(Not so) secondary concerns

PEM speaks with various secondaries specialists regarding how to manage the commercial and legal risks in what’s shaping up to be a historic year in the secondaries market.

More deal activity means more risk-taking. So with the first six months of 2011 turning out to be the busiest “of any year in secondary market history”, according to secondaries broker and advisor Cogent Partners, we ask various secondaries professionals what this means in terms of GPs commercial and legal risks.

Daniel Green, an investment director at secondaries firm Greenpark Capital, on the primary risks to identify when buying a large portfolio of fund stakes:

“A large portfolio would probably be sold in an intermediated process which are frequently highly visible to all potential acquirers. Such processes can be very competitive. Therefore pricing can become aggressive. Higher pricing means lower returns. So the best returns from secondary investing are unlikely to be made from acquiring large portfolios. This is why we focus on finding smaller deals (ranging from single interests to small portfolios of interests) that can be acquired without such intense competition.”

Mathieu Dréan of Triago, speaking on buyers and sellers liabilities after executing a deal:

“All liabilities and obligations between seller and buyer are clearly assigned before executing a secondaries transaction. The typical transaction is very clean-cut, with sellers usually only retaining a financial interest in the event of a clawback in the fund. When purchasing direct assets in the secondaries market, however, many more liability concerns need to be addressed. The general rule for direct deals is for company liabilities tied to the past to stay with the seller.”

Simon Goodworth, a private equity partner at law firm Covington & Burling, on the various legal risks surrounding secondary deals:

“Secondary transactions give rise to a range of risks, many of which the parties will seek to address through the transaction documentation. For a buyer, one risk will be determination of risk of further unexpected financial obligations; not so much in relation to outstanding commitment, which is readily understood and identifiable, but risks such as distribution clawback (where a buyer may find itself responsible for returning monies to the fund that it never received in the first instance!).

“In either fund stakes or direct secondaries, buyers will be concerned to identify deferred or contingent financial obligations such as indemnities, guarantees, obligations to contribute further capital or advance further monies etc.

“In some transactions GPs may insist on buyers and sellers being jointly and/or severally responsible for certain warranties and representations which strictly should, arguably, only relate to one of the parties, and may make approval of the transaction conditional on this.”

David Atterbury, a principal at secondary and fund of funds manager HarbourVest, on negotiating with banks in the secondaries market:

“Banks tend to have wider objectives relative to pensions and endowments when selling their private equity assets. Unlike other sellers, banks will consider how the deal impacts the level of regulatory capital they are required to hold, and also be more focused on how the transaction ultimately gets booked in their P&L statement. Other LPs in contrast are more of a straightforward economical animal to negotiate with – their main consideration being the level of cash received on closing”.

The September issue of Private Equity International includes an in-depth report on the secondaries market. For a deeper look into the multifarious legal risks in secondary trading, click here.