Harvard Study: Why GP Economics Really Matter

One of private equity’s biggest selling points has always been the relatively strong alignment of interest between the general partner and its investors. The fund manager’s “skin in the game,” through its capital commitment to a fund and its typical 20% profit share, has received much scrutiny from those looking to explain the industry’s relative ability to generate above-market returns.

Until now, however, few researchers have gone a level deeper to examine the influence a GP’s distribution of its profits and ownership to the individual members of the partnership influences outcomes. Simply put: how aligned are the individual partners with each other, and how does that impact success?

In a recently released paper, Josh Lerner and Victoria Ivashina of Harvard University show just how important the structure of a partnership’s economics can be to the success of its funds, its ability to retain talent, and its ability to raise money in the future. (Download the full paper).

Retaining talent is of particular significance to investors—prior research has demonstrated that even when a departing partner is replaced with a “comparable” talent, performance suffers.

Among the most interesting findings:

• Past performance does not have a significant bearing on a senior partner’s share of carry; being a founder has a significant one.

• Senior partners who leave during the course of a fund’s life have significantly lower carry shares (9% vs. 16%) and ownership stakes (13% vs. 23%) than those who stay The lower share of carry among departing partners is not explained by poor performance.

• Senior partners are more likely to stay at a firm with lower carry inequality (at a level of statistical significance).

• The loss of one senior partner at an average sized firm (one with 4 senior partners, significantly impacts subsequent fundraising. The next fund is typically 17% smaller.

Lerner discussed the research with Privcap in a recent video:

https://privcap.wistia.com/medias/ofwdw513i0?embedType=async&videoFoam=true