Although not a new phenomenon, private fund restructurings now occupy a prominent position in a private equity secondaries market that reached an estimated $70 billion last year. That burgeoning market has enabled primary fund managers to initiate a process that gives their investors a choice: sell now and achieve early liquidity, or hold tight and continue to benefit from upside potential (and, in some cases, investors are invited to opt for a combination of both). No longer regarded as a sign of weakness, such transactions can boost a GP’s new fundraising while helping to solve a liquidity mismatch between investors, some of whom may be willing to hold assets for longer than others.
GP-led restructurings are certainly a helpful innovation, but the process is complicated and conflicts between the various parties involved – the GP, the selling investors, the “rolling” investors and the buyers – need careful management. The complexities and potential conflicts can be exacerbated by the fact that the Limited Partnership Agreements (LPA), often negotiated over 10 years ago, may not have anticipated these types of transactions and may need to be changed. In some cases, the consent mechanisms are cumbersome and may enable minority investors to hold-up a deal that the majority support.
Market practices have developed around these transactions and continue to evolve. In April this year, the Institutional Limited Partners Association (ILPA) issued guidelines for GP-led restructurings which have sharpened the focus on some of the key issues. The active engagement of a highly respected investor-led association is welcome, especially if it helps GPs to improve efficiency, transparency and predictability; enables investors to make informed decisions; and reduces execution risk for buyers.
ILPA’s guidelines considered the various stages in the restructuring process and strongly encouraged early engagement with the limited partner advisory committee (LPAC) and, perhaps, a broader subset of the investors, regarding the contemplated secondary transaction process. ILPA then set out some suggested practices to ensure that there is clear and comprehensive disclosure to the limited partners of information regarding the transaction and the process, including the selection of the winning bid for the assets and regarding the management of conflicts of interest, the main terms for the continuation fund and other key transaction terms, including termination or break-up fees (if there are any).
The guidelines made some fairly specific suggestions for certain aspects of the process – including, for example, prescribing that investors who do not respond with a positive decision should be treated as if they opted for a “status quo alternative”, with no change in economics – and not all of these suggestions will be feasible in all cases. ILPA acknowledged this, noting that the “highly unique nature of these transactions and broad range in the scope of deals” means that the guidance “may not be universally appropriate or applicable to every circumstance”. One problem will be that older LPAs may not deal specifically with the mechanics of the transaction, and ILPA recommended that, in future, they should – at least at a high level.
Some of the debate in the industry has concerned allocation of the costs of these transactions. ILPA recommended that fees be allocated to the parties that benefit from the transaction and that limited partners who elect to do nothing should not bear the costs. In addition, where the GP benefits – for example, through additional fees or a stapled commitment to a successor fund – ILPA said that the GP should bear some proportion of the costs, although how much was left open.
The significant role played by third-party advisers, including legal counsel, intermediaries and fairness opinion providers, was highlighted by the guidance and some recommendations aimed to ensure that the LPAC and limited partners were given reliable information. In some cases, a fairness opinion may be helpful, but it is clear that this is not mandated in all cases.
ILPA’s guidance has contributed to a constructive dialogue. It certainly does not fit every situation or answer every question. But, in general, it is helping to build LP confidence in GP-led deals and reflects the LP community’s acknowledgement that they are going to continue to be an important segment of the broader market in the years to come. A focus on transparency, interest-alignment and fairness is to be welcomed by all concerned, and is a sign of a maturing market.