MJ Hudson on the ‘fine art’ of selling a fund interest

MJ Hudson, the alternatives asset management consultancy, has released a guide detailing how to sell a fund interest and maximise price in an auction process.

The 46-page document – Catalogue of the secondaries market: A Guide to the sale of private equity fund interests – took one year to compile and includes a step-by-step checklist for potential sellers of fund stakes, details how auction processes are run, outlines required documentation and tax and legal considerations, and includes a model non-disclosure agreement and offer letter.

“We wanted to try to educate the industry – it’s still a pretty dark market, as information doesn’t flow around that well,” Eamon Devlin, a partner at the firm, told Secondaries Investor. “We tried to find something useful, particularly to the more private holders of interests such as family offices and pension funds who might be looking to sell [stakes].”

MJ Hudson plans to distribute the guide later in the first quarter.

For potential sellers, MJ Hudson suggests a step-by-step process that involves:

• Cataloguing the assets for sale
• Deciding on whether to appoint an intermediary
• Appointing lawyers and tax advisors
• Completing technical preparations such as a data room of relevant documents for the fund interests for sale, including LPAs, co-investment agreements, side letters and th latest financial reports
• Conducting preliminary due diligence

Sellers should be aware of notice periods for a transfer; any right of first refusal clauses; whether a buyer needs to be considered creditworthy; restrictions on who can purchase the fund interest; and costs, among others. A £5,000 ($6,489; €5,827) flat transfer fee per fund stake is “relatively commonplace”, the guide notes.

“Ensure you have the full list of closing conditions from the fund manager – you don’t want to delay a transfer of an interest because the fees for the GP’s counsel have not yet been paid,” warns Devlin.

The guide also suggests nine areas sellers should consider when valuing a fund interest – including the funding ratio, the fund’s vintage, how levered the underlying portfolio companies are and whether the purchase price is paid upfront or is deferred – as well as steps involved in an auction process.

“[A]lthough the move to higher pricing has been common to the secondaries market as a whole, the terms for individual transactions vary significantly from market averages and many factors come into play,” the guide cautions.

It also covers UK stamp duty and ways to mitigate this, such as arranging execution and retention of the key transfer documents outside of the UK, though it warns that this is not a surefire way to escape liability.

In the US, the guide outlines the consequences of effectively connected income, Foreign Investment in US Real Property and publicly traded partnerships regulation on secondaries transactions – all issues that can thwart or delay the transfer of a fund interest.

In closing a deal, there are at least four issues that could delay this process, the guide warns. These are ROFR clauses, PTP issues, end of quarter transfer requirements and payment of the GP’s costs.

The guide focuses on selling interests by way of auction as successful secondaries sales are mostly completed this way, it notes. As the goal of an auction is to encourage buyers to increase their bids to the highest level, selling a fund interest is “a little like selling a piece of fine art”, MJ Hudson concludes.

Stay tuned to Secondaries Investor for excerpts from the guide covering sellers’ common mistakes and top tips from well-known market participants.