Until recently, GP-led secondary deals have generally been associated with “zombie funds” with lingering, hard-to-sell assets.
However, 2017 witnessed the maturation of a relatively new feature in the private equity industry’s liquidity toolkit. This development was highlighted this past summer when Lexington Partners purchased LP interests from investors in BC Partner’s ninth flagship buyout fund, while committing new capital to the fund’s successor.
This article reviews the three forms these transactions have tended to take and discusses some deal-making best practices.
The simplest of secondary transactions is the Tender Offer for LP-Interests, whereby the GP facilitates offers from one or more buyers for all or a portion of the fund’s LP interests. For buyers, the dynamics are similar to negotiating one-off LP transfers.
For sellers, the advantage is having the GP manage the process. These transactions do pose “prisoner’s dilemma” issues for selling LPs, who must balance the risk of missing out on a liquidity opportunity against the risk of getting left behind—sometimes, with a new single, large investor.
A more complicated variant, the Fund Recap, usually involves the sale of all or a significant portion of the existing fund’s assets into a new special purpose vehicle (SPV) with buyer capital, but managed by the existing fund’s GP. The fund recap can breathe new life into the existing fund, enabling the GP to continue to manage the assets beyond its prescribed term.
The Stapled Secondary, a variant of the two forms just described, is typically associated with fund recaps.
The article further provides a detailed consideration of four factors that help ensure the success of a GP-led secondary transaction: getting the right price; getting the right fund terms; getting to know your contract; and getting ahead of problems.
According to Credit Suisse, GP-led secondaries have grown from 10% of the market in 2012 to over a third of the market so far in 2017. Credit Suisse also predicts that private equity secondary transactions may approach $40 billion for 2017. Evercore predicts that $15 billion of that will be GP-driven.
As GP-led secondary transactions involve a great deal of up-front planning and strategy, GPs should consider consulting early with counsel and, potentially, a financial advisor to ensure that all are rowing in the same direction. In particular, certain transaction forms may give rise to broker-dealer issues and, depending on the population of LPs and the domicile of the fund entities, non-U.S. legal issues.
By, Michael Hong, Partner at Paul Weiss in New York. He is in the Corporate Department and a Member of the firm’s Private Funds Group.
Content originally from Transaction Advisors
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