to as the fund sponsor or manager). These are the people who will be sitting in front of you at your interview and who you – presumably – hope to join. Unlike LPs, the general partners are responsible for running the fund and they are legally liable for the actions of the fund. For their services, LPs earn a management fee and a percentage of the fund's profits, called carried interest. In theory (not always in practice) the management fee is designed to cover the day to day running costs of the partnership and is calculated as a percentage (often 2%) of the capital committed by the LPs. The carried interest is what makes the job exciting and provides the GP with the opportunity to make serious money – if they do a good job and makes significant profits then they get to share those rewards, often up to 20%. It is of course a little more complicated than that - there will usually be something called a hurdle rate, which is a cumulative annual return – expressed as a percentage – which is paid to the LPs before any carry becomes payable to the GPs. After that a formula will define exactly how the remaining proceeds are divided.The objective of carry is to align the interests of the GPs and the LPs. Another, additional, way of doing this is for the GPs to commit some of their own money to the fund (effectively as if they were also an LP). Many potential LPs will expect that 5% or so of the funds committed capital should come from the GPs, which can make it difficult for first time wannabe GPs to launch a fund, unless they are already wealthy individuals. On the other hand, an existing GP with a good track record will not only find it relatively easy to raise new funds, but will also benefit enormously from their performance.Understanding this when you are sitting across the table from a GP in interview should help you understand their motivation and expectations, as well as showing that you understand the basic structures of the industry. Good luck!
Private Equity Interviews - Part 2: Know Your GP From Your LP
PRIVATE EQUITY
by JFH on May 29th 2023
This is my second post about information that you should be familiar with if interviewing for a role in Private Equity (the first was on valuation). The objective is to arm the uninitiated with information that will make you able to talk, if not like an expert, then at least like someone who is not a complete newcomer to the subject.Like most financial topics, PE is rife with acronyms which often seem designed to close the subject to outsiders. If you are interviewing for a first job in the sector, you can get away with not knowing them all, but a bit of knowledge should prevent you from making unnecessary and potentially embarrassing mistakes and may help you stand out from the crowd.Two related acronyms that you will hear all the time in relation to private equity are GP and LP, which stand for General Partner and Limited Partner. Most (not all, but the vast majority) of PE funds are structured as Limited Partnerships for reasons that I have covered in previous posts. The distinction between GP and LP is an important one.Limited partners are usually institutional or high net worth investors interested in receiving the income and capital gains associated with investing in the fund (these are not products designed for retail investors). They do not take part in the fund's active management and they are protected from losses beyond their original investment as well as any legal actions taken against the fund. When they agree to invest in the fund, they make a commitment to provide capital up to a fixed amount, as and when it is required (this is an important point – they do not pay in the whole amount on day one). Requests for capital are made when the fund is ready to make an investment – these are called draw-downs and will be made to all the funds LPs pro-rata to their commitment. A failure to pay up when a draw down is requested usually has serious consequences, so the LP has to ensure that they have cash or cash equivalents on hand to respond when required.The general partners on the other hand are responsible for managing the investments within the fund (they may also be referred to as the fund sponsor or manager). These are the people who will be sitting in front of you at your interview and who you – presumably – hope to join. Unlike LPs, the general partners are responsible for running the fund and they are legally liable for the actions of the fund. For their services, LPs earn a management fee and a percentage of the fund's profits, called carried interest. In theory (not always in practice) the management fee is designed to cover the day to day running costs of the partnership and is calculated as a percentage (often 2%) of the capital committed by the LPs. The carried interest is what makes the job exciting and provides the GP with the opportunity to make serious money – if they do a good job and makes significant profits then they get to share those rewards, often up to 20%. It is of course a little more complicated than that - there will usually be something called a hurdle rate, which is a cumulative annual return – expressed as a percentage – which is paid to the LPs before any carry becomes payable to the GPs. After that a formula will define exactly how the remaining proceeds are divided.The objective of carry is to align the interests of the GPs and the LPs. Another, additional, way of doing this is for the GPs to commit some of their own money to the fund (effectively as if they were also an LP). Many potential LPs will expect that 5% or so of the funds committed capital should come from the GPs, which can make it difficult for first time wannabe GPs to launch a fund, unless they are already wealthy individuals. On the other hand, an existing GP with a good track record will not only find it relatively easy to raise new funds, but will also benefit enormously from their performance.Understanding this when you are sitting across the table from a GP in interview should help you understand their motivation and expectations, as well as showing that you understand the basic structures of the industry. Good luck!
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