Scarcity Partners has raised AUD 75m (USD 50m) in the past 12 months to fill a perceived hole in Asia’s alternatives industry: a strategy entirely focused on providing growth capital to local GPs. There have already been two deals in Australia – in an outsourced CIO provider and a private credit manager – and the team is making regular trips throughout the region in search of further opportunities.

“No one has offered an investment vehicle whereby investors can access the equity or operating leverage of high-quality investment firms in Asia,” said Adrian Whittingham, Scarcity’s founding partner.

“There are multi-affiliates and offshore GP staking firms are coming here, but we don’t see anyone providing market education. Blue Owl [NYSE:OWL] and others mainly come to raise money. Their minimum cheque size is so big they struggle to find opportunities in the region.”

Scarcity’s founders originated from a multi-affiliate. Pinnacle Investment Management [ASX:PNI] – where Whittingham spent 15 years through 2022 – is one of two Australia-listed entities that back investment managers. It and Pacific Current Group [ASX:PAC] operate globally across public and private markets. Notable private equity portfolio managers include Five V Capital and Roc Partners.

Scarcity, which invests from an evergreen vehicle and to date has sourced capital from family offices and high net worth individuals, positions itself as growth-oriented whereas the likes of Blue Owl are yield-focused. Rather than generating returns via the consistent management fee streams of GPs, it pursues multiple expansion. Put GPs on the right course and by year seven there could be an exit to Blue Owl.

Mid-cap GP staking firms – from Bonaccord Capital Partners to Azimut Alternative Capital Partners – have emerged to fulfil this role in North America, offering to facilitate succession planning by allowing founders to take money off the table and assisting with fundraising. Some large-cap players are now looking to target the same kinds of opportunities, with Blue Owl launching a mid-cap strategy.

Opening the middle market widens a previously narrow addressable universe for GP stakes in Asia. Interest is rising – almost every manager questioned by AVCJ claimed to have been approached by prospective investors – and Paul Greenwood, CIO of Pacific Current, is adamant that there will be more deals. His travel schedule is like that of Scarcity, taking in India, Singapore, and Hong Kong.

Yet several lawyers and placement agents observe that following the rise of GP stakes in North America, internal dialogues about how to capitalise on the spread of activity to Asia have faded. Investors claim to have participated in processes and conducted due diligence without pulling the trigger, unable to get comfortable with a market that – for various reasons – isn’t quite ready to bloom.

“What you tend to find in Asia, because of the stage of market development, is a larger proportion of mid-market firms that are highly key person dependent,” said Chris Lerner, who has served as an Asia-focused operating partner at Bonaccord since last year when the GP stakes investor entered into a partnership with Thrive Alternatives Asset Management, which Lerner co-owns.

“There is one single person, the firm starts and ends with them, all decision-making is with them, and if they were not there, the firm would not exist in its current form. That’s not a risk we want to take.”

Paths to institutionalisation

A couple of deals involving Asian GPs closed in the second half of the 2010s when large-scale GP stakes deals started to take off globally. Affiliated Managers Group [NYSE:AMG] acquired 15% of Baring Private Equity Asia in 2016 for USD 187.5m – exiting when EQT [STO:EQT] bought the firm six years later at 6x its entry valuation – and Blackstone Strategic Partners picked up 19.99% of PAG for USD 400m in 2018.

In early 2022, Dyal Capital Partners – now Blue Owl – paid about USD 1bn for a 12% stake in MBK Partners. Though later than the other investments, there was a familiarity in the profiling: an established pan-Asian manager with scale, multiple strategies, and a perceived desire to use third-party shareholders as a means of facilitating succession planning.

Sandwiched in between these larger transactions, Japan-focused Advantage Partners sold a 14.9% interest to Tokyo Century, a domestic financial services company and an existing LP. Tokyo Century was keen to deepen its relationship with Advantage, expressing a willingness to increase its commitments not only to the PE funds but also to the more nascent public equities and Asia ex-Japan strategies.

The private equity firm was already contemplating succession – ownership options had been issued to non-founder employees a year earlier – and it held discussions with global GP staking firms, which at the time were starting to look at smaller managers. But Tokyo Century was the most compelling option.

“It was clear – then and even now – that GP stakes firms follow a financial model. They have a template of economics they look for, based on cash and carry streams from the GP, and they come up with a number they will pay, based upon current strategies and funds,” said Richard Folsom, co-founder and representative partner of Advantage.

