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Inviting a stakeholder in? Make sure your house is in order.
Your dream home — you’ve designed it, expanded it and weathered storms in it. Now, you're inviting a new resident — not just to invest in it, but to live with you. They’ll walk your halls, look into your books and have a voice in renovations. Are you ready for that?
Selling a general partner (GP) stake is not just financial. It can be emotional, strategic and deeply personal. When you layer on top of that the financial complexity and tax impact across all stakeholders, navigating the sale can be daunting. Understanding the different phases of the transaction will not only help you traverse many unknowns but also help to set a clear path forward, taking into account that many of these phases come with a tax impact.
Why consider a GP stake sale?
As firms mature, they begin encountering transitions that may include the desire to expand investments and asset classes, bring in new talent to diversify capabilities and succession planning. Selling a GP stake can unlock capital to fuel these goals, and the structure of that sale can vary.
- Primary sale (cash-in): Selling newly issued equity to raise growth capital — for hiring, launching new funds, expanding co-investments or improving infrastructure.
- Secondary sale (cash-out): Monetizing an existing partner’s stake to provide liquidity, diversify wealth or implement a succession plan.
- Hybrid: A mix designed to meet your firm’s growth needs while allowing founders to partially exit, which could also include preferred equity or debt.
Getting your home in order: Sell-side readiness
Anyone who has sold a home understands the immeasurable benefit of starting the preparation months before putting the house on the market. Similarly, preparing for due diligence on the sell side requires a well-organized and transparent presentation of your firm’s legal, financial, operational and tax positions. A well-organized approach to these areas not only supports a smoother diligence process but can also build buyer confidence and possibly strengthen your position in negotiations. Let’s look at some of the key financial and legal information that should be assessed for tax readiness.
Having the appraisal done: Valuation
With the sell-side foundation in place, the valuation process begins with telling a compelling story about the GP’s long-term earnings potential. This includes demonstrating stable management-fee income, strong profitability, a solid track record, limited partner relationships, fundraising strength, thoughtful succession planning, key-man risk mitigation and a clear strategic position in the market.
Income streams that establish the basis for sale valuations
Structuring the sale: Tax impacts and possible pitfalls
When evaluating the tax implications of a GP stake sale, several factors must be considered to fully understand how the transaction will affect the seller. Accurate modeling across transaction options is crucial to understand the current and future tax exposure. Common deal structures are generally outright or installment.
- An outright sale is a straightforward transaction in which the financial and tax impacts occur upon close.
- An installment sale allows for the recognition of gain over a period of time and the buyer agrees to pay the purchase price over time.
Sellers must also remember the disguised sale rules when structuring a GP stake sale that includes a property contribution to a partnership (in a primary transaction). For tax purposes, if a partnership receives property and then distributes different property or cash within two years, it’s generally treated as a sale. Transfers occurring after two years may also be recast as a sale for tax purposes under some circumstances.
Capital gain or ordinary income
In addition to deal structure, sellers must consider how their gain will be characterized. For partnership interests, this depends on the nature of the underlying assets — typically management-fee receivables and carried-interest rights.
Many sellers mistakenly assume that holding a GP stake for over a year ensures capital gain treatment. However, partnership interests are unique, and a portion of the gain can be treated as ordinary to the extent of unrealized receivables in the partnership. For asset managers, management contracts may qualify as unrealized receivables — especially if they are short-term (usually terminable within 30 days) or tied to future services — which can trigger ordinary income treatment. A thorough review of these contracts is essential to assess tax consequences accurately.
For international sellers, any gain tied to a US trade or business (the management company) may be treated as effectively connected income and taxed in the United States.
Bifurcated holding periods and carried interest also warrant attention. A recent capital contribution can result in a bifurcated holding period, treating part of the gain as short-term, even if it’s a longstanding partnership. And while the carried interest look-through rule is more relevant to hedge funds given the short-term nature of assets, it should still be reviewed. Sellers should carefully plan for how primary and secondary proceeds are allocated between the management company and carry vehicles.
Sweetening the deal with a step-up basis
As noted, partnerships and partnership interests aren’t like other assets, and this is most apparent when discussing tax basis, specifically “inside” and “outside” basis. Outside basis is the partner’s basis in the partnership interest. Inside basis is the partnership’s basis in its own assets. When a new partner acquires an interest in a partnership, depreciation and amortization may cause a disconnect between the inside and outside basis.
A Section 754 election helps reconcile outside and inside basis. This is done by the partnership making an affirmative election to step-up the basis of the assets within the partnership. This step-up can be highly valuable to the buyer, allowing for increased future deductions via amortization or depreciation.
During deal negotiations, sellers should quantify the tax benefit by calculating basis accurately and modeling various scenarios to support their position. Allocating the purchase price to the management company versus carry vehicles will drive this calculation.
Closing day and post-deal infrastructure
After the ink dries, actions related to tax and financial infrastructure still need to be taken. Based on the details of the deal, the partnership must revamp and refine its financial data reporting structure to provide the new GP with timely reports. GP stake buyers will require detailed information, including quarterly financials, tax estimates and clear deadlines for delivering audited financials, estimated K-1s and final K-1s that align with their reporting timelines. Sellers will need to establish a process to maintain GAAP-ready books and financial estimates, including estimated K1s (with requisite detail such as UBTI, ECI, FDAP and state sourcing), so the new partner can meet any federal, state or foreign filing requirements.
Additionally, if there’s a Section 754 election, the partnership must meet the reporting requirements to establish the basis for the buyer’s tax benefits.
The buy-side view
In our related blog, we explore the buy-side considerations in a GP stake sale, focusing on the tax treatment of carried interest, income and loss allocation, and key structural elements like vesting, forfeiture, clawbacks and GP buy-in/buy-out provisions. Read our blog on the buy-side view here.
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