Investing in GP Fund vs deal by deal

For real estate investors and asset managers, one of the most important decisions is whether to structure investments through a GP (general partner) fund or on a deal-by-deal basis. 

Each approach has its own advantages and disadvantages that must be weighed carefully. This article will provide an overview of GP fund investing, how it differs from deal-by-deal investing, key considerations for both models, and examples of real-world GP funds. 

Whether you are an investor evaluating GP fund investment opportunities or an asset manager structuring your investment strategy, this guide will help enhance your understanding of this critical choice.

How does a GP fund work?

A GP fund is essentially a pooled investment vehicle set up by a general partner (GP) and funded by limited partners (LPs), who are the fund’s investors. The GP makes all the investment decisions and manages the fund’s portfolio, while LPs contribute capital but have limited control. The venture capital fund, real estate fund or private equity fund itself has a finite lifespan, usually 10-12 years in private equity, sometimes shorter in real-estate (5 years in total is not uncommon), divided into:

• Investment period (typically 5 years): The GP sources deals, acquires assets, and manages the portfolio. No distributions to LPs during this time.
• Harvest period (typically 5-7 years): GP exits investments, sells assets, and distributes proceeds back to LPs.

The GP charges fees, typically including:

• Management fee (typically 1-2% of assets): Covers operating costs.
• Carried interest (typically 20% of profits): The GP’s share of fund gains.

The GP commits a small % of the fund’s capital themselves to ensure alignment of interests. Once the fund’s performance hits a hurdle rate of return (typically around 8%), any profits are split 80/20 between LPs and the GP.

Advantages of a GP fund

For limited partners seeking private equity exposure, GP fund investing is tough to resist. Top-tier private equity GPs like Blackstone and Apollo can raise funds upwards of $20 billion or more from pensions hungry for uncorrelated returns.In real-estate, the sums are typically lower. 

• Ability to raise significant capital based on the GP’s track record. A $100 million+ fund is common.
• Scale and diversification. A fund allows investment in a portfolio of assets, reducing risk.
• Expertise of the GP in sourcing, underwriting, and managing deals. Investors rely on the GP’s capabilities.
• Alignment of interests when GP invests their own capital.
• Potential for higher returns than the public markets. Private equity targets 20%+ IRRs.

Challenges with a GP fund

GP funds offer access to elite private markets, but the price of admission can be steep and it is important to do extensive due diligence and understand that as an investor, your money is locked up. 

• Requires extensive track record for fundraising. Emerging managers may struggle.
• Loss of control for LPs once capital is committed. The GP has full discretion.
• Long lock-up period. Capital is tied up for 10+ years.
• Higher fees than investing independently. The typical 2 & 20 fee structure.
• Carry structure may promote riskier bets by GP late in fund life.

Private Equity fund structure: GP and management company

Most private equity funds structure the GP as a separate entity from the management company for efficiency, flexibility and investor confidence:

• The GP serves as the legal decision maker for each fund. It assumes full liability and is replaced with each new fund while remaining aligned with the broader firm’s strategy .
• The management company employs the investment professionals and handles back office functions. It owns the firm’s brand and track record.

Source: A Simple Model

This structure allows the management company’s resources and expertise to be leveraged across multiple funds efficiently. The GP remains focused solely on raising capital and its own fund investors. Meanwhile, the management company provides stability, continuity and reputation benefits that carry forward into new fundraising efforts.

Private Equity fund basics

Private equity funds have a standard structure and set of terms that provide a starting point for negotiation between the GP fund managers and LPs:

• GP commits 1-5% of the fund’s capital. Ensures alignment and “skin in the game”.
• Term is 10-12 years total. Investment period lasts 5 years, with remainder for exits.
• Management fee of 1-2% on commitments or assets. Declines post-investment period.
• Preferred return hurdle of 8% must be cleared before any carry.
• Carried interest is typically 20% of profits split to GP. Accrues deal-by-deal or whole fund.
• GPs want flexibility in investment strategy. LPs want discipline on asset types and geographies.
• LPs seek clawback provisions to recoup carry if fund underperforms long-term.

These economic and structural terms are modeled on the industry’s standard or “Model LPA”, though negotiation produces many variations.

What is a Co-GP fund?

Some private equity funds have multiple GPs who co-manage the fund together. Reasons for a co-GP structure include:

• Allowing emerging managers to team up with experienced firms to gain credibility.
• Combining complementary expertise like operations, finance and real estate under one fund.
• Expanding networks and deal pipelines through multiple GPs.
• Providing succession planning and continuity for LPs across funds.

The co-GP model must have clear delineation of authority, accountability and economics between the participating GPs. Effective coordination and communication are critical to prevent discord.

