With a growing population of funds raised between 2006 and 2008 now reaching the end of their lives, the number of GP-led restructurings to deal with leftover assets is on the rise. But as managers seek out ways to keep working the assets, LPs can find themselves with limited options and the number of parties involved in restructuring negotiations often makes them fraught with conflicts.
“The big issue is that inherent conflict where the GP is really looking out for his or her own interests, potentially setting up another fund and transferring the assets in, while some LPs want to stay put and others want new investors to put capital in to take them out,” says Tom Angell, leader of accounting and advisory firm Withum’s Financial Services Group out of New York.
For investors presented with a secondaries deal already negotiated by the manager, there can seem like there are few options on the table, and the LPs’ interests may diverge. Some LPs looking for liquidity will be focused on the price on offer, while others will want to stay in the portfolio with no change to the economics, and still more might see the potential for greater returns in a pay-to-play arrangement that splits up the assets in question.
John Rife, a London-based partner with law firm Debevoise & Plimpton, says: “While these are conflict-laden transactions, they actually start with a more fundamental conflict between the LPs, where there is one camp that believes in the fundamentals of the underlying portfolio and another that wants to take cash off the table and move on. If you don’t have that conflict between your LPs, these aren’t the right transactions to be looking at in the first place.”
It is becoming increasingly common for the GPs to stay in on secondary restructurings, bringing in new money and selling the assets to a new fund, but continuing in the manager role with that new vehicle. If there is no feeling that the manager is to blame for the assets not yet being ready to exit, they can be the best people to take the assets through to peak valuation, adding a further layer of conflicts.
“The primary conflict is between the sponsor and its own investors,” says Morri Weinberg, partner in Ropes & Gray’s asset management practice, and a veteran of funds restructurings. “But then there are other constituencies at the portfolio level, including management teams, co-investors and lenders, potentially. In terms of navigating the minefield, a number of these constituencies may have to buy in to at least some aspect of the deal, and that takes a lot of thought in terms of putting together a potential transaction that is going to get the buy in required.”
Weinberg worked on one of the first GP-led restructurings back in 2012, when Behrman Capital formed a new fund to buy out five remaining companies from its vintage 2001 fund. Since then, activity has taken off on both sides of the Atlantic, with Nordic Capital recently completing the biggest-ever deal of its kind when Coller Capital and a unit of Goldman Sachs backed a €2.5 billion restructuring of its 2008 seventh fund. That deal, which involved nine companies worth €4.4 billion, allowed the firm to hold the assets for another five years, with about 60 percent of the original LPs selling their stakes to the secondaries investors, and the remainder rolling over into the new structure.
“These days, there is a recognition that these are transactions that GPs are viewing as potentially part of their liquidity toolkit, because the situations with respect to certain portfolio companies may just mean that the potential upside in a few more years will be much more significant,” says Weinberg. “Frankly, all of these deals are bespoke and success comes down to the GP really understanding the transaction from the different points of view of the investors.”
Advisers point to three must-haves for managers seeking to navigate conflicts: transparency of communication, third-party input and ample time.
Angell says: “You have to make sure that everything is done as transparently as possible. You need to make sure you take care of the interests of the current LPs, and that they are properly included in the conversation, because otherwise you run the risk of running into an issue down the road and ending up in litigation.”
Julie Corelli, a partner at Pepper Hamilton and co-chair of its funds services group, says: “Most GPs pave the road ahead rather than springing it on LPs, talking early about the options for outstanding assets in quarterly letters, and setting out plans for assets that might not be at peak valuation when the fund is due to end.”
She advises GPs to shop around for several potential deals before presenting a secondaries transaction to LPs, and says getting a third-party valuation is also critical to showing all parties are getting fair treatment.
Angell says: “The valuation is basically the whole key to the deal, because the secondary wants to make a good deal and the LPs want to make a good deal, but if the discount is too large you won’t get the LPs to sell and it becomes difficult. There is often a very fine line between a good deal for the secondary and a good enough deal for the LPs.”
He adds: “The secondary buyer is going to do their own due diligence on the assets and make their own judgement, but if the GP gets somebody independent to look, then at least there’s a little more confidence for the LPs that the GP is working in their best interests.”
The US and Europe divide
There is a divergence between the approach being taken in US deals and those being done in Europe. The Securities and Exchange Commission has been vocal about scrutinising GP-led restructurings, and particularly so-called stapled secondaries, which combine the purchase of an existing pool of assets with the commitment of new capital to the GP’s next fund.
Rife says: “In the US, the market seems to be coalescing around a fairly standard approach to these deals in terms of the standard of disclosure, what information is shared and how long you are giving LPs to consider the information, with the US tender offer rules applied as an overlay, requiring 20 business days from when the offer is provided until the recipient has to make a decision. In Europe, the approach is more fragmented, and we see processes being run where LPs are given a week or two to digest a thousand pages of information and come back with a decision.”
A third party may also provide a fairness opinion as an additional layer of comfort that potential conflicts have been addressed.
Finally, once a deal with a potential buyer is agreed, LPs will want plenty of time to digest it.
“You are going to have to give LPs plenty of time and plenty of information,” says Corelli. “That time might actually include the time to go out and structure their own alternatives. If you’re asking for approval in five days, that is just not enough.”
Weinberg adds: “Very often LPs feel somewhat hard-pressed by the timing that might be involved after receiving the full disclosure package. These are extremely complicated transactions and it takes time for people to digest them.”
While the road may not be easy, we can expect many more deals. Geoffrey Kittredge, chair of Debevoise & Plimpton’s European private equity funds group, says: “Investors are becoming more accustomed to these transactions and able to consider them more quickly. In the past, they may have been viewed as a sign of weakness on the part of the GP, with some using them to create a continuation vehicle in lieu of raising a successor fund. That is certainly no longer the case. We see GPs with very strong track records considering these as one of a number of different ways to address an LP desire for liquidity.”
Angell adds: “There is just so much secondary capital out there, and a willingness on the part of a number of parties to make these things work. It is just a question of striking a deal that suits everyone.”
– This article appears in the Legal special supplement of sister title Private Equity International‘s May issue.