Secondaries market participants often talk about the need for win-win-win in GP-led transactions: they need to work for the LPs, the GP and the secondaries buyers. Given the significance of these three generalist stakeholder groups, how important is alignment with the management team of a portfolio company or companies involved in an underlying GP-led transaction?
According to Tom Lin, a partner at Clifford Chance, the mere fact the new vehicle housing the assets will have a different cost base to the original fund, and the fact there is liquidity being generated in the secondary transaction, means it’s worth examining how the management team will be aligned in the new structure.
“How you have incentivised management in the first place needs a rethink. Plus, you can’t overlook the value that management has helped create, even if your management incentive programme (MIP) might not explicitly have a GP-led secondary as a triggering liquidity event,” Lin says.
All the industry sources affiliate title Private Equity International spoke to for its Secondaries Special report agreed that alignment between portfolio company management and other parties is key, though opinions on the extent to which management teams hold power in these deals differ.
“When we start discussions with the GP, it’s always one of the first questions: what’s your relationship with the management team like?” says Johanna Lottmann, managing director at PJT Partners.
When an adviser agrees to take on a continuation fund mandate from a GP client, often the first step in the process is to undertake a transferability review to ascertain elements such as which stakeholders need to be paid out, who needs to be offered liquidity, and where waivers need to be sought regarding portfolio company-level debt, among others.
Indeed, early engagement with the management team can pay off, says Thomas Liaudet, a partner at Campbell Lutyens.
“You have to think about it early on – you don’t want it to become an 11th-hour topic and affect the deal,” Liaudet says. “In most cases, a liquidity event for the fund’s asset is a liquidity event for the portfolio company management team – including if the asset is being moved into a separate fund managed by the same GP.”
There may be rare cases where a continuation fund process is not a liquidity event for the management team, such as where a minority investor has been brought in, say, 12 months prior, and where the management incentive plan has been reset at that time. In such a case, it may be too soon to reset the MIP when conducting a continuation fund, says Nigel Dawn, global head of private capital advisory at Evercore.
Even if a liquidity event is not triggered for the management team in a continuation fund transaction, it is an opportune time for the GP to sit down with the management team and discuss alignment, Lottmann says.
For buyers, ascertaining how excited a management team is about being owned by the same sponsor for an additional period of time is crucial. Some buyers approach the transaction in the same way they would a co-investment opportunity.
“We prefer at least one in-person meeting… Follow-up questions can be addressed via videoconference,” says Rick Fratus, managing partner at Stafford Capital Partners, a London-headquartered investment firm. “We want to hear the go-forward business plan directly from management so that we can understand how the company will practically achieve its targets. While we are focused on the quantitative measures, we also like to get a qualitative feel for the management team and their capabilities.”
Reviewing the management compensation structure is critical, and Stafford prefers transactions with a new/rollover structure that aligns all three groups – LPs, GPs and incoming capital.
“Ultimately, investment success will rely on the execution of the business plan by the management team, and we want to ensure that they have the ability to do that, and that they are fairly incentivised,” Fratus says.
A chief executive who isn’t 100 percent aligned with the GP’s vision for the company can raise red flags, adds Bernhard Engelien, head of European secondaries capital advisory at Greenhill.
“If you have a CEO of a company who is about to retire and you suddenly tell [them] you have to do another five years, I think that could be a problem,” Engelien says. “When we look at whether or not to take on a mandate, the stability of the management team is important.”
According to Evercore’s Dawn, a chief executive cashing out completely and retiring isn’t necessarily a problem if there is a natural succession plan in place. “If it’s the original CEO who may have been in that seat for 20 years and they’re not actually the [one] driving the value at that point, you want to make sure that [the person] who is incentivised is the one really driving the value,” he says.
Do the chief executive and senior management team ultimately have any say in whether a GP-led secondaries transaction involving their company goes ahead? In theory, they have no veto rights to block a deal. That said, they can make it difficult for the transaction to proceed by not granting access, or by making themselves available to potential secondaries buyers who have won exclusivity on the deal and are conducting their due diligence, says Philip Tsai, global head of secondary market advisory at UBS.
Management teams can benefit from being sold to their current owner. While a sale to another private equity firm or a strategic buyer can be a time- and resource-intensive exercise, a continuation fund process is much less intense for the portfolio company, according to Dawn.
“A lot of management teams really like these transactions because, compared to a sale to a third party, it’s much less invasive in terms of diligence that’s done by the new buyer,” he says. A management team that already likes the GP it is working with, and with which it is aligned, tends to result in a much smoother process than having a new investor come in that it doesn’t know, he adds.
Ultimately, management teams can sabotage a deal and be entirely unhelpful if they wish to, so ensuring they’re on board with the company’s growth plan is paramount, says PJT’s Lottmann.
“The best continuation funds are where the GP says we have the best management team on the planet,” she says. “We love these guys, they love us. We want to continue to work for another five years and take this asset to the next level.”