Investment and payout structure

The fund’s investment and payout mechanics aim to align the interests of LPs and GPs:

• During the investment period, capital is typically  called from LPs to make acquisitions. No distributions occur.
• After the investment period, companies and assets are sold off and proceeds distributed to LPs.
• The GP only shares in profits once a hurdle rate preferred return is achieved for LPs.
• Profits above the hurdle are split 80/20 between LPs and GP as carried interest.
• Clawback provisions allow LPs to retroactively claim excess carry payments if fund performance declines.
• GPs may retain a portion of carried interest in escrow to cover potential clawbacks.

This waterfall structure ensures LPs get priority on returns of capital and substantial upside before GPs participate. The preferred return and clawbacks protect against excessive risk-taking by GPs as well.

GP fund examples

One example of a real estate private equity firms running GP fund structures with a profile on Investbase: 

OpenDoor Capital

OpenDoor Capital is a real estate investment firm based in Kihei, Hawaii that pursues a value-add investment strategy focused on multifamily properties and mobile home parks. 

Founded by Brandon Turner, OpenDoor Capital targets markets like Houston, Austin, Dallas, and Eagle County, Colorado. With extensive in-house property management services expertise, OpenDoor takes a vertically integrated approach to adding value through operational improvements.

• Active mobile home and multifamily investor with a value-add approach.
• Has 15 deals and $982M under management, with 1,900 investors.
• Has 35 years combined experience and a target 20% annualized return (note: target returns are not guaranteed).
• Currently managing 4 funds focused on mobile home parks.

These examples illustrate the diversity of strategies, return profiles and asset types that GP real estate funds pursue. By pooling capital and expertise, they aim to consistently outperform the markets.

Advantages of deal-by-deal carry

For experienced real estate investors, deal-by-deal investing provides the flexibility to hand-pick opportunities without mandates to deploy capital. This allows savvy investors to build a portfolio of select assets based on their own underwriting and investment thesis. 

Deal-by-deal investing cuts out the general partner middleman, eliminating management fees and carried interest paid to an external fund manager. Investors retain full governance over their capital rather than relinquishing control to a general partner.

To sum up: 

• Flexibility to invest selectively in deals you find most attractive. Avoid mandates to deploy capital.
• Lower fees by cutting out the GP middleman.
• Greater control over the fate of your investment capital.
• Ability to build your own track record before establishing a dedicated fund.
• Potential to ride a single home-run deal for higher returns.

Challenges in deal-by-deal carry

While deal-by-deal investing provides more control and flexibility, it also poses greater challenges compared to investing through a GP fund structure.

• More limited access to deals without the GP’s networks and resources.
• Need to perform diligence and execute deals yourself. Lose GP’s expertise.
• Difficult to diversify effectively across asset classes and geographies.
• Harder to leverage others’ capital to scale. Rely on own balance sheet.
• Returns may underperform more diversified portfolios. Lack of loss cushion.

What is the difference between a GP and a fund?

While often used interchangeably, the GP and the fund are distinct entities with separate roles:

• The GP is the general partner entity that makes decisions and manages the fund’s operations.
• The fund is the collective investment vehicle that deploys capital into companies and assets.

The GP has a fiduciary duty to act in the fund’s best interests at all times. The fund’s legal purpose is to generate returns for its investors by following the GP’s strategy. The two work in tandem, with the GP actively managing the mostly passive fund.

What is GP and LP in a fund?

GPs and LPs are the two types of partners in a private equity fund:

• General Partners (GPs) manage the fund and make all investment decisions. They receive a management fee and carried interest in the fund’s profits.
• Limited Partners (LPs) provide most of the fund’s investment capital as passive investors. They receive income, dividends and capital distributions from the fund’s investments.

The GP is liable for the actions of the fund administrator, while LPs have limited liability for losses beyond their invested capital. The LP model allows pooled investment with the GP actively managing in the LPs’ interests.

General partner vs. limited partner

LPs are silent financiers while GPs are active asset managers and decision-makers. This division of ownership and control appeals to investors who want exposure to private equity without direct management responsibilities. To illustrate the details in a table:

Fund level vs. deal by deal carry

GPs may structure carried interest on either a whole fund basis or deal-by-deal:

Fund level carry

• All fund gains and losses are aggregated
• Carry paid only after preferred return hurdle for LPs
• Incentivizes GPs to maximize overall fund performance

Deal-by-deal carry

• Carry paid on each profitable deal, regardless of losses
• Incentivizes chasing home runs even if some deals lose money
• Requires strict clawback provisions to protect LPs

Deal-by-deal carry better aligns GPs to each deal’s success. But fund level carry encourages a balanced portfolio approach. LPs prefer fund level payouts for the added discipline and reduced risk-taking.

Conclusion

GP fund investing provides access to private market returns for limited partners without direct management responsibilities. For real estate investors, contributing to a GP fund run by experienced managers allows leveraging proven expertise and strategies. But giving up control means careful due diligence is imperative to align with a GP whose interests, incentives and track record are thoroughly vetted. 

The decision between deal-by-deal or GP fund investing should factor in risk tolerance, expected returns, lock-up terms and quality of the manager. With so much capital at stake, wisdom and discernment are vital when selecting the best investment vehicles.