GP Commitment

Structure

Three questions define a GP commitment: how large it is, how it is funded and how it is held. The Morgan Lewis Contribution by Principals chapter in its venture capital and private equity funds deskbook describes each of them.

• Size: the traditional answer was 1 percent of committed capital, a figure that began as tax advice to ensure the general partner was treated as a partner. The chapter says that 1 percent remains a good starting point in venture capital, that percentages have trended upward as limited partners seek more alignment, and that larger managers increasingly state a fixed-dollar minimum.
• Form: cash is the most typical and preferred form. Nonrecourse promissory notes and management fee waivers are also used.
• Holding: principals may fund the general partner's commitment directly, invest as limited partners, or co-invest alongside the fund in a parallel vehicle. Contributions are generally made pro rata with limited partners.

The formula is simple: GP commitment equals the commitment percentage multiplied by total fund commitments, divided between the general partner's own contribution and any commitments of its principals.

Worked Example

Consider a hypothetical venture partnership with $80,000,000 of investor commitments and a general partner commitment of 2.0 percent of total commitments. The commitment is $80,000,000 divided by 98 percent, then multiplied by 2.0 percent, so total commitments are $81,632,653 and the general partner commits $1,632,653. Limited partners hold the remaining $80,000,000.

Suppose the partnership pays a management fee of $1,600,000 in a year and the general partner funds its commitment by waiving that fee instead of paying cash. Under the Morgan Lewis description, the waived fee is exchanged for a potential future allocation of income equal to the waived amount, so the general partner receives nothing for that year unless the partnership earns a profit. Against that, the principals have contributed no outside cash: the commitment is financed by the fee that investors would otherwise have paid.

Why the GP Commitment Matters to a Limited Partner

Skin in the game works only if the money is the principals' own. The ILPA Principles 3.0 (page 17) say the general partner should hold a substantial equity interest, contributed in cash and not through a waiver of management fees or specialized financing facilities. They add that the general partner should not cherry-pick co-investments, that its whole equity interest should sit in a pooled vehicle whose share may not decrease, and that it should be restricted from transferring its economic interest, with limited partners notified of any intent to transfer.

What It Means for a Limited Partner

A limited partner should compare the commitment with the personal wealth of the people making investment decisions, because a percentage means little without it. A 2.0 percent commitment from founders of a new firm can be a larger personal bet than 1.0 percent from a manager with several successful funds. Ask four questions. How much of the commitment is cash? Who funds it, and from what source? Is the amount a fixed percentage or a dollar minimum? And does the key person provision tie the people who made the commitment to the investment decisions? Morgan Lewis notes that some limited partners read a fee waiver as a sign that the manager does not need the fees, and others read it as stronger alignment because fees are earned only if the partnership profits.

In Life Sciences and Healthcare

Life sciences funds carry long, binary risk: the BIO, Informa and QLS Advisors study of 2011 to 2020 found that 7.9 percent of Phase I candidates reached approval over an average of 10.5 years. A manager whose personal capital is in the same vehicle bears the same long duration and the same failure rate as investors. A limited partner can reasonably ask whether a clinician or scientist who joined as a principal commits real capital, or participates only through carried interest.

Frequently Asked Questions

What is a typical GP commitment?

One percent of total commitments is the traditional figure and, according to the Morgan Lewis deskbook, remains a good starting point in venture capital, while percentages have trended upward. Some larger managers state a fixed-dollar minimum instead. The right level is the amount that is meaningful to the principals personally, which is why ILPA stresses a substantial interest rather than a number.

Can a GP commitment be funded by a management fee waiver?

It can be, and some agreements do. The Morgan Lewis chapter describes the fee waiver as a funding option in which waived fees are exchanged for a possible future allocation of income. ILPA Principles 3.0, however, say the commitment should be contributed in cash and not through a waiver of fees. Limited partners are split on the practice.

Why does ILPA oppose cherry-picking co-investments?

If a general partner invests personally only in deals it expects to do well, its capital stops aligning interests and starts competing with the partnership. ILPA Principles 3.0 therefore ask that the general partner's whole equity interest sit in the pooled vehicle. Related terms are explained in Co-Investment.

Related Reference

Alignment terms belong to the structure discussed in growth equity. Related entries: Key Person Provision, Management Fee and Carried Interest.