Determining Whether to Commit Cash or Make A Cashless Contribution Toward Your Fund

Standard GP Commitment 

What is it?

Under the typical model, a GP would subscribe for an LP interest in the fund and contribute cash toward its interest much like an LP.

Why?

It is simple and shows LPs that a GP has skin in the game.

What are the risks?

If the Fund is not profitable, the GP loses to the same extent as its LPs. 

 

Cashless Contributions

What is it?

Under the “cashless contribution” approach, A GP would waive all or a portion of its management fees to “fund” a subscription by the GP for an interest in the Fund.  The entire amount of waived fees would be treated as deemed contributions to fund the GP’s interest.

Why would a GP do it?

Cashless contributions have two main potential benefits:

  1. Cash Flow - Conserves cash by: 
    1. Eliminating the need to fund capital contributions ahead of the receipt of management fees; and 
    2. Deferring tax liability on forgone management fees until the fund makes distributions; and

Tax Optimization - Reduce management fee income that is taxed as ordinary income and increase capital distributions that may be taxed as long-term capital gains.

What are the risks?

General risks:

If the fund does not return LPs’ capital contributions, the GP will receive neither the waived fees nor a return from the fund (i.e., GP gets neither fees nor carry if the fund returns less than 1X).  

Tax risks:

There are IRS and industry guidelines for when they will respect cashless contributions of management fee waivers. 

There may never be an assurance that the IRS will not take issues with cashless contributions. There is uncertainty and tax risk here, and GPs should consult their own legal counsel in making a determination on waiving a portion of management fees for an interest in the Fund.

Important Note:
All GP cashless contributions of management fee waivers into fund contributions must be made by the time of the first capital call for a fund.

 

Comparison of Standard Commit vs. Cashless Contributions

  Standard GP Commit Cashless Contribution
Do we have to invest cash in advance of receiving fees? Yes, though alternative capital commitment structures to match management fees and capital contributions could be used No, the GP interest is funded by waived fees
Are the management fees taxable as ordinary income? Yes No
Is the GP interest taxed as long-term capital gains? Yes, assuming the LTCG holding period met Yes, assuming the LTCG holding period met
When is income recognized for tax purposes? Income from management fees is recognized in each year paid Income generally recognized in the year(s) when there is an exit
Do GPs have to waive the entire fee? N/A No, we can waive only a portion of the fee (and reduce their investment amount), and receive the rest in cash
Can we change approaches later? No, the waiver must be elected upfront No, the waiver must be elected upfront

 

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