“Sometimes I think we need a psychological counsellor in these deals.”
That was the comment from one investment professional on the sidelines of the British Private Equity & Venture Capital Association’s secondaries forum in London this week. The executive was referring to the emotional complexity of GP-led secondaries deals which, as one of the panels had just discussed, can often be more important than any of the technical or legal issues that must be overcome for a transaction to get over the line.
The reasons for this are many. Fund restructurings frequently emerge from a breakdown in GP-LP alignment in which a fund’s constituents may have diverging views as to the best way to maximise the value of the assets while creating liquidity for investors. The result can be disgruntled parties – LPs who feel they’re being taken advantage of and GPs who feel they deserve to be rewarded for spending time and resources on managing a portfolio, regardless of what has happened up to that point.
Or as one market participant put it: fund restructurings don’t happen when everyone around the table is happy, the LPAC relationship with the GP is great and the LPAC is just going to agree to an extension.
Panelist Steven Nicholls, a partner at Hollyport Capital, summed up the circumstances that often lead to restructuring opportunities: “There’s mistrust, there’s people who have fallen out, everything’s long overdue. There are so many things that are dysfunctional.”
Some memorable examples come to mind. In 2016, for example, the attempt to restructure First Reserve’s 2006-vintage energy fund hit an unfortunate perfect storm of events that included listed assets in the portfolio, volatile oil prices and a prolonged deal process that came together to scupper the deal. The icing on the cake was an “influential and upset LP” (as a person familiar with the deal described to Secondaries Investor at the time); the California Public Employees’ Retirement System’s then managing investment director of private equity Réal Desrochers had taken time out of his busy day to pen a letter to First Reserve outlining CalPERS’ displeasure with the proposal to restructure the fund. Desrochers’ letter is understood to have shaped the opinions of other large US pension LPs and the restructuring attempt fell through.
We’ve seen other high-profile deals fall though due to LPs sensing arrogance or greed in the proposals. Even though there may be a perfectly rational basis for running a secondaries process, emotions can get in the way and throw a spanner in the works.
These processes should be an exercise in empathy. A manager with a well-performing fund who has already delivered what they promised to LPs is more likely to be granted leeway when proposing a fund restructuring than one whose fund is hovering around the hurdle rate. Conversely, LPs should be aware that a GP needs to be compensated for continuing to manage assets – as in the case of a continuation vehicle – and that no matter how distasteful, a manager can be justified in asking for continued management fees to keep the lights on, as well as resetting a fund’s economics to incentivise and retain staff if it is to maximise the value of a portfolio.
Ultimately, getting to know the parties involved in a potential deal is key. “Someone may come across really well in a boardroom meeting but you need to spend $100 on lunch with them to really get to know them and understand where they’re coming from,” said the managing director at a global secondaries firm.
The old adage still rings true: private equity is a relationship business. Never more is this true in the emotion-charged world of GP-led secondaries.