Restructurings, particularly those of the single-asset variety, require secondaries buyers to think almost like direct investors. What is the best possible five-year story for this asset and what ingredients need to be in place to make it happen?
Although alignment between the GP, secondaries buyer and rolling LPs is clearly integral to success, there is a fourth, often-overlooked party: the portfolio company’s management. How can you be sure the sponsor and management team have the same vision for the asset? Does it even matter if they do?
The answer to these questions depends on the circumstances. For those who dabble in end-of-life situations with a hint of dysfunction, a lack of alignment between the GP and management teams is common, says one senior London-based buyer with a focus on restructurings.
The portfolio company’s management feel starved of support and investment and see no upside – for the company or their own jobs – under that GP’s control. The GP, having given up on hitting carry, is pushing a narrative about the future of the company designed purely to eke out more fees.
These situations make up an ever-decreasing part of the market. Most GPs that came to market over the last few years have been of higher quality; most secondaries buyers more selective about what they will back. While it is still important for a buyer to engage with a management team, the GP is generally trusted to give an accurate picture of future alignment.
“The GP has worked with the company, very often with that management team, for a number of years,” says Julie Prewer, a principal with advisor Rede Partners. “That knowledge and experience is part of what de-risks the transaction.”
“No matter how much time the buyer spends with the management team of a company, they’re never going to know it as well as the GP,” adds Gerald Cooper, partner with Campbell Lutyens. “What gets them comfortable is ensuring there is proper alignment, both in terms of the GP putting skin in the game as well as ensuring that the carry is structured in a way that compensates them for performance.”
Management for the chop
If a sponsor isn’t aligned with a management team, it can always get a new one. In buyout situations the C-level is likely to be composed of ‘management for hire’, not founders and entrepreneurs with a significant financial and emotional stake in the portfolio company.
From a technical and legal perspective, it is much easier to remove a management team than it is a GP. It may be that chopping the management is an obvious efficiency saving.
“We’ve gone into deals where the GP basically told us, ‘We understand the management is important to you but, FYI, we have plans to change them’,” says one buy-side secondaries partner. “As long as the GP’s transparent about that it’s fine.”
This process need not be rancorous; rather just part of the organic development of any business, says Chi Cheung, a partner with secondaries buyer Glendower Capital: “The management team for a recovery or growth stage company is different from the management team for an IPO story. Or indeed, if the strategy is to sell to a larger strategic [buyer], the management team may have different aspirations.”
While the sponsor remains the first port of call for due diligence, increasingly concentrated deals have made asset-level research more important. In deals Glendower leads, particularly single-asset transactions, undertaking a site visit and spending “significant” time with the chief executive and CFO of the company is crucial, says Cheung, speaking to Secondaries Investor in January. It is more difficult for buyers in the syndicate, which do not have the resources to do their own investigation.
“When we do deals like that it’s because we really back a certain GP,” says one buy-side source.
“We may have to accept that we couldn’t take on the same concentration size that we would [as a lead buyer]. We are taking it largely blind.”