In the first part of our series on GP-led restructurings, Gabriel Boghossian, who leads secondaries at King and Wood Mallesons, laid out what should happen at the beginning of the process. Now he takes us through the stages immediately before a deal.
Status quo option
When curtailing the life of a fund and selling assets to a vehicle that you also manage in a stapled deal, you have to give LPs an opportunity to convert their sale proceeds into a stake in the new vehicle. There is no legally prescribed time period or form of communication by which to seek this action, though a period of up to a month is common.
This so-called ‘status quo’ option is really an ‘economic status quo’, with the economic provisions being replicated in the rollover vehicle. However, the term of the new vehicle will be longer than the existing fund and may also include materially different reporting and governance provisions. In most cases, these tend to be more LP-friendly in the new vehicle.
Rollover LPs are sometimes offered the opportunity to commit further primary capital for follow-on investments in the existing assets. In that case, the GP has to navigate a concern that a decision by an investor not to ‘re-up’ will lead to dilution – in which case, the status quo is arguably less than a true status quo.
The limited partnership agreement usually requires GP conflicts of interest to be managed by an LP advisory committee vote. In practice, this typically takes the form of a two-stage process: initial in-principle approval is sought before an intermediary is appointed and sale options are explored; a binding and formal approval is sought once bids are received.
Investing as a limited partner is intrinsically passive – the advisory committee is not being asked to endorse the deal terms or otherwise approve the proposed restructure. Nevertheless, an advisory committee conflicts waiver is sometimes interpreted as an endorsement of the transaction terms. Therefore, advisory committee members frequently seek independent legal advice and the cost of this advice is generally a fund expense, increasing the transaction costs.
Usually, the waiver only requires a simple majority of members. Where one or more members abstain from voting and others are conflicted due to their involvement in the stapled secondaries transaction, it can make for a fine balance.
Disclosing full details in good time before the meeting is crucial; there have been many advisory committee meetings which have failed to achieve the necessary waivers due to a lack of information. But seeking irrevocable and unconditional waivers too early in the process is unlikely to go down well with LPs.
The GP’s decisions in a restructuring can come under intense scrutiny, and a fairness opinion prepared by a third party introduces an objective perspective to the process.
However, a fairness opinion does not state that the bid price is the best one that could be obtained in the circumstances; only whether the price is ‘fair’. Opinions which conclude that a deal (secondaries or otherwise) is ‘unfair’ are rare, and there is often a suspicion that the opinion is little more than an expensive rubber stamp. It is therefore frequently used alongside, rather than instead of, the other conflict mitigation steps available to GPs.
Recent transactions have shown that clear and frequent communication with investors to secure sufficient buy-in is critical. Full and frank disclosure of conflicts is a prerequisite, but conflicts still need to be avoided when possible, and minimised or otherwise managed when they are unavoidable.
It is possible LPs will demand more prescriptive terms as a reaction to this wave of restructurings, for example, by specifying the circumstances in which a restructure will be possible in the LPA, or stipulating that a full LP vote or consent is required in the event of a proposed transaction.
Gabriel Boghossian is a partner based in KWM’s London office specialising in advising private equity funds in relation to secondaries deals, co-investments and GP-led restructurings. Prior to joining the firm in 2016 he spent over five years at Macfarlanes as a senior solicitor and obtained his law degree from the University of Edinburgh.