Stapled deals can push the boundaries of fiduciary duty

Why it can be problematic to connect a GP-led secondaries deal to a primary fundraising.

“A very neat way to provide a service to investors”, as well as to push forward fundraising efforts – that was how EQT managing partner Thomas von Koch described the role the stapled secondaries deal played with its latest fundraise.

Scandinavia’s largest private equity firm announced on Wednesday it had held the final close on its latest Asia mid-market fund, collecting $800 million for the vehicle. The fundraise saw Partners Group acquire stakes in two of EQT’s existing flagship funds and increasing its commitment to the Asia fund, as Secondaries Investor reported last summer.

Stapled secondaries – in which an investor buys stakes in an existing portfolio and commits to a new fund – are not new and needn’t be controversial. However, in some respects they appear to push at the boundaries of fiduciary duty, which is why they were the subject of scrutiny by the US Securities and Exchange Commission in 2015.

As Nordic Capital tiptoed its way through its recent general partner-led secondaries transaction, it was adamant about one thing: there was no stapled element.

The timing of Nordic’s transaction – driven by the 10-year life of its 2008 fund – was not without complication; it came during the marketing of the firm’s ninth flagship fund.

When I spoke to managing partner Kristoffer Melinder, he was clear about the lack of a staple. The fundraising was as good as done as early as February this year, we understand, and separate advisors were at work on the two different projects: MVision on the fundraising and Campbell Lutyens on the GP-led.

Are Coller or Goldman, the two buyers in the secondaries transaction, among the investors lined up for Fund IX? Because of SEC rules, Melinder was unable to say.

He stopped short of criticising stapled deals when we spoke, choosing his words carefully.

“As I understand it there are many reasons why funds might contemplate doing a transaction like this. For us it was very clear: we saw tremendous value potential in the portfolio that was impossible to realise in the existing fund structure. This has enabled us to do so.”

BC Partners is also among those which have successfully run a stapled secondaries process to push along a primary fundraising.

But I can’t quite get comfortable with one part of these processes.

A process (an auction, typically) to acquire fund stakes from limited partners is being orchestrated by the GP, or at least an advisor selected by the GP. An auction exists to achieve the best possible deliverable price. The GP, however, has one eye on the other side of the staple – the new fund – so the pool of buyers is narrowed to those who will commit primary capital. Logic dictates this must depress the price offered to LPs.

The counterpoint to this is that the GP’s fiduciary duty is to the fund, not to the investors. And if LPs are not compelled to sell, then there should be no problem. As BC Partners’ outgoing investor relations head Laura Coquis said of their staple, LPs needed the “option to ignore it”.

And if LPs really want liquidity and don’t like the price on the table, they can start a sale process of their own.

Yet there is a potential problem with this option: the control that the GP normally exercises over LP stake sales. Sure, if you don’t like the bid tabled by the GP’s chosen partner, then you are free to look elsewhere, but are you likely to do this knowing that – technically, anyway – the GP could frustrate this process? It is unlikely a GP will veto an LP’s plans – this is a relationship game – but it may well come up with reasons to delay a deal in the interests of the fund.

EQT declined to comment on this particular element of stapled transactions. It may be an academic concern at the moment, but it is one GPs should keep in mind.

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