In this second part of our Q&A with law firm Proskauer, Mike Suppappola and Kate Simpson discuss the use of special purpose vehicles in structured secondaries and treading a fine line in fund restructurings and recapitalisations.
Click here to read the first part on tail-end deals and preferred equity.
What other types of more complex secondaries transactions are you also seeing?
MS: I do see a lot of structured secondaries deals. A secondaries fund might purchase a direct portfolio of interests and the seller wants continued participation in any upside in the portfolio. The seller will participate with the buyer in an SPV and they will negotiate a split of the cashflow whereby the seller will receive distributions if portfolio returns exceed a certain hurdle or other threshold. It’s similar conceptually to preferred equity, but it’s a slightly different way of thinking about it. The seller isn’t contributing additional capital to an SPV, but it would be getting the potential for future profit, typically in exchange for a reduced purchase price.
Another common type of structured secondaries we see involves secondaries buyers purchasing a direct portfolio of buyout or venture interests. The buyer creates a structure whereby it is the sole LP of a newly formed investment vehicle and it brings in a third-party manager. They are essentially wrapping a fund around the acquired portfolio so that the secondaries buyer can capture the economics but then pay someone else to provide the expertise on managing the direct assets.
KS: In addition to those direct deals, we are also continuing to see GP recapitalisations and restructurings where a liquidity solution is offered to existing investors by a buyer which may also be putting extra capital into the fund and/or providing investment into a new vehicle from the manager. These transactions can also involve resetting economics for the manager itself. They are increasingly attractive as they can offer upside to all parties – they offer investors immediate liquidity and allow them to rebalance their portfolio, they provide access to a known pool of assets for the buyer and afford the manager an opportunity to realign economics and potentially gives them fresh capital to support the portfolio.
What are some of the legal challenges associated with these transactions?
KS: These transactions can be very complex as they involve multiple competing interests. Any decision to restructure and offer existing investors a liquidity option and/or an option of continued participation creates an inherent conflict for the manager. Particularly if the economics are reset, it is, in essence, a transaction with the manager on both sides. Accordingly there needs to be an in-depth analysis of the fund documents and the transaction to determine the impact of the structure, the potential risks and the necessary waivers and approvals.
Ultimately it will likely come down to a question of value. The buyer will want to negotiate a good deal whilst the investors, and indeed any former executives of the manager still holding carried interest, will want to ensure as high a price as possible. As the manager is operating on both sides of the deal – as manager of the fund being restructured and of the new restructured buyer vehicle – it must tread a fine line to ensure all parties are fairly treated. Fundamentally a transparent process and seeking parity of treatment are key.
Mike Suppappola and Kate Simpson are both partners in Proskauer’s Private Investment Funds Group based in Boston and London respectively.
This article is sponsored by Proskauer. It appears in the September issue of Private Equity International magazine.