Our sister publication Secondaries Investor occasionally encounters people who dream of a liquid secondaries market, one in which buyer and seller alike have bid and ask prices for funds, and investors slip in and out of limited partnerships with ease. There are several reasons why this is unlikely to happen, one of which is Publicly Traded Partnership rules.
This week, secondaries intermediary NYPPEX told its clients that a “record number” of private equity partnerships have reached their yearly limits for the transfer of LP interests under PTP rules, Secondaries Investor reported, although the firm could not give precise numbers. In some funds, a backlog of pending secondaries transactions means some transfers may not receive approval until 2021 or even later.
Funds want to avoid becoming a PTP, a type of corporation, with all the tax obligations it brings. A fund is deemed to be a PTP if interests in the partnership are traded on an established securities market or interests in the partnership are readily tradable on a secondary market, according to law firm Morgan Lewis.
PE funds appear to meet the criteria, but there is a long list of exemptions, or ‘safe harbors’, which allow them to stay on the right side. Safe harbors include if a fund has fewer than 100 partners, if there is only one trade during the tax year (regardless of size) or if the total of stakes traded within the tax year represents less than 2 percent of a limited partnership.
Why is it important to take advantage of safe harbor rules? It helps funds stay in their LPs’ good books. Some more conservative GPs withhold consent on a secondaries sale because it would breach the 2 percent limit, opting not to explore other safe harbor options. Market sources tell us PTP issues can delay deal closes by up to 18 months. This is hardly a recipe for goodwill.
GPs like to keep confidential the number of LP stake transfers that take place in their funds. As a result, LPs sometimes only learn that they can’t sell a stake after they’ve found a buyer for their portfolio.
“For years, GPs have placed a low priority on understanding how to optimise their available safe-harbor exemptions for secondary interest transfers,” says Laurence Allen, chief executive of NYPPEX. “Now, with higher secondary interest transaction volumes, it is becoming more of a priority issue.”
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