GP-leds: Avoiding legal snags

GP-led secondaries are complex deals that sit at the cross section of M&A and fund formation, with multiple parties involved. So, while a degree of standardisation has crept into the market, there are also a number of common legal issues that can potentially delay or even derail transactions.

“I see with surprising regularity situations where sponsors haven’t done the necessary tax analysis on these transactions before they go out to market,” says Debevoise & Plimpton partner John Rife. “No secondaries buyer will proceed without being able to kick the tyres on the tax consequences of investing in a continuation vehicle, and it can be extremely disruptive to have to tear everything up and begin again when some unforeseen tax issue emerges.”

Amyn Hassanally, a partner and global head of private equity secondaries at Pantheon, agrees that tax can throw a deal off course. “GPs often seek to do tax-free transfers, which, to some extent, buyers like, because it increases the level of alignment. But it can get complicated and is something that has to be considered on a deal-by-deal and jurisdiction-by-jurisdiction basis, with buyers’ tax objectives in mind. For example, if a US asset is held in a corporation, that can lead to unwanted tax consequences for the buyer and can ultimately lead to value leakage at exit.”

Debevoise & Plimpton partner Gavin Anderson adds that foreign direct investment filing requirements can also be thorny, particularly given that many secondaries buyers are part of larger organisations. “You have to look at aggregate holdings for the purposes of certain filings, and that can get extremely complicated if an investment suddenly starts hitting thresholds.”

Reps and warranty insurance

Another important evolution in the GP-led secondaries market involves the advent of reps and warranty insurance. “Initially, when the GP-led continuation market was born, early deals involved primarily end-of-life situations,” says HarbourVest managing director Rajesh Senapati.

“In these deals, purchase price holdbacks were used as a source of indemnification and thus created a temporary delay in getting the full purchase price to selling LPs. With the advent of reps and warranty insurance, LPs can now get all their cash on day one.”

Anderson adds: “Given that the sponsor is on both sides of the transaction, reps and warranty insurance helps to mitigate the potential conflict if something goes wrong. It means the GP ideally ends up chasing an insurance provider, instead of itself, which is inevitably a less complicated situation.”