Filtering investments by GP AUM
AUM can quickly lead your astray
Happy Sunday!
I’ve written on the idea that people (wrongly) filter their deal flow by IRR. I think the second most common filtering algorithm is AUM and that’s what I’d like to tackle today.
The concept is pretty simple - if someone owns a lot of property, they’re likely more experienced than the guy who’s just getting started … right?
As you can already tell, the answer is “not necessarily” and I’ll explain why this is the case from the perspective of an LP.
Benefits of filtering GPs based on AUM:
Stronger relationships - service providers (e.g. brokers) will typically favor GPs who can close with certainty and have closed many times before. Therefore, bigger firms may get preferential terms from brokers, lenders, and contractors. This can translate into earlier access to deals and better terms.
Institutional infrastructure - larger managers typically have in-house accounting, asset management, compliance, and investor relations teams … these resources can reduce operational risk and provide LPs with better reporting and communication
Reduced key person risk - with a trained team in place, the business can continue even if leadership pursues another career, asset class, or something health-related unfortunately happens to the CEO. Key person risk is one of those things that I don’t think gets enough attention within the world of lower middle market GPs.
Stability and financial backing - a larger, diversified portfolio under management can mean the firm is less dependent on any single property or project. Cash flow from management fees can support the GP’s business through downturns or the lack of fees from a struggling property.
Drawbacks of filtering GPs based on AUM: