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 (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 which may be willing to hold assets for longer than others.
GP-led restructurings are a helpful innovation, but the process is complicated and conflicts between the 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, often negotiated more than 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, the Institutional Limited Partners Association 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, if it enables investors to make informed decisions, and if it reduces execution risk for buyers.
The ILPA’s guidelines considered the various stages in the restructuring process. The guidelines strongly encouraged early engagement with the limited partner advisory committee – and, perhaps, with a broader subset of the investors – regarding the contemplated secondary transaction process. The ILPA then set out some suggested practices to ensure that there was clear and comprehensive disclosure to the LPs of information regarding the transaction and the process. This would include information pertaining to the selection of the winning bid for the assets, the management of conflicts of interest, the main terms for the continuation fund and other key transaction terms, such as termination or break-up fees (if there were any).
The guidelines made specific suggestions about certain aspects of the process. This included treating investors who did not respond with a positive decision as if they had opted for a “status quo alternative”, with no change in economics. The ILPA acknowledged that not all of these suggestions would be feasible in all cases, noting that the “highly unique nature of these transactions and broad range in the scope of deals” meant 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. The ILPA recommended that, in future, they should – at least at a high level.
Some of the debate in the industry has concerned the allocation of the costs of these transactions. The ILPA recommended that fees be allocated to the parties that benefit from the transaction and that LPs that elect to do nothing should not bear the costs. The association added that where the GP benefited – for example, through additional fees or a stapled commitment to a successor fund – it should bear some proportion of the costs, though how much was left open.
The guidance highlighted the significant role played by third-party advisers, including legal counsel, intermediaries and fairness opinion providers, as well as some recommendations aimed at ensuring that the LPAC and LPs 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.
The 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.
Simon Witney and Andrew Rearick are special counsel and international counsel respectively at law firm Debevoise & Plimpton. A version of this article first appeared on the firm’s European Funds Comment.