Private equity and other fund managers continue to manage legacy funds and side pocket investment vehicles, which are now in liquidation. By winding up these legacy vehicles, managers may be able to remove the ongoing costs of managing them and the associated drag on the internal rate of return and general performance results. Additionally, closing these vehicles may free up capital and resources that can be diverted to forming other investments and asset acquisitions.
Legacy assets: Esoteric and hard to value
Legacy vehicles typically continue to hold assets and remain in existence because managers have difficulty selling them. The assets held are often esoteric, complex, and hard to value; therefore, secondary markets and liquidity solutions are scarce, and the assets themselves are challenging to sell.
Managers are increasingly looking to third-party providers to help value these assets with the aim of transferring them in a GP-led secondary deal. In most cases, managers have either decided to buy the legacy fund assets using their balance sheets or have an existing separately managed account to purchase the assets. In these cases, managers look to third parties to price the assets, giving them an independently verified value that can reliably be considered fair market value.
VRC has assisted several managers with pricing these obscure assets and, in some cases, has created new valuation methodologies to help underpin assets, including contingent liabilities.
In one instance, VRC helped an asset manager that sponsored a legacy fund with an equity interest in a company that held litigation claims (“Cuba Claims”) arising from the Helms-Burton Act, a federal law related to the US embargo against Cuba that created an avenue for individuals with claims to confiscated property in Cuba to sue certain persons who used their property.
The legacy fund had interests in a corporation that was one of the largest landholders in Cuba and, as a result, had potential causes of actions against any US or foreign entity that had used or would use, in the future, their confiscated lands in Cuba.
The manager had trouble selling the Cuba Claims, and retaining them complicated the manager’s proposed sale of its interest in the company from the legacy fund to a newly raised fund. With the assistance of valuation methodologies and a fairness opinion delivered to the selling fund, the manager was able to price the Cuba Claims, and VRC assisted the manager in selling them for cash to an affiliate without challenge from the company’s creditors and the legacy fund’s investors.
SEC guidance and need for fairness opinions
Regardless of whether a legacy fund’s assets are esoteric or hard to value, the Securities and Exchange Commission is increasingly scrutinizing manager-led transactions. This has culminated in the commission’s proposed new rules and amendments under the Investment Advisers Act of 1940 to enhance the regulation of private fund advisers and to protect private fund investors by increasing transparency, competition and efficiency in the $18 trillion marketplace. The new proposed rule requires all managers undertaking these transactions in certain situations to obtain a fairness opinion from an independent provider.
Costs and pricing
The costs of valuing the assets and providing a fairness opinion are directly correlated to the size of the transaction, how esoteric the assets are, the number of assets involved, difficulty in getting underlying financial information on the assets, and associated risks around the transaction. In most instances, there are long-term benefits to managers outweighing the costs. Winding up legacy assets can remove drag on the internal rate of return and general performance while freeing up capital and resources that can be focused on forming new vehicles and acquiring new assets.
Chad Rucker, Esq, is senior managing director at VRC specializing in solvency and fairness opinions.