What risk do GPs have to consider when LPs force an exit?

When General Partners (GPs) are faced with a forced exit by Limited Partners (LPs), they have to consider the immediate tax implications related to performance fees. If the exit occurs ahead of their preferred timeline, the GPs may realize performance fees sooner than expected, which can lead them to incur a higher immediate tax liability.

When profits are distributed, GPs are typically taxed on the performance fees at their ordinary income tax rate, which could be significantly higher than the capital gains tax rate applied to longer-held investments. The sudden need to exit can disrupt the planned tax strategy that the GPs might have been implementing to minimize their overall tax burden, thus elevating their immediate tax obligations.

In this context, it is essential for GPs to be aware of how a forced exit can affect their financial outcomes, specifically in terms of tax implications, which could add significant costs and impact their net returns after taxes.