Private Equity News and Lexology had a great article going through how General Partners can leverage the recycling of distributions from capital gained on exits to be reallocated into the fund. LPs can benefit from this because they don’t have to produce a new mandate for an allocation into a fund of fund or direct fund investments. Many institutional LPs invest only in Fund of Funds anyways, so there’s often a time horizon for the LP capital to be allocated throughout the term of the fund of fund’s investment period. So an easy way for LPs to still allocate and re-up will be to leverage this guidance that would be specified in the LPA. (limited partnership agreement)
Most times there’s a cap of what can be called 25% or less and there are limitations on the time duration of when it can be called.
Here’s a great case study i found on Quora on how this works. Screenshot below and link to view thread here
Brad Feld also unpacks this with some additional great scenarios! and for the sake of keeping it simple, here is an attempt to distill this
In year 3 of the fund, if theres a deal that exits for $50M, you can pull out $20M. Instead of just charging the 2%*3 = $6M. If you just use that $6M to redeploy into the fund, to hopefully invest into more companies and provide more outsized returns, and you also get to periodically provide distributions to the LPs which also makes them happy. In this example, out of the $20M, the LPs get $14M back, and you are putting the money back into work as workable capital.
Brad Feld’s most simplistic expectation to see as a fund is you invest $1M, and over the course of time you see it become $3M (3x return)
Essentially as a VC or private equity investor, if you are doing a great job picking great companies, the power law rule will essentially let your few unicorns that have outsizes returns deliver more than the entire fund anyways.
If you are also able to be flexible with how you offset the management fees, you can also make a difference in how you impact the returns provided back to LPs. See this great example here where you can see that just reducing your management fees from 2.5% to 1.5%, you are able to increase your net multiple to LPs. Greenspring Associates outlines this pretty well, and here’s a screenshot of how they map this out in a chart.
Also, some best practices according to Greenspring Associates is that are on Carried interest of the industry standard is paid when there is a 1.ox DPI and only provide the premium (20%+ if expected) after that hurdle of minimum dpi is achieved.
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