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Secondaries sellers should unlock secrets

New technologies have improved convenience and security in the secondaries market. In these deals, GPs do themselves and their LPs no favours by hiding important fund information.

The use of virtual data rooms and online investor portals has been on the rise over the last few years. But in the current recession, LPs are demanding even more detailed information.

This desire for granular information extends to participants in the secondaries market – including potential buyers, sellers and intermediaries – all of whom are looking for tools that will make due diligence cheaper, faster and more secure. New technologies are able to meet such needs, but GPs must make sure to balance security with convenience.

Improvements in GP-LP data sharing comes at a time when the general use of digitalised M&A due diligence is exploding. Merrill DataSite has estimated that the number of data rooms being used for mergers and acquisitions deals has grown from 200 to more than 1,400 in the last few years. The average cost ranges between $15,000 and $20,000, but can reach more than $1 million as the fee is based on the number of pages posted online.

“The more restricted the access to the information is, the greater the probability that will have an effect on pricing. With full transparency, the seller is much more likely to get a higher price than they otherwise would if they are not allowed to share statements for a manager's fund”

According to Merrill, use of such data rooms can shorten deal times by 40 percent and increase the number of bidders by allowing easier access to information, as a company in a different country can do due diligence from its office instead of booking a flight to go through physical data. They also cut costs for sellers by reducing the need for producing numerous documents or renting space for data rooms.

Several surveys have estimated that the number of deals that use some form of online portal or data room has risen to more than 60 percent a year, in part due to cross-border transactions, while Merrill said last year that the number of bidders conducting due diligence on M&A deals in Europe has increased by around 25 percent due to the advent of virtual data rooms. Such technology was even a key factor when hotel owner Fairmont needed to organise a quick defence against a takeover bid by Carl Icahn in 2006.

Fairmont used its virtual data room to post more than 150,000 web pages covering detailed information that bidders could view anonymously, with index and keyword search functions making it easier to find needed materials. The fact the multiple bidders could view the documents simultaneously without having to travel helped speed up the pace of the auction, while protection features helped prevent unauthorised copying or distribution of sensitive materials.

Secondaries secrets
The private equity secondaries market, now going through an unprecedented boom, is also the site of the exchange of reams of information. But GPs, who must approve these transfers, must be assured that the information shared will remain secure. “Certain general partners will try and restrict the buyer universe, others will try and restrict the type of information that can be shared, and some try to do both,” a managing director of a major secondaries intermediary says. “You have a lot of control regarding the online data rooms; you can see who is coming in, how often they are coming in, you can prevent them from printing, make documents read-only and prevent them from downloading.”

John Toomey, managing director at HarbourVest Partners, says some of the most important information he looks for in evaluating a potential secondaries investment opportunity includes financial statements, annual, semi-annual or quarterly reports and perhaps an annual meeting presentation. “As a buyer I'm not interested in what the prior cash flows were. I just need to know what the assets are today that are in the ground,” Toomey says. “So if the last financial statement is of September 2008, I need to know if there's been any draw downs and distributions from September through today, and usually we just get a copy of the capital call notice or the distribution notice through the same means in which we had gotten all the other information, through the online data site or e-mailed directly through the seller.”

Major dara room providers such as Merrill, Intralinks and Bowne all offer portals and data rooms which include precautions like password-protected sites and encryption capabilities. While in the past, online investor portals were mainly about storing documents, LPs are now demanding more detailed and granular portfolio and transaction information that is harder to protect and requires more sophisticated technical tools to safeguard.

“In the absence of returns, transparency is paramount,” says Greg Woolf. “Investors need tools that allow them to access information dynamically, not just in the form of static documents, so internal users and investors can click through and see real-time information, slice and dice their portfolios and analyse their exposure to certain companies, sectors and industries in an interactive manner.”

In March, Woolf's firm launched an updated online portal and data management tool, Vantage Insight, which gives private equity firms interactive data access and analysis capability, with beefed up encryption and authentication capabilities.

