By Madeline Shi, PitchBook
Behind the scenes of the recent wave of investment in GP stakes in PE firms, some partners bringing in new capital have another crucial concern in mind: succession planning.
The market for buying minority stakes in money managers has grown rapidly over the past few years, with more investors attracted to steady revenue streams generated by managers with investing success. As the demand heats up, more firms are warming to the idea of carving out an ownership stake to bolster their balance sheet.
In addition to fund expansion and growth initiatives, PE firms oftentimes seek minority capital to prepare for a smooth succession. At the same time, some investors mulling a stake in a firm want to see a solid succession plan in place before making a commitment.
Earlier this month, Kudu Investment Management acquired a minority stake in Escalate Capital Partners, a boutique asset manager known for its private credit and growth equity focus. The investment came as Escalate’s co-founders, Tony Schell and Ross Cockrell, decided it was time to plan for new leadership within the firm.
Founded in 2005, Austin-based Escalate has grown from a two-person shop to a versatile investor that manages more than $800 million across four funds.
Although Schell and Cockrell aren’t expected to retire anytime soon—both are in their late 50s—they believe it’s better to formulate a succession plan early.
Chris Julich, 50, who joined Escalate in 2008 and now serves as an investment partner, will take on a larger leadership role, and several other team members will be promoted to senior positions in different teams from administration to investing, according to Schell.
The deal with Kudu established a valuation for Escalate that clarified the worth of ownership stakes in the manager. By setting a price for these shares, the GP stake investment helps to create incentives for the firm’s next generation of leaders, Schell said.
Escalate will use the funding to make additional hires ahead of a planned round of fundraising for next year and may also build a new satellite office within the US.
Seeking GP stakes investment in connection with succession planning has grown more prevalent in recent years as the industry matures and executives approach retirement age.
“Thinking about the evolution of the private capital industry, it’s not surprising that we’re seeing a lot of firms now at the point needing to achieve or embark on a succession plan,” said Rob Jakacki, Kudu’s co-founder and CEO.
He added that some asset managers have taken a haphazard route that had repercussions for the success of their businesses.
Moreover, investors in GP stakes also regard smooth leadership transitions as important criteria when they evaluate deals.
“We’re long-term [investors] without an ability to liquidate, or forced-liquidation rights of our interest, so we need to have that level of comfort well into the future,” Jakacki said. “That makes it incumbent on us to have a strong understanding of what the next generation of leaders at a business looks like or is likely to look like.”
Schell said that when it comes to GP-LP relationships, limited partners would hold the same expectation.
Because allocating to a new GP is costly and time-intensive, he said, LPs prefer making a long-term commitment to the relationship, rather than engaging in one-off transactions.