What is matrix pricing and how is it used in the market?
It’s very commonplace in the industry to have a portfolio of LP interests where you have one or two or even more funds which may have Right of First Refusal clauses to existing investors. If a buyer is buying a portfolio of 25 funds and one or two of them may drop out because of ROFRs, that puts their portfolio pricing at risk.
One standard practice is for an advisor to look at the list of GPs of the funds that are in the portfolio and contact the GPs early in the process to understand which are restrictive and which are not. Some GPs are very strict about the fact that they’ll only allow transfers to a select group of buyers.
There are many funds that have a ROFR to existing investors built into their limited partnership agreements. In those scenarios, if a buyer puts in a bid at, say, 100 percent of NAV for the 25 funds, what they may do when pricing each of these fund interests is for the ROFRs funds, the price allocation may be much higher, for example 120 or 130. For the other funds that are not subject to ROFRs and that should be transferred without issue to the buyer, the price allocation may be 75 to balance out the portfolio to 100 percent of NAV.
It doesn’t really change the price of the portfolio – the price of the portfolio remains exactly the same – it’s just the allocation of the price. It means existing LPs may not be able to match the price offered and no LPs ROFR the fund.
If you’re an existing LP, aren’t you artificially being priced out of a potential purchase?
While an existing LP is still technically getting a “look”, the benefit they thought they were getting – an opportunity at a first look – you’re no longer getting it as part of this process. However, you counter that with the other scenario that there are many secondaries deals that don’t go through advised processes, they go directly through a ROFR process. An existing LP calls the GP saying they need to sell their fund stake. The GP sends the request to its existing LP base where there is a ROFR and it is bought. Not every secondary in a GP goes into a portfolio sale.
We have advised on many processes of single line sales where a ROFR can be exercised, and we have advised on many sales where we know a piece hasn’t joined the portfolio sale because it has gone straight to the ROFR process with the GP.
Is there anything suspect about this?
Buyers are using an attribution methodology to make sure that the portfolio transfers. It’s always the seller’s decision not to sell and it’s always the GP’s decision not to consent to the transfer. No one is being forced to do anything.
What’s the highest matrix pricing you’ve seen for ROFR stakes?
We’ve seen 120, 130 pricing where the overall portfolio is 100.
What price does a buyer typically have to offer to beat a ROFR clause?
You can never ensure it, you just have to make sure the price is high so that if someone tries to exercise the ROFR they have to match that price or higher. The buyers price it to a level where they know the market doesn’t trade at that level for that fund. They have to take an educated guess. In the case of a venture fund that no one has heard of and market pricing is in the mid-70s, a buyer could bid 85 or 90 and that will be good enough so that ROFR is not exercised.
What percentage of funds are subject to ROFR clauses?
There are always some. But as GPs become more savvy about the secondaries market, existing LPs – for example secondaries buyers – it’s part of negotiations to ask for preferential secondaries rights. GPs, as a sweetener to potential investors, may offer preferential co-investment rights and ROFR rights on secondaries to LPs. It’s a way to make terms more LP friendly. At the moment it’s the minority of funds in a portfolio that have ROFRs but over time, as newer vintages become part of the secondaries flow in the market, there will be a higher percentage.
Sunaina Sinha is the founder and managing partner of secondaries advisor and placement agent Cebile Capital.