LPs, GPs, and GP Catch-Ups: How Private Equity Really Works Behind the Curtain

Private equity thrives on partnerships between Limited Partners (LPs) and General Partners (GPs). LPs provide most of the capital, while GPs manage investments and aim to increase the value of acquired companies. A key feature is the GP catch-up mechanism, which ensures GPs are rewarded only after LPs receive their initial investment and a preferred return (usually 8%). This aligns incentives and drives performance.

For SaaS and AI companies, private equity offers more than funding - it brings expertise to improve operations, expand markets, and scale efficiently. GPs analyze metrics like recurring revenue and customer acquisition costs to identify growth opportunities. Meanwhile, LPs oversee fund performance and governance, ensuring their goals align with the fund's strategy.

The profit-sharing model follows a "waterfall" structure:

1. LPs recover their investment first.
2. LPs receive a preferred return.
3. GPs enter the catch-up phase to claim their share of profits (typically 20%).

Private equity’s structured approach combines financial resources with hands-on management, making it a powerful tool for growth in sectors like SaaS and AI.

What is Private Equity? Structure, Strategy, and How PE Funds Make Money | M&A Masterclass Moment

Limited Partners (LPs) and General Partners (GPs) Explained

Understanding the roles of Limited Partners (LPs) and General Partners (GPs) is key to grasping how private equity funds operate, especially in sectors like SaaS and AI. At the heart of every private equity fund lies a well-defined partnership between these two groups, each with distinct responsibilities.

What LPs Do

Limited Partners (LPs) are the primary source of capital for private equity funds. These investors, often institutional entities or high-net-worth individuals, commit substantial financial resources but remain largely uninvolved in the fund's daily operations.

When General Partners (GPs) issue a capital call, LPs supply the funds needed for acquisitions and growth strategies. Beyond funding, LPs may serve on advisory committees, where they review issues like potential conflicts of interest, valuation practices, and updates to fund policies.

What GPs Do

General Partners take on the active management of private equity funds. They oversee every phase of the investment process, from raising capital and sourcing deals to managing portfolio companies and planning exits. GPs attract investors by presenting their strategies and demonstrating their ability to generate returns.

Once a fund is established, GPs focus on identifying investment opportunities. In sectors like SaaS, this involves analyzing metrics such as monthly recurring revenue (MRR), customer acquisition cost (CAC), and customer lifetime value (LTV) to evaluate a company’s growth and scalability.

After acquiring a company, GPs shift their attention to improving its performance. They collaborate with management teams to drive operational changes, explore strategic add-on acquisitions, and refine capital structures. When it's time to exit an investment - whether through a sale, IPO, or other methods - GPs aim to maximize returns through precise timing and execution.

LPs vs. GPs: Key Differences

The roles of LPs and GPs are clearly defined, with their compensation structures reflecting their responsibilities. LPs, as passive investors, receive most of the fund's returns, while GPs benefit from management fees and performance-based incentives, such as carried interest. This alignment of interests ensures both parties are focused on the fund's success. On the regulatory side, LPs typically need to meet accredited investor criteria, while GPs may face additional requirements, such as registering with regulatory bodies, depending on the fund's size and structure. Together, these roles form the backbone of private equity operations.

How Decisions Get Made in Private Equity

Private equity decision-making unfolds through distinct stages, with General Partners (GPs) taking the lead in operational decisions and Limited Partners (LPs) maintaining oversight to ensure their investments align with agreed-upon strategies.

Before Making Deals

General Partners are at the forefront of identifying and evaluating investment opportunities. They rely on their networks and conduct in-depth market analyses to find targets that fit the fund’s strategy and risk-return goals ^[3]. The initial screening process focuses on whether potential deals align with the fund’s objectives and meet specific financial benchmarks.

During due diligence, GPs perform detailed evaluations of a company’s financial health, legal standing, operations, and ESG considerations ^[2][3]. For SaaS and AI companies, this process includes assessing the scalability of their technology and growth potential. GPs also structure transactions and negotiate deal terms before moving forward.

While LPs don’t get involved in the day-to-day search for deals, they play a critical role in verifying information and ensuring all legal documentation is in place before committing capital ^[1]. GPs often consult LPs on major deal terms, particularly for larger investments that could significantly impact the fund’s performance.

The most effective partnerships occur when GPs and LPs establish clear expectations from the start - covering investment strategy, risk tolerance, and desired returns ^[2]. This upfront alignment reduces potential conflicts and ensures both parties are on the same page about their roles in the decision-making process.

Once a deal closes, the focus shifts to managing the investment and creating value.