“The relationship we have with Tokyo Century is more than that. They looked at the strategic value, the synergies between the two firms, and the growth potential of the platform.”

The stock option issuance in 2018 diluted the founders – chiefly Folsom and Taisuke Sasanuma – from 100% to 80%. Introducing Tokyo Century took the percentage split to 64-16-20. Another batch of stock options issued this year reduced the founders to 55%. Meanwhile, Tokyo Century has backed funds, participated in co-investments, provided mezzanine financing, and helped with deal sourcing.

Southeast Asia-based Navis Capital Partners, founded six years after Advantage in 1998, has been on a similar journey. The firm allows junior team members to acquire equity using vendor finance – making deductions from annual bonuses – and they sell out under the same formula on retirement. A stock option issuance this year took non-founding partners and other senior executives to 35% ownership.

Nick Bloy, a managing partner at Navis, observed that “the idea of needing a wealth transition mechanism is remote” to co-founder Rodney Muse and himself because they enjoy what they do and are comfortable having significant personal wealth tied up in the firm. To the extent he expects inbound enquiries from investors to continue, they are more likely to come from strategic players.

“These would be global groups that like what we’re doing, like the middle market, are interested in Southeast Asia, but would rather buy than build organically. And they will do everything to retain the younger guys while transitioning out the wealth of the older ones,” Bloy said.

Continuity questions

What Advantage and Navis also have in common is they have given succession due forethought. Advantage switched from a partnership structure to a holding company ahead of Tokyo Century’s arrival but plans to issue stock options and launch multiple strategies were first drawn out nearly 20 years ago. They were put on hold in the wake of the global financial crisis.

Navis, meanwhile, had an external shareholder from the outset. HAL, a Dutch investment holding company, helped capitalize the management entity and made a sizeable contribution to Fund I. It also took a 25% stake in the GP. HAL continued investing in funds and providing strategic advice until Bloy and Muse bought the GP interest 10 years ago. Stock issuance to non-founders began shortly thereafter.

Many managers in Asia haven’t the longevity of these two, so succession planning isn’t viewed as a priority. This bleeds into concerns about not only key person risk, but the ability to retain mid-level talent if economics – as well as decision-making power – are biased towards one or two founders. For GP stakes investors, there may not be sufficient organisational stability to give them comfort.

Asia has seen plenty of disputes between founders and mid-level rebellions where deal captains stage a coup or spinout. According to Wen Tan, founder and CEO of Azimuth Asset Consulting, which helps GPs address strategic and governance issues, economics, governance, and ego are the root causes. The problem is managers tend to be reactive rather than proactive.

“In many situations, you are scrambling to protect what exposure you have because you know a lot of people are no longer there,” he said. “Whether one individual is recruiting others or people who have worked together before are coalescing into a firm, there is a need to think long-term about governance, voting, decision making, and the economic split – currently and across generations.”

There is plenty of anecdotal evidence suggesting an evolution in behaviour; that younger GPs are learning from their forebears and laying the foundations for a more equitable distribution of economics. This evidence is often presented in the context of Asia as an emerging private equity ecosystem, the implication being that it will ultimately move in the same direction as North America and Europe.

“Certain private equity firms that got their start post-global financial crisis and are now on their third or fourth funds are thinking about it,” said Albert Cho, a Hong Kong-based private funds partner at Gibson Dunn. “It’s not just the founders but also investors asking who is the next line of key persons. They may want to see that reflected in the fund documents.”

Solving for specifics 

At the same time, the GP stakes space has seen a proliferation of would-be participants, from specialists pursuing returns-first agendas to institutional players – like insurers and sovereign wealth funds – motivated by strategic objectives. Consequently, managers have more solutions at their disposal.

This manifests itself in several ways. Certain elements of these deals have always been highly negotiated: a 20% interest in the GP holding company might get the investor to an equal portion of all management fees accrued by that entity, but the carried interest entitlement – the percentage share of distributions flowing to the house, not the team, and which funds are included – tends to vary.

A strategic investor, meanwhile, may prioritise governance over fee streams. This could result in certain information rights and representation on the board or investment committee being baked into the deal. Sometimes, significant LP participation in future funds is added as a sweetener.

There is also scope for flexibility as to what GP ownership means. For example, a deal might be structured as preferred rather than perpetual equity, whereby the investor receives 20% of revenue generated by the manager until a certain return threshold is reached.

“They could do equity or preferred equity, and then there are more debt-oriented deals as well,” said Matthew Dickman, a partner and a leader in the private funds transactions group at Debevoise & Plimpton. “Firms also seek to differentiate themselves in terms of value-add they can bring to the GP. For some GPs, valuation is everything. Others see the help as invaluable.”

Indeed, the pitch has evolved from what one Asia-based manager somewhat witheringly referred to as bridge financing for younger partners who cannot afford to acquire equity from founders. This is perhaps especially true in the mid-market space where primary capital outweighs secondary capital in deals and the proceeds are used to create balance sheets that support growth initiatives.

In addition to providing capital that enables succession and seeds new strategies, investors look to assist with capital formation – plugging managers into their LP networks – recruitment on the business development side, liquidity solutions, acquisitions of other managers, and implementing best practices across technology, human resources management, and operations.

Such efforts are not always transformative. Michelle Cheh, a partner in the investment funds group at Kirkland & Ellis, warned that an investor may struggle to market the target manager’s funds or push these funds below its own in the pecking order. Nevertheless, Lerner of Bonaccord maintains that a US mid-market manager without a GP stakes investor could find itself at a competitive disadvantage.

“Returns in PE are coming down in general. The days when you could invest on mispricing of assets and get multiple expansion are over. Everything is about operational value-add, talent retention,” he said.

“You must run your business like a company and understand what is best in class in all facets. If you are a USD 3bn AUM [assets under management] manager with great returns, you probably haven’t been thinking about that so much.”

Moreover, smaller managers might be solving specific growth-oriented problems. For example, rising interest in GP stakes in Australia is linked to market maturity, but some industry participants highlight the burden of keeping pace with relatively high GP commitments to funds in expanding franchises. Borrowing against interests in existing funds isn’t always an option.

“If you are building a VC strategy, it’s 10-12 years before you see money come back and you’ve probably raised four funds in that time and put GP commits into each one. It’s a cash flow draining exercise,” said Steve Byrom, founding partner of Australia-based LP advisory firm Potentum Partners. “Monetising some unrealised carry to continue making those GP commitments can be an attractive proposition.”

A matter of fundraising

While competitive dynamics may prompt investors to look for opportunities in less saturated markets like Asia, talk has yet to translate into meaningful action. When deals have been done in the region, they tend to involve strategic players – family offices seeking closer alignment with their partners, corporates chasing diversification and deal access, global managers eyeing a toehold in Asia – not GP staking firms.

One explanation is captured in Lerner’s description of Bonaccord’s “capital preservation first” strategy. Target GPs must have at least 10 years of history, three vintages in the ground, and no exposure to geopolitical and regulatory risks over which they have no control. It boils down to consistency of performance and sustainability of business model – and Asia, for the most part, isn’t there yet.

Pacific Current has similar expectations in terms of longevity, plus a minimum AUM threshold of USD 1.5bn and typically a 50% margin on a USD 20m revenue base. And that’s before it gets into less quantifiable metrics around manager profile and capabilities.

In addition, the ability to raise that next fund – and for it to have a meaningful impact on the manager’s bottom line – is crucial, according to Pacific Current’s Greenwood. These sentiments are echoed by Scarcity, with Whittingham keen to build a portfolio of profitable GPs that are nearing an inflection point, on the cusp of achieving institutionalisation and accelerating scale.

It is a common concern. Geoffrey Burgess, another partner and leader of Debevoise’s private funds transaction group, observed that investors struggle to justify spending time on a USD 20m-plus deal when there are insufficient management fees or a lack of visibility on said fees.

And in this context, Asia’s fundraising difficulties represent yet another hurdle. Managers focused on the region, excluding renminbi-denominated strategies, have received USD 40.4bn in 2024 to date, compared to full-year totals of USD 70.7bn in 2023 and USD 111.4bn in 2022, according to AVCJ Research. About 30% of this year’s total went to Asia funds raised by listed global managers.

“I can’t imagine managers in the region currently looking that attractive to GP stake investors given many are struggling with fundraising, so there is no certainty as to the future management fee flows,” said Kirkland’s Cheh.