Acquisitions of listed funds of funds can present excellent opportunities in the secondaries market for sophisticated buyers willing to navigate the complexities of a public acquisition, explain Katherine Ashton and David Schwartz, partners at Debevoise & Plimpton.
Prospective purchasers of a public fund of funds must navigate a complex overlay of fund regulation, securities law requirements and tax considerations. But the rewards can be attractive.
The structural complexity of a listed vehicle acquisition is driven largely by the multiple layers of regulation applicable to the fund and its investments. To market its equity to retail investors, the fund will normally be subject to more stringent domestic regulations than those that apply to funds restricted to institutional or high net worth individual investors. Also, as a listed entity, the fund is likely to be subject to takeover laws as well as prospectus requirements if a transaction involves a new issuance of securities.
An important decision for a buyer is the choice of a transactional form. This usually means a choice between an asset purchase, or a tender or exchange offer. In a tender or exchange offer, a buyer makes an offer directly to the shareholders or limited partners of the publicly-traded vehicle. Depending on the jurisdiction of the target fund, this type of structure may be subject to takeover rules that closely regulate the offer process. For example, throughout Europe there are regulatory limits on the buyer’s ability to make an offer for less than 100% of the equity in the fund, requirements for equal treatment of holders and detailed procedural requirements governing the offer process and timing. If the goal is to take the fund private, the buyer must also consider the minimum acceptance threshold required to delist.
An asset transaction can be structured for the acquisition of all or a portion of the fund’s underlying portfolio of partnerships. Depending on the applicable regulatory regime, this type of structure can avoid some of the regulatory requirements that would be applicable to a tender offer process. However, asset purchases of individual underlying partnership interests will require the cooperation of the manager of the fund as well as the consent of the general partners of the purchased portfolio partnerships. This can add significant delay as well as the risk of acquiring less than was originally expected.
In some cases, the buyer may give the holders of a listed fund the option to accept an equity consideration (rather than cash) so they can continue their exposure to the underlying portfolio partnerships. This consideration could consist of new equity securities of an existing fund entity, or equity securities issued by an entirely new investment vehicle.
In the European Union, an offer of new equity to holders will sometimes require a prospectus and regulatory approval. From a securities law perspective, any offer of equity consideration also requires careful analysis of registration exemptions under United States federal and state securities laws, as well as the rules of other jurisdictions.
Giving different options to the existing holders may enhance the bidder’s offer, but also greatly increases the complexity of the transaction.
It is important to avoid or minimise future adverse tax consequences for the ultimate investors. The buyer will need to consider the impact of local taxes and withholding taxes on dividends and interest, as well as any other restrictions on the ability to repatriate earnings. Any offer of equity consideration to the holders of the listed fund will also require careful tax analysis to determine, among other things, whether the existing holders can obtain tax-free rollover treatment and whether the acquisition should be divided as a part sale and part contribution/merger transaction for tax purposes.
Similarities to public and private acquisitions
In some ways, negotiating the acquisition of a listed fund or its portfolio raises the same issues that arise in the context of most public company acquisitions, including little or no opportunity for post-closing recourse. Therefore, buyer’s due diligence is critical.
In other ways, the multiple constituencies and counterparties make these transactions more akin to negotiating a complex private acquisition. Unlike a standard secondary trade, a significant investment in or takeover of a listed fund usually involves negotiations with several parties, including other shareholders in the listed fund, the fund’s board of directors, and the fund’s investment manager.
Often these parties will have different objectives. Once the definitive agreements are signed, requirements for underlying general partner notices or consents, disclosure and regulatory approvals can lead to a substantial period of time between signing and closing. It is important for the parties to reach a comprehensive understanding in the acquisition agreement regarding process, timetable and the level of effort required to overcome the hurdles to execution.
The acquisition of a listed private equity fund is a complex transaction that poses significant challenges to the buyer, the listed fund and their respective advisors, but if structured, priced and timed correctly, can provide the seller with needed secondary liquidity and the buyer with opportunity for an attractive return.
Katherine Ashton and David Schwartz are partners at Debevoise & Plimpton, based in the London and New York offices respectively.