Secondary transactions clearly present multiple advantages to LPs, in terms of a source of liquidity and to enable changes in investment allocations. In response to changing LP demands, private equity managers are increasingly taking the lead in these transactions. Says Julien Gervaz, CEO of digital secondaries trading platform Palico, “Private equity firms have been under pressure, with LPs wanting co-investment and greater liquidity options, and even asking to lower the management fees.”
A key driver behind the growing popularity of GP-leds is a change in perceptions as to when they can be used, rather than as a last resort when things have not gone to plan. Marco Wulff, Partner and Co-founder of Montana Capital Partners (MCP) observes “GPs are welcoming these deals as they see the opportunity to further develop portfolio companies and extract more value. And LPs are more positive as it gives them greater liquidity options.”
As GP-leds become more popular, they are becoming more efficient. “We’re seeing very good quality assets coming to the market, blue-chip GPs are increasingly using the secondary market as a liquidity tool. And there’s a much better understanding of how it works across all stakeholders – GPs, LPs and the advisors,” says Martins Marnauza, Partner at Coller Capital.
However, on a day-to-day basis, the desire for PE houses to meet changing investor demands creates new challenges. These transactions are time consuming and can place pressure on a managers’ internal operations. “IR teams have been working on this on an underlying basis, they’re now spending more time preparing or working on GP-led deals,” says Gervaz.
LPAs, LPACs and ILPA
Given the greater pressure on mid and back offices, one might assume a change in fund documents at the point of inception to ease the growing administrative burden. However, that doesn’t seem to be the case: “If we look at the legal documents, there aren’t special rulings regarding GP-led solutions. Even new funds that are raising now don’t have special language around GP-leds,” says Christian Diller, also Partner and Co-founder of MCP.
Explains Samantha Hutchinson, Fund Finance Partner at Cadwalader, “These transactions have only gathered pace in the last 18 months or so; it’s too early to see LPAs being set up with a view to facilitate GP-leds, and given the different permutations and complexity of different types of GP-led processes, it’s difficult to envisage how LPAs could be amended to cater for such bespoke solutions.”
Amrita Maini, Fund Finance Senior Associate at Cadwalader adds: “When LPAs are being negotiated with investors, a discussion about potential distress or need for an end of fund life solution could create nervousness amongst LPs, which is another reason why we’re perhaps not seeing any specific clauses.”
Typically, when GPs are considering a restructuring, approval is sought from the LPAC (Limited Partner Advisory Committee) in the first instance as a means of establishing potential conflicts of interest. “Otherwise, these deals can be handled within the typical terms of the LPA,” adds Diller.
As these deals grow in popularity, the inherent conflict of interest – with GPs acting as both buyers and sellers – has prompted ILPA to announce that it will issue new guidance in order to protect investors. Hutchinson believes the association’s focus will be on transparency: “They will likely want to ensure that existing investors see the same information as the bidders and that the GP has carried out proper market testing for pricing. These are areas GPs themselves also want more clarification on.”
The rise of the secondaries market, with increasingly active control over fund stakes by both GPs and LPs, challenges just how “limited" limited partnership interests may become. GP-leds require greater involvement from LPs, regardless of each investor’s individual liquidity needs. The pivotal role the LPAC plays in GP restructurings requires investors to make complex decisions beyond what is asked of them under fund governing documents. “This is one of the potential issues; for those passive investors committing to a relationