As GP-led secondaries transactions have become both more common and more accepted by the market, sponsors and investors have questioned how the process for such transactions could be streamlined while still providing protections regarding potential conflicts.
The result is an emerging trend of sponsors incorporating provisions in fund documents that pave the way for future GP-led transactions.
Nonetheless, sponsors that wish to include express provisions governing GP-led transactions should be aware that such transactions are highly bespoke and subject to a rapidly evolving market. Even sponsors experienced in these transactions should keep in mind that the next deal may look very different than the last in terms of structure, process and/or economics.
Given that there is no one-size-fits-all approach, any such provisions should provide guardrails to the process, with the understanding that there are limits on what can and should be hardwired.
A provision regarding GP-led transactions could address the following two points:
The approval process, and how conflicts of interest will be addressed
Transactions of this nature carry innate conflicts of interest. While limited partnership agreements generally address the approval process for transactions where the general partner is conflicted, a provision regarding GP-leds could specify a particular approval process, such as approval by the fund’s limited partner advisory committee, or even that certain kinds of transactions are permissible without transaction-specific approval.
For example, a GP-led provision might put forward that transactions that comply with certain price discovery requirements need notice only, and not any specific investor or LPAC consent. Such carveouts from consent are consistent with the wider trend of parties agreeing to limit the types of conflicted transactions that require prior approval when other safeguards are in place.
Although some sponsors may wish to hardwire a fund’s governing documents to permit GP-led transactions without specific approvals – and investors may be willing to provide the GP with that authority if it is dependent on particular price discovery requirements – a sponsor may, from an investor relations perspective, choose to seek some form of investor or LPAC approval despite contractual authority, based on the facts and circumstances of the particular deal.
The pricing for a GP-led transaction often poses particular conflicts of interest; the process for determining whether a price is fair for investors on either side of the deal is one of paramount importance.
A provision on GP-led transactions may specify how a fair price can be determined. This process could involve negotiating directly with buy-side and/or sell-side minority investors, third-party bids, or auctions and valuations from independent valuation agents. Sponsors can also authorise the LPAC to pre-approve other methods of establishing a price sufficient to remove the need for any additional transaction-specific approvals.
A GP-led provision may also require a formal fairness opinion in conjunction with one or more of these pricing mechanisms, particularly in light of the US Securities and Exchange Commission’s proposed rules in this area. That proposal would require an SEC-registered investment adviser to procure a fairness opinion with respect to each of its GP-led secondaries transactions from an independent opinion provider. It would also require the adviser to disclose to investors the material business relationships between the adviser and the opinion provider over the past two years.
Other provisions that may facilitate GP-leds
Whether or not a sponsor includes an express provision on GP-leds, it may wish to consider evaluating other provisions in a fund’s governing documents and how they could be modified to facilitate future GP-led transactions. For example, sponsors may want to ensure that expense provisions would permit the special allocation of expenses relating to GP-leds to particular investors, such as investors electing liquidity.
In addition, sponsors may want to provide mechanics for allocations of broken deal expenses relating to GP-led transactions that are not completed. To facilitate the structuring of GP-led transactions, sponsors may also wish to review provisions permitting distributions in kind to make sure they afford the flexibility necessary for tax-free rollovers.
Sponsors contemplating GP-led provisions in fund organisational documents may also wish to consider the following:
- Disclosure – Whatever approach a sponsor decides to take with respect to the fund’s governing agreement, it should make sure that its Form ADV, and the fund’s private placement memorandum, adequately and accurately describe that approach.
- Regulatory developments and ILPA recommendations – As noted above, the SEC has proposed fairness opinion requirements with respect to GP-led secondary transactions. In addition, advisers considering GP-led provisions may wish to familiarise themselves with ILPA’s recommendations regarding GP best practices in this area.
- Alternative transactions – Sponsors seeking greater flexibility with respect to GP-leds may also be interested in increasing their ability to hold assets for longer or generate other sources of follow-on capital and/or investor liquidity. Term extension provisions, borrowing provisions that facilitate net asset value borrowing facilities, provisions governing interactions, and transactions with successor funds and amendment provisions should all be considered carefully. Sponsors may also wish to consider alternative fund structures, such as evergreen and long-term funds, that permit a more flexible timeline for dispositions of investments.
Maurice Gindi and Kenneth Blazejewski are both Now York-based private investment funds partners with Cleary Gottlieb Steen & Hamilton. Sophie Smith, based in London, is a counsel advising on private investment funds for the law firm. A version of this piece has already been published by Cleary Gottlieb.