Conflict is inherent to the structure of GP-led transactions: the leading managers participate in the new transaction while navigating obligations to existing LPs.
Transparency is the key to minimising the risks posed by those conflicts, said Igor Rozenblit, managing partner of regulatory consultant Iron Road and former co-head of the private funds unit at the US Securities and Exchange Commission.
Rozenblit recently spoke with Secondaries Investor about where he sees regulatory risk in the technical aspects of these restructuring transactions. It boils down to two areas: how the auction is run and how the price is determined.
Most managers, though not all, hire an intermediary to run an auction process. That process itself bears explaining to existing investors. “Particularly important is to be transparent with the selling LP about whether or not you only pursued a GP-led track, or whether you pursued a more whole secondary transaction when you went out to market with your piece,” Rozenblit said.
Fadi Samman, a partner who specialises in fund formation and secondaries transactions for Akin Gump Strauss Hauer & Feld, said running a fair process typically means “hiring an intermediary to run an auction and to solicit multiple bids to get a market-driven price. Oftentimes, GPs will also get a fairness opinion or an appraisal or other third-party view on the assets to help substantiate that price discovery.”
Rozenblit said transparency around how that price is determined is also paramount, “but more than that, it’s about any material fact about the portfolio that might not be readily apparent from just looking at the valuations.” Material facts include losing or gaining LPs, whether there’s an unsolicited offer, whether the manager plans to go out into the market, and if one big asset in the portfolio already has an indicative price. “That all is disclosable information,” he said.
To manage expectations, managers are increasingly adding language to LP agreements to make it clear they may undertake GP-led processes. The addition of such language has increased over the past two years and now appears in about half of agreements, Samman said.
No more status quo?
Whether existing LPs can roll at status-quo terms or must participate in new terms alongside new investors is not an area of regulatory risk, but rather an economic function of the market, according to Rozenblit.
Three or four years ago, the so-called status quo option was a “fundamental piece of structuring a fair process, giving LPs the option to roll on a status quo basis”, Samman said. “And by that we meant fees are the same, carry is the same. The only thing that really changes is an extension of the term.
“That view seems to have shifted, and increasingly we are seeing far fewer status-quo roll options in these transactions. They have not been eliminated, but we are seeing more and more deals without a true status quo option offered.”
Selling LPs have a little bit less information than the buying GPs. If they find they’re stuck because they get dragged along in the transaction due to the way the fund was structured, then that’s probably fine because they agreed to that structure before they invested, Rozenblit said.
Potential enforcement?
Thus far, the SEC has handed down just one action with regards to a GP restructuring transaction. That 2018 action was against Veronis Suhler Stevenson over a 2015 deal involving the lower-mid-market private equity firm’s 1998-vintage fund. It centred around a failure to disclose material information to LPs.
While the SEC’s regulatory focus pre-empted the preponderance of GP-led transactions that came to define the covid markets, the increased usage will only inspire more scrutiny, not less, Samman said.
Total secondaries market volume in 2020 was estimated at around $60 billion, with GP-led deals comprising 53 percent, a majority for the first time, according to Evercore’s 2020 full-year volume report.
“We don’t quite know, but my instinct says there will be enforcement actions,” Samman said. “We have seen this happen in frothy markets before.”
Such enforcement, if it happened, would not dramatically alter the landscape of GP-led transactions, according to Samman.
Rozenblit agrees. His expectations around regulation have evolved since 2015, when he said the SEC was scrutinising GP-leds to ensure limited partners were not being offered two bad options.
“I think what’s true for every enforcement action is that it’s very idiosyncratic, and because of that it’s really difficult to draw huge sweeping conclusions about markets based on any particular enforcement action,” he said.
In the meantime, “as long as it’s clear [how the process was run and how the price was determined], that’s how risk can be managed”, he added.
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