The case for clarity in end of fund life issues

Ambiguity around who pays for what when a vehicle comes to the end of its term could scupper growth in the GP-led secondaries market.

GPs dealing with end of life issues has been a hot topic this year as a wall of funds raised in the aftermath of the global financial crisis reach the end of their terms. These so-called tail-end funds can provide secondaries buyers with attractive pickings as they tend to have shorter durations and provide a relatively high internal rate of return and distributed to paid in ratios, as Elm Capital noted in its first half report.

For its part, the Institutional Limited Partners Association has been tackling GP-led restructurings within the context of end of life issues. As ILPA’s managing director of industry affairs Jennifer Choi told us in September: “You don’t want to have ambiguity around how an extension is going to be granted. You don’t want ambiguity around whether or not fees are being charged. You don’t want to decide that at the point you’re also making the decision about the future of the fund.”

A couple of recent data points gathered by our research team provide some interesting food for thought in this area.

According to the 2018 Fees and Expenses Benchmarking Survey conducted among PE firm CFOs by sister title private funds management, there is not much provision in fund docs for the end of the fund’s life when it comes to who pays what. Around half of the CFOs who responded to the survey said they do not stipulate fee and expense arrangements in their LPA beyond any stipulated extension periods. It is, instead, negotiated at the time of extension. Is this smart? Not according to Tom Angell, partner at WithumSmith+Brown, one of the sponsors of the survey. “It is safe to say that a lack of vision early in the process could yield negative outcomes – from a failed transaction and significant expenses to angry investors and regulatory scrutiny – if fee and expense arrangements are left open for negotiation at the time of the extension,” he writes in a guest commentary analysing the results.

It is a similar story for fund restructurings – moving the assets to a new fund, with new terms. Only 16 percent of respondents said their LPA stipulates who pays for the costs relating to a potential fund restructuring. Just over half said it is decided when the situation arises.

“In essence,” writes Angell, “the plan is no plan at all.”

Indeed, another data set – this one taken from the soon-to-be published LP Perspectives survey from sister publication Private Equity International – suggests disquiet among investors on this front. A majority of LPs have now been party to a fund restructuring proposal. Of these, more than a third said they did not have sufficient time to make a decision, while a similar proportion said they had insufficient information. Most divisive, however, were the costs: nearly two-thirds of LPs said the costs of the process were not fairly divided between the GP and the fund.

This matters because these processes require significant external advice, as well as the costs related to setting up a new vehicle. LPs may be slightly less enamoured with the process if they find out late in the day that they are paying for it via their fund assets.

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