LP Radar: Zombie dilemmas

It’s not surprising LPs get irate about the terms of fund restructurings. But ultimately, they need to be grateful that the market is offering them some kind of way out.

Inevitably, some limited partners are going to get frustrated when dealing with funds that have gone on past the end of their contractual lives – even if (or possibly because) their options are so limited.

Two recent fund restructurings come to mind, in which the secondary market kicked in to help buy out existing investors who had stayed in the funds well into their extension periods.

Both deals received plenty of accolades in the market; both were viewed as innovative ways to revive funds that GPs had been unable to close during their terms, while providing existing investors with a possible route to liquidity.

However, both deals – one involving Willis Stein & Company, the other involving Behrman Partners – were also panned by some LPs as nothing more than flagrant attempts by the GP to keep getting paid for work that they should have finished doing a few years ago.

In the case of the Willis Stein fund (its third), a majority of existing LPs were bought out with financing provided by Landmark Partners, Vision Capital and Pinebridge Investments, as well as Willis Stein management.

However, some existing LPs chose to roll over their Fund III interests into a new vehicle being created to house the three remaining portfolio companies. Willis Stein initially tried to attach carried interest to a portion of this rollover, but the idea met with strong opposition. Some LPs saw it as the firm trying to extract more capital out of LPs who had already paid out millions in management fees. Eventually, the firm back-tracked and dropped the proposal completely.

There were also some vociferous complaints over the restructuring of Behrman Capital’s third fund, a $1.2 billion 2000 vintage with five remaining portfolio companies. Those companies were rolled into a new, $1 billion vehicle funded by Canada Pension Plan Investment Board, Goldman Sachs and other investors.

In this case, none of the existing LPs chose to roll over their interests into the new vehicle. But some of them were annoyed that portfolio companies were being charged an exit fee as part of the deal – although sources close to the transaction said that 97 percent of the overall exit fee would go back to LPs to help fund the cash-out.

This kind of frustration is perfectly understandable. GPs and LPs agree to a contractual life for funds, and if the manager fails to close down the fund in time – for whatever reason – it seems unfair for the LP to be penalised financially as a result.

LPs know they are going to have to deal more frequently with this kind of situation; many can see it already in their portfolios. And it’s always going to be a test of their patience, particularly with funds that are never going to make them any money. However, the fact remains that their interests may be better served in the long run by making sure that the remaining assets are still under the stewardship of a well-incentivised manager.

Perhaps they do sometimes feel strong-armed into going along with a restructuring plan. But if they have a better idea, they can always take it to the LP advisory board. And otherwise, perhaps they’re better off just cutting their losses, making a clean break, and moving on – while counting their blessings that at least the market has at least provided them with a way out.