The GP-led solutions market has received much attention in recent times, with commentators suggesting the best ways to achieve a successful scenario. Michel Galeazzi, partner and co-founder of Zurich-based private equity investment and management firm Evoco, discusses the drawbacks of GP-sponsored restructurings and why a different model can result in higher prices for limited partners.
Longer holding periods, unstable financial markets and valuations, and regulatory burdens are increasingly generating headwinds for general partners, particularly for those who have not raised a new fund since 2008. External pressures are often matched by internal complications, with first-generation partners retiring and new funds therefore difficult to raise.
The alignment of interests between limited partners and GPs is also widening, particularly in cases where value creation is lagging or exits did not materialise in time, and even successful private equity operations can be brought down by an imbalance between management fee and expected carry.
To avoid entering a downward spiral, such situations need to be actively rectified.
One model that has arisen to address such situations – the “GP-sponsored restructurings” model – has several drawbacks. In this model, a GP looks for backers to co-acquire its own portfolio, offering liquidity to legacy investors, with the Cognetas/Motion Equity Partners rebranding a well-known example.
By acting as both buyer and seller, the existing GP has a clear incentive to depress valuations. New investors – often secondaries funds – are facing a situation where they back an existing team that was not able to generate previously promised realisations. In addition, these new investors are usually taking over the key decisions on the portfolio.
This situation puts the previous GP essentially into an advisor role, and the LPs would call them a GP for hire. Remember that being an advisor is fundamentally different to being an investor.
There is another model emerging. In this model, a specialised buyer provides a platform for active value creation, offering liquidity to LPs and adding the necessary specialised manpower and capital to the existing portfolio. This model is known as a fund succession, with the €40 million Defi EuroCap transaction that Evoco closed in 2015 as a successful example.
In this transaction, Evoco provided capital to outgoing LPs and manpower to act as the core of the investment manager, complementing the existing team. After a handover period, the buyer took charge of the portfolio and value creation.
Instrumental in such a transaction is that the existing GP is in full control of the fund succession process to make sure that a deal is delivered. The risk of an aborted process is significant, to all parties.
By engaging with investors and the GP, the buyer concentrates on delivering a successful transaction and value creation while the current GP can continue to support the portfolio companies. The obvious benefits include the elimination of conflicts of interest, as the buyer only transacts if the GP does not buy out LPs in the old fund, which allows the purchase price to be higher.
Ultimately, a solution with a revitalised GP team generates further benefits for investors, such as transaction certainty and a clear choice between getting cash distributions or keeping exposure to the portfolio. In addition portfolio companies benefit from a focused GP team, provision of fresh capital and a clear strategy to further develop value.
Michel Galeazzi began his career at UBS in the M&A advisory unit. He then spent four years with 3i, focusing on media, manufacturing, and healthcare investments in Germany and Switzerland, and prior to founding Evoco with Felix Ackermann, he was an associate director in HgCapital’s portolio team in London.