Making fund recaps fair

Secondaries advisors are increasingly incorporating fairness opinions into GP-led restructurings, giving LPs an independent perspective while providing insurance for fund managers. Overall, fairness opinions represent a step in the right direction toward better representation of LPs.

As GP-led restructurings continue to rise – the latest reported examples this week being Terra Firma and Odin Equity –  discussions about whether limited partners are getting a fair deal are becoming more common.

In turn, that’s starting to shape best practice around including fairness opinion letters as standard. Common for decades in mergers and acquisitions, it is an opinion provided by an independent advisor confirming the liquidity option offered to the seller of the assets was fair. The letter itself is typically fewer  than 10 pages, but the analysis and data backing it up can be nearly 10 times that, depending on the size of the fund being restructured and the number of portfolio companies.

Currently, about 50 percent of GP-led restructurings in the US contain a fairness opinion, while about 20 percent  in Europe do, according to Houlihan Lokey, which along with Duff & Phelps has written the vast majority of them.

“From a sponsor’s perspective, the fairness opinion is pre-packaged expert witness testimony in the unlikely event of litigation by LPs or in the more likely event of receiving a regulatory review in a subsequent [Securities and Exchange Commission] presence exam,” said Tad Flynn, head of asset management services at Houlihan Lokey, who frequently writes the opinion letters. “As such, it’s a type of insurance.”

Often, the fairness opinion is the only independent perspective available to LPs weighing the alternatives presented by the sponsor, Flynn added.  Some sources I spoke to, however, said investors rarely request them.

One advisor who wished to remain anonymous argued that not all GP-led transactions need a fairness opinion, which can add significant costs to the process. The source felt they were typically only required in cases of extreme complexity or when LPs were effectively being forced to accept a certain action.

That could be changing, however, as investors more actively protect their interests in restructurings. One way to do that is to have more input in the selection of an advisor and in how fees are structured, another source said, since LPs typically end up paying fees that are rolled into a purchase price.

“Increasingly, they also want their own advisors,” the source said. “They need them. LPs can’t spend much time on restructurings”, given already over-stretched in-house resources.

For now, fairness opinions have emerged as a best practice and represent a step in the right direction toward better representation of LPs in fund restructurings.

How often have you seen fairness opinions in GP-led restructurings? And what, if any, could be a better way to introduce checks and balances in private equity? Let us know at marine.c@peimedia.com.