The alternative investment advisory practice at Berkeley Research Group focuses on end-of-life fund matters, such as restructurings and wind-downs. It was a key contributor to the Institutional Limited Partners Association’s recent guidance on GP-led restructurings. Managing director Finbarr O’Connor and director Gavin Farrell discuss how GPs can use the guidance to help put their plans into action.
A confluence of factors has led to rapid growth in sponsor-led transactions over the past few years: lengthening of asset-hold periods driving managers to seek fund extensions past originally projected ten-year terms, existing LPs seeking liquidity, and – reflective of these circumstances – significant demand from secondaries buyers with gobs of dry powder.
And like any other busy M&A transaction market, the GP-led corner of secondaries transactions is experiencing significant innovation, with deals increasing in size, sophistication, and complexity. Further, these transactions are often riddled with conflicts, which has prompted the Institutional Limited Partners Association to articulate guidance to industry participants on best practices for the approach to such transactions.
GPs contemplating these transactions should take note: LPs want more transparency and engagement. GPs should recognise that the success of the proposed transaction increases with transparent and early engagement with LPs and their advisor, so it is critical that the rationale be socialised with LPs as early as possible.
GPs will want to ensure there is a realistic ability to achieve the liquidity proposed under the transaction. Therefore, when the GP team formally makes its proposals to LPs, it is vital that the GP ensures the proposal is realistic and that potentially material issues for LPs have been anticipated and fully addressed. Advance discussions with the LPAC and the LP’s advisor will help the GP position the proposal for LP approval.
The GP should ensure that all existing LPs have equal access to any and all information that has been made available to the LPAC, potential bidders, or new LPs. The timing of the provision of such information symmetry should be determined by the LPAC and the GP, perhaps during advance negotiations of the transaction documents with the buyers/new LPs. LPACs should work with GPs to develop the protocol for sharing information with LPs, respecting confidential proprietary GP information, and should seek to ensure that the transaction data room is opened to all LPs as part of the solicitation process.
Check what’s in your proposal
GPs and LPs alike should welcome a framework that facilitates an informed evaluation of transaction proposals. GPs, your proposals should include a clear description of the proposed transaction, the process, and the terms and economics of each option. LPs will expect to receive enough data on the outlook for the underlying portfolio, including a current fair market value and a projected timeframe for the realisation of all investments.
Transparency is a cornerstone here. Laying bare the competitiveness of the marketing and bid process you ran, and how you handled and disclosed conflict-prone issues, is expected. For example: the number of bids sought and received, the economics involved in the GP’s management of a continuation fund, and how any stapled primary commitments may have influenced offers from bidders. The terms provided to the new LPs in the continuation fund should be fully disclosed to all existing LPs to enable LPs to select from the choices of options available. To the extent the terms for new LPs are different, those terms – and the basis for the difference to the terms for existing and rolling LPs – should be fully disclosed.
Provide your LPs an even hand in structuring your transaction terms
LPs want options. And status quo is an option, too. A fundamental principle is that exiting and rolling LPs receive equivalent economics. However, it is not uncommon for rolling LPs to require a hurdle over the cash-out price, beyond which they will pay carry, for the inherent risk of not taking cash and rolling. Reset carry may be established, perhaps in a performance staircase, beyond the hurdle where rolling and acquiring LPs are on the same terms, often a key principle in the new vehicle or restructured fund.
Where there is fresh capital being contributed as dry powder in the continuation vehicle, it may be more appropriate to recalibrate the GP’s economics depending on the use of that capital. However, a risk that LPs often perceive, and one that needs to be managed, is the potential misalignment of the GP’s incentives for the management of new capital versus rolling/acquired interests.
In circumstances where the existing GP is out of the carry, it may be appropriate to provide for a carry reset for incentive purposes, particularly for a continuation fund under a similar hurdle/staircase approach.
Related issues arise in mature fund extensions. LPs often point to the fiduciary requirement of the GP to do the right thing, whereas a practical reality is if the fund needs extending (or a sale to a continuation vehicle) for a period to successfully harvest, the GP’s incentive may need to be realigned beyond the original terms of the LPA for the extension period.
GPs, the economics offered in your proposal to exiting LPs should be supported by an independent opinion of fair value. And the selection of the fairness opinion provider should be made in consultation with LPAC and not solely by the GP (or its advisor) proposing the transaction.
The treatment of transaction costs associated with a GP-led transaction naturally is a sensitive topic. Disclosure of the reasonable allocation amongst buying, selling, and rolling LPs should be provided; and in cases where the GP is clearly benefiting from either additional fee revenue or through stapled commitments, the GP should share some portion of transaction costs.
GPs should also note that LPs may not agree to shoulder the burden of broken deal costs for a GP proposed transaction in which the LPAC did not approve the terms of transaction; or have ample opportunity to review and opine prior to transactions costs being incurred.
Embrace the growth in collective engagement from LPs as a positive trend
GPs have long recognised that LPAC engagement and support, on a fully informed and advised basis, greatly increase the likelihood of timely LP acceptance of a GP’s proposal. And, in general, LPACs seek to provide GPs with transaction feedback that will maximise the value of the fund’s assets and generate the highest and best outcome for all LPs. Given the time-sensitive and complex nature of GP-led fund restructurings, ILPA recommends that LPs consider retaining an independent specialist advisor to act for the benefit of all LPs.
The LP’s independent advisor reviews all transaction documentation, vets the GP’s solicitation process (including all bids received), performs an independent analysis of the GP’s process to determine fair market value, analyses the alternatives considered by the GP, and generally acts on behalf of all LPs to ensure their best interests are met.
In addition, GPs will need to be prepared to work with the LP advisor to allow an examination of conflict-prone areas, such as the terms of any related-party transactions with GP. If the GP is involved with or has economic interests associated with the buyer, the LP advisor will seek to ensure all other buyers have the same access to the information. In addition, the advisor will want to understand all arrangements post-transaction with the GP, and if any concessions were provided to the GP with the buyer/new LPs in the transaction.
Although a GP-chosen transaction advisor may exist, GPs should recognise that LPs often question the independence of such arrangements. Drawing some parallels to the world of corporate restructuring transactions, established practice is for affected stakeholders to be separately advised, independent from the transaction sponsor’s or corporate’s advisors. As the market for GP-led transactions further develops, leading to more sophisticated, complex, and larger transactions, a natural evolution will inevitably require a similar segregation of advisors. GPs seeking to promote and enhance the success of secondaries transactions should embrace this evolution that mirrors the corporate world, with advisors on both sides.
GPs, your LPs are speaking out. If fund restructurings and secondaries transactions are to be “led” by the sponsor, enhance your success factors by providing open, early engagement and transparency with your LPs and their advisor. Anticipate and address conflicts, both real and perceived. Provide your LPs with the options they want, most likely liquidity or a roll-over option, recognising that a fundamental principle is that the economics offered to rolling LPs should be at least equivalent to those cashing out.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates. BRG advises managers, investors and LPACs on fund restructurings, portfolio asset sales, and mature fund situations.