After Making Deals

After an investment is made, the decision-making process pivots to active portfolio management. GPs take charge of daily fund operations, overseeing portfolio companies and making decisions to drive operational and financial improvements ^[1][2][3]. Their responsibilities often include implementing strategic initiatives, enhancing efficiency, and closely monitoring financial performance to maximize returns.

GPs may also provide hands-on guidance to portfolio companies, including replacing leadership when necessary ^[1][3]. For SaaS and AI firms, this might mean helping management optimize technology systems, explore new markets, or refine customer success strategies.

LPs, on the other hand, step back from daily operations but maintain vital oversight responsibilities. They receive regular updates and reports from GPs to stay informed about fund performance ^[1][2][3]. LPs also play a role in fund governance, ensuring that activities align with their investment goals ^[4].

Advisory committees, often including LP representatives, are instrumental in post-investment oversight. These committees review potential conflicts of interest, approve valuation procedures, and monitor the ethical conduct of GPs ^[1]. Additionally, as transparency becomes more important, LPs now expect detailed, standardized reports with granular insights into portfolio performance and valuations ^[3].

Exit Planning and LP-GP Teamwork

The final stage of the investment cycle involves planning and executing exits. GPs determine the best strategy - whether it’s an IPO, sale to another private equity firm, strategic buyer, or recapitalization ^[1][2][3] - and manage the process to maximize returns for LPs.

During this phase, LPs influence or approve key decisions that affect fund performance ^[1]. LPs often vote on significant matters, such as extending the fund’s life, altering its terms, or replacing a GP if necessary ^[1]. This ensures they retain control over major changes that could impact their returns.

The profit-sharing model aligns the interests of both parties during exits. GPs typically earn carried interest - about 20% of the fund’s profits - but only after LPs achieve their preferred returns, generally set at an 8% annual hurdle rate ^[1][2][4]. This structure incentivizes both GPs and LPs to aim for successful exits.

Exit strategies can involve complex arrangements like NAV-based loans, continuation funds, or partial exits ^[3]. These approaches require increased communication and collaboration between GPs and LPs, reinforcing the importance of their partnership.

As private equity markets grow more competitive and complex, LPs are demanding greater transparency and collaboration from GPs. This evolving relationship, built on continuous alignment from deal sourcing to exit, is at the heart of private equity’s value creation model.

GP Catch-Ups and How Profits Get Split

Private equity funds use a structured approach called the waterfall to distribute profits, ensuring the interests of Limited Partners (LPs) and General Partners (GPs) are aligned. This process follows a step-by-step sequence, with profits allocated based on performance milestones. Let’s break down how profits are distributed and the role of GP catch-ups in this system.

The Profit Distribution Process

In private equity, the waterfall structure prioritizes LPs when distributing profits. Here’s how it typically works:

1. Return of Capital: LPs first recover their initial investment before profits are shared.
2. Preferred Return (Hurdle Rate): LPs usually receive a minimum return - commonly around 8% annually - on their investment. This ensures they achieve a baseline return before GPs can claim any carried interest.

After these steps, the remaining profits move into the next phase of distribution. At this point, the structure can differ depending on the fund:

• European Waterfall: All investments in the fund must meet the preferred return threshold before GPs receive any carried interest.
• American Waterfall: GPs can receive carried interest on profitable individual investments, even if other parts of the portfolio haven’t yet met the hurdle rate.

Once these thresholds are met, GPs are typically entitled to 20% of the total profits as carried interest. However, instead of immediately receiving this share, GPs benefit from the catch-up mechanism, which accelerates their compensation after LPs’ returns are secured. Let’s take a closer look at how this works.

How GP Catch-Ups Work

The GP catch-up mechanism ensures that GPs are rewarded based on the fund’s overall performance. After LPs receive their returned capital and preferred return, the remaining profits are allocated entirely to the GP until their cumulative share reaches the agreed-upon percentage - usually 20% of profits exceeding the hurdle rate. Once this catch-up phase is complete, any additional profits are split according to the standard 80/20 agreement between LPs and GPs.

Here’s an example to illustrate:

• A fund returns the original investment to LPs and provides the preferred return.
• Any remaining profits are then directed entirely to the GP until their share equals 20% of the total profits above the hurdle rate.
• After this, the remaining profits are split - 80% to LPs and 20% to GPs.

This structure ensures LPs are protected, as they recover their investment and earn a minimum return before GPs receive significant compensation. At the same time, it motivates GPs to maximize the fund’s performance, as their earnings depend on exceeding the hurdle rate and entering the catch-up phase. The waterfall system creates a balanced approach that aligns the goals of both LPs and GPs throughout the fund’s lifespan.

