Capital Stack Alignment

[Zachary Ware]

I am interested in what you all think are the biggest ways that a capital stack/ fees can align with investors and GPs. For investors, what do you like to see as and as GPs, what do your fees look like to make sure that all parties' interests are aligned? I have read that some like to go light on the acquisition fees and heavier on the refinance/disposition fee.

[John Sayers]

Seems 98% of "alignment of interest" topic are presented by the GPs of the world. That alone is a flag to consider; to be aware of potential systemic bias.

GPs who subscribe to ALL the "standard" fee types are a flag. They may target more unsophisticated investors and/or the very busy ones. 

"When" fees are paid and "how much" are important components to the elusive alignment. Some legal teams put the GP first in all things. In doing
so, there are many good sounding deals that are written up by legal that will always end for GP/LP as either win/lose, win/break-even or win/win. That's not the best alignment, yet some will think it is.

For example on just one fee type: if a deal reimburses the GP team at closing for all the costs incurred up to closing, the additional acquisition fee is then basically 100% profit on day 1. The larger the deal, the smaller the % should really be, or a flat fee. Some are playing the % game on larger deals, pulling in $600-$1 Million+ profit on day one. No matter what the deal does, $3/4 Million at close can encourage a transaction mentality of "more deals", "more deals", to feed the need for quick $$. Focus is not as likely to be on running the deals.

Many a GP says the LP is "paid first" with a pref, yet that usually overlooks the potentially large mix of closing fees. It's "true" though as they are talking about the flow after closing, and not from the day of the wire. Maybe LPs should ask GPs to share the GP's IRR/ Multiple, COC, ARR. The transparency and clarity could be refreshing.

For sure, GP's need to be rewarded and compensated! The method and means should be remain reasonable.

As a LP, one way to look at it is if a deal was a 2 party JV, what terms would you accept or reject? Maybe look at the capital stack, returns, legal, fees, splits etc. as if you are the sole investor putting in the total raise. Would you still accept the PPM/OA terms? If not, then maybe it's not as aligned as it may initially seem.

In the end, there is no perfect sweet spot mix of the parameters. The GP's skills and ethics are most important when the tides are receding.