Doing your homework
It is clear that participants in the secondaries market have zero nostalgia for offline due diligence methods. Todd Miller, managing director of secondaries advisory firm Cogent Partners, says that while some buyers complain about having to put in a password every time they need to look at a document, the ease and ability to track deals has made online due diligence ideal.

“The days of the physical data room are over,” he says. “From our standpoint, let's say we have a buyer and they're looking at six deals, when they log into the site with us they can see all six transactions.”

Miller adds that such features also show who has been looking at the documents and doing the necessary due diligence. Virtual data sites can show how many times a document has been viewed, who has viewed it and what areas of the transaction the potential buyer was interested in.

“It's very helpful for us to know how busy someone's been in the online data room and if they have really done their homework or are they just placing a bid to get to the next round,” Miller said.

Such advantages may spell the end for physical data rooms which force potential bidders to take time out of their schedule to look through numerous documents and requires careful planning to ensure that rival bidders are not tipped off by a competitor's visit. Toomey says his firm worked on two deals in 2008 that involved the use of in-person data rooms, which created a burden by requiring a team of three or four to fly to New York, spend one or two days going through the information provided, coming back to Boston and formulating an offer.

Even then, there may be information that is missing or needs to be confirmed. “Do I have to fly back to New York to confirm the information?” Toomey asks. “It is much easier to have 24/7 access to it, you can refer back to it and once again I think that is reflected in the pricing.”

Watermarking
When it comes to the security side, Netage CEO Krassen Draganov says that certain security features have become standard across the industry, especially document watermarking that imprints the name and company of someone who has downloaded or printed a file, and which can help identify anyone who is leaking information. “Watermarking of documents has become a must-have feature. I don't think we have sold a portal in the last year and a half without it,” he said. “While this was more of an exotic feature three or four years ago, if you don't have that now it is generally considered bad practice.”

However, he says more high-level security measures, such as digital rights management that operates akin to online banking, have not been employed very much in the private equity context, as they can be complicated and create a backlash. “They introduce a level of user unfriendliness that firms try to avoid,” Draganov says. “You might theoretically have a PDF document that only opens on a client's machine which has an extra toolbar installed on their Adobe Acrobat reader. These kinds of things can make it difficult to share information with other parties. You have to make things usable; security has to be something in the background that just happens without the user being inconvenienced.”

Draganov says he doubts that sites requiring more intensive security measures such as a SecurID – a number that has to be typed in addition to a username and password, and which changes every few minutes – will take hold in the industry as it is an unnecessary step and burden.

Bringing down the price
Toomey says that overdoing it on security can also hurt the bidding process as well. “The more restricted the access to the information is, the greater the probability that will have an effect on pricing,” said John Toomey. “With full transparency, the seller is much more likely to get a higher price than they otherwise would if they are not allowed to share statements for a manager's fund.”

Toomey says from his firm's standpoint, particularly considering the universe of opportunities seen in the secondaries market today, if they have two opportunities that are largely the same in terms of asset quality and manager quality, and one seller is willing to share much more information than the other, HarbourVest will likely make a play for the former. “You are bidding on the unknown,” Toomey says. “You may get half the number of bids that you would get otherwise because some buyers would look at the opportunity and say ‘well if you can't share the information with me how can I possibly bid’. Those that do have the courage to bid in the face of little or no information are likely to be very conservative without better information, and that is going to affect pricing.”

Draganov agrees that, while you don't want to open up too much information due to confidentiality, keeping too tight a lid on documents can hurt bids. This harms the selling LP and is no good for the reputation of the GP whose fund is changing hands. “If the secondaries buyers who are bidding don't have certain information they may substitute it with discounts, so if I don't know exactly what you are holding maybe I'll just lowball you,” he said.

However, Draganov says there is only so much a fund or a technology provider can do to prevent bidding LPs from sharing information once they have it. “It's like the car alarm analogy, you can build the best car alarm in the world but if someone is really determined to steal it they will be able to,” he says. “You won't prevent someone from logging into the website from their office and then having five other people look over their shoulder.”

For now, it appears the technology providers have found a happy medium between security and convenience. “The technology has lived up to the expectations and needs of the industry,” Draganov says. “I don't think people will be looking to change in the next year and a half for obvious budget reasons.”