Profit Distribution Example with Numbers

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Creating Value in SaaS and AI Companies

Private equity’s pursuit of high returns has led to tailored strategies for driving growth in SaaS and AI businesses. These industries demand a different playbook compared to traditional sectors, and private equity firms have stepped up with specialized approaches. General Partners (GPs) contribute operational know-how, strategic direction, and financial resources to help these companies grow efficiently and prepare for successful exits.

Growth Strategies for SaaS and AI Companies

To create value in SaaS and AI, GPs focus on targeted growth strategies that address key operational and market challenges. These include:

• Boosting revenue by refining pricing models and expanding into new markets.
• Improving efficiency through automation and advanced technology systems.
• Accelerating product development with increased R&D investments and strategic partnerships.
• Reducing churn by implementing strong customer success programs.

Limited Partners (LPs) play a crucial role in amplifying these efforts. Their industry knowledge and networks bring an extra layer of support, helping portfolio companies unlock additional growth opportunities.

Collaboration Between LPs and GPs in Value Creation

LPs and GPs often work hand-in-hand to maximize value in SaaS and AI investments. LPs, such as corporate pension funds and insurance companies, frequently act as early adopters of portfolio solutions, offering valuable case studies and references that help build credibility.

Performance monitoring is another key area of collaboration. Both LPs and GPs keep a close eye on critical metrics like net revenue retention, gross revenue retention, customer acquisition costs, and sales efficiency. These metrics are tracked through detailed dashboards, with updates provided on a monthly or quarterly basis.

LPs also contribute to talent acquisition, leveraging their networks to connect portfolio companies with experienced executives. This is especially important in the competitive SaaS and AI job market, where recruiting top-tier leadership can significantly influence growth.

Additionally, LPs provide broader market insights and long-term strategic perspectives, complementing the day-to-day operational support offered by GPs. This dynamic exchange of guidance strengthens the overall value creation process.

Leveraging Top SaaS & AI Tools Directory for Growth

To support these growth initiatives, platforms like Top SaaS & AI Tools Directory offer practical resources for portfolio companies. These tools are designed to help businesses streamline operations and accelerate revenue growth.

The directory includes solutions for lead generation, CRM management, email outreach, and customer engagement - all of which are critical for boosting recurring revenue. For companies preparing for exits, the platform provides insights and best practices from successful SaaS businesses, enabling faster implementation of proven strategies.

A standout feature is the directory’s focus on AI-powered solutions, which align perfectly with private equity’s emphasis on operational efficiency. Tools for analytics, business optimization, and process automation help portfolio companies achieve measurable improvements - a key focus for GPs.

Joining the directory’s waitlist also provides access to exclusive training and strategic recommendations, giving companies an edge in driving operational success and scaling effectively.

What SaaS and AI Companies Need to Know

For SaaS and AI companies, navigating private equity can unlock the growth capital needed to scale. But here's the catch: traditional valuation metrics often don't fully capture the potential of these businesses. Private equity investors focus on different indicators, and aligning your operations with their expectations is crucial to success.

How to Work with Private Equity

Partnering with private equity firms isn't just about securing funding - it’s about aligning on ambitious financial and operational goals. These firms typically aim for internal rates of return (IRRs) of 15% or more ^[1], meaning your growth plan must support aggressive scaling.

Private equity firms bring more than money to the table. They offer operational expertise, strategic guidance, and access to valuable networks that can accelerate your company’s growth. But with this support comes high expectations and intense scrutiny. To meet these demands, you’ll need robust reporting systems and the ability to back up your strategic decisions with data.

These firms excel at streamlining operations, refining strategies, and strengthening management teams ^[2]. For SaaS and AI companies, this often translates into more efficient customer acquisition, improved product-market fit, and faster feature rollouts. The key? Collaborate with your private equity partners rather than resisting their guidance. Their operational insights can be a game-changer.

Getting Ready for Private Equity Investment

Before you dive into a partnership with private equity, operational readiness is non-negotiable. Investors will look for consistent revenue growth, solid unit economics, and a clear path to profitability. You’ll need to prepare detailed financial records, clarify your market opportunity, and demonstrate strong leadership ^[2]. Organizing your documentation ahead of time is essential, as the process can take months.

Your market positioning also plays a critical role. Companies that stand out with unique offerings, strong customer retention, and clear competitive advantages are more likely to secure favorable investment terms. In the crowded SaaS and AI landscape, differentiation is everything.

Building relationships with potential investors early on can also make a big difference. Attend industry events, participate in accelerator programs, and maintain regular communication with investors who specialize in your sector. These connections often prove more effective than cold outreach when the time comes to raise funds.

Growing with Top SaaS & AI Tools Directory

The Top SaaS & AI Tools Directory is a valuable resource for companies preparing for private equity investment. It offers access to tools for lead generation, CRM management, and customer engagement - key areas that can strengthen your operational profile during due diligence.

Being listed in the directory can also boost your market visibility, potentially attracting investor interest. Many investors use directories and marketplaces as discovery channels, so having a presence on such platforms can be a strategic advantage.

Additionally, the directory focuses on AI-powered solutions that demonstrate operational efficiency. Tools for analytics, business optimization, and process automation signal to investors that your company is equipped for scalable growth. Just as private equity firms focus on improving operations, leveraging these tools shows you're ready to meet their standards for efficiency and growth potential.

Joining the waitlist for the directory gives you access to exclusive training and strategic recommendations to prepare for private equity discussions. You can also gain insights from successful SaaS companies featured on the platform, helping you benchmark your performance and identify areas for improvement before investors conduct their evaluations.

Finally, the directory emphasizes building predictable, scalable revenue models. Since private equity firms prioritize recurring revenue, the tools and strategies offered through the platform can help you establish the foundation needed to align with their value creation goals.

Conclusion: Private Equity Success Behind the Scenes

The success of private equity partnerships hinges on the dynamic between Limited Partners (LPs) and General Partners (GPs). These relationships are the engine behind value creation, particularly in fast-evolving industries like SaaS and AI.

The GP catch-up mechanism plays a pivotal role in aligning the interests of fund managers and investors. By ensuring that GPs only earn their share after achieving strong returns, this structure incentivizes exceptional performance and creates a win-win scenario where both investors and portfolio companies benefit.

For SaaS and AI companies eyeing private equity funding, success often depends on operational readiness and a sharp strategic focus. Beyond providing capital, private equity partners bring expertise, industry connections, and the ability to accelerate growth. However, they also expect high performance standards and transparent reporting - a combination that demands meticulous preparation.

These operational demands pave the way for meaningful collaboration between LPs and GPs. From sourcing deals to planning exits, private equity thrives on clear communication and aligned goals. When both parties work in sync, the results can be transformative.

To further strengthen operational strategies, tools featured in resources like the Top SaaS & AI Tools Directory can offer valuable support. These solutions help streamline operations and drive strategic growth - qualities that private equity firms prioritize when assessing investment opportunities.

FAQs

What is a GP catch-up in private equity, and how does it benefit both GPs and LPs?

A GP catch-up is a feature in private equity that allows the general partner (GP) to claim a larger portion of the profits once the limited partners (LPs) have received their preferred return. This mechanism ensures the GP eventually receives their full share of carried interest, which is typically set at 20% of the fund's profits.

This setup works well for both sides. It encourages GPs to aim for higher returns, aligning their goals with those of the LPs. For LPs, it establishes a results-driven incentive, where the GPs are motivated to deliver strong performance, ensuring both parties benefit from the fund's success.

How do private equity firms add value to SaaS and AI companies, and what strategies do they use to drive growth?

Private equity firms play a pivotal role in boosting the performance and profitability of SaaS and AI companies by employing advanced strategies and tools. One of their key approaches involves leveraging AI-powered insights to refine operations, enhance financial management, and maximize revenue potential. This often leads to improved EBITDA margins and higher valuation multiples.

Some of their core strategies include using AI for customer analytics, fine-tuning pricing strategies, and enhancing go-to-market plans. Beyond that, private equity firms prioritize expanding into new markets, introducing innovative products, and revitalizing brand identity to fuel growth. These tactics align with performance objectives while driving long-term value and measurable results.

What’s the difference between European and American waterfall structures in private equity profit sharing?

The way profits are distributed between Limited Partners (LPs) and General Partners (GPs) in private equity varies between the European and American waterfall structures.

A European waterfall requires LPs to be fully reimbursed for their invested capital, along with a preferred return (commonly around 8%), before GPs can start earning carried interest. This structure prioritizes LPs, ensuring they recover their initial investment and a return before GPs share in the profits.

On the other hand, the American waterfall allows GPs to begin earning carried interest as soon as individual deals become profitable. Unlike the European model, this doesn't require the entire fund to meet the preferred return threshold first. While this approach can result in faster payouts for GPs, it introduces a slightly higher risk for LPs, especially if some deals fail to perform well.

Both systems aim to balance the interests of LPs and GPs, but the choice between them often depends on the investment strategy and the level of risk each party is willing to accept.

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