Three issues challenging the legal eagles

Complex structures, scale and breaching safe harbours top lawyers’ lists of challenges unique to today’s secondaries market.

As the secondaries market evolves, so too must its advisors. This week I talked to a number of lawyers about the biggest challenges they’re facing as the market grows. Here were the top three issues raised:

1. Complexity rising

Fund recaps and restructurings aside, even the most vanilla of LP transfers these days has been made more complex by the use of leverage and other deal mechanics. Lawyers are increasingly faced with transactions that some say more closely resemble M&A deals than the secondaries trades they were previously accustomed to.

“We did a transaction about a year ago where the initial thought was that it was just going to be a sale of three fund stakes, but it ended up being an M&A-type wind-up deal,” one UK fund formation lawyer said.

2. Scaling up

Portfolios coming to market are getting larger, which can make it difficult to co-ordinate diligence reviews and GP discussions regarding transfer consents across a potentially large number of sectors and geographies. A three-way conversation between the buyer, LP vendor and the GP of each fund within the interests sold is inevitable.

“On larger deals involving a number of portfolio interests, this will often mean that in practice it will be necessary to run parallel negotiations with a number of different GPs with a view to securing their consent, often to a common but very compressed timeframe,” noted a Europe-based lawyer.

3. Perilous harbours

Fund managers try to limit transfers of LP interests to less than 2 percent of total fund commitments each year, in an effort to comply with regulations that would otherwise put the fund at risk of being considered a publicly-traded partnership (PTP) and jeopardise its ‘safe harbour’ status. Exceptions are made when a single commitment that exceeds 2 percent of total capital is traded, or in a structured solution when a block trade occurs.

If a PE fund were to be re-classed as a PTP, the GP would never be able to raise another fund and LPs would likely sue for negligence. So far, this hasn’t happened – but it’s a serious risk that may increase alongside trading volumes.

“The issue tends to come up more when there’s high trade volume in a particular [strategy or sector] or if a few LPs with hefty commitments start trading. It eats up a chunk of the safe harbour.”