@Scott Trench co-invest percentages may be high, but aside of co-investments / "skin" numbers etc., he is quite spot on that the overall risks are normally too lopsided. "Heads they win, tails they win." is a horrible model for the investor. It's the foundation of the Wallstreet fund model; things some investors are trying to distance from, yet get stuck in still via many syndication models. I will throw out deals that have 5 different fees and all at maximum levels. The gold rush made a lot believe they earned something that they have not. It's just how many guru classes are taught. Some sadly teach how to exploit and manipulate the new investors. Raising capital is a popular class/topic that is not always taught with best intentions.
I am with@Brian Burke on "The dirty little secret is that alignment of interest in a sponsor/investor relationship is impossible". With that, it does not by any means imply that the current methods, percentages, fees, contracts etc. are the very best version to reduce/lower the misalignments to a smaller delta than the current status-quo.
Sadly, Scott is right that many deals are setup so that if a LP loses capital the GP still has profited; many do so on day one! Only a few have claw backs in the docs, and the rare will step in and forfeit unilaterally (but rarely contractually) to try to make things right. LPs should also not forget that the docs are written by the lawyers of the GPs and they represent the interest of the GP.
Some GPs will give 10+ reasons why one method is more "aligned" than other etc. As always, opinions are, just opinions. Note that when the words "incentive" or "incentivizes" are used, the reasoning tends to be often aimed at the lower level of scruples and integrity type of person. A low moral person needs more external incentives to stay involved in a deal they sponsored but is now a major challenge. A high moral person will not run nor only think just of self. LPs should think about the content of the taught alignment concepts, as well the source. Consider if they could have any inherent bias.
Ultimately, the most important thing is a GP that is honest, skilled, fair and actually acts like a fiduciary. The % of skin is below all that.
Brian says it better: "What is important is finding a sponsor that has experience, a track record, a strong management team, a strong balance sheet, and perhaps most importantly, a brand and reputation to protect. On top of that, you want someone who understands that their interests are not aligned with yours and can and will prioritize and balance your interests over their own. That trait can't be measured in dollars."
As long as there are a ton less savvy or under-educated investors (be it stocks, bonds, RE etc), the markets will be overly tilted to GPs that never really are at risk to lose any capital, even in a crap deal. The syndication market can do better. But will it and how?
@Scott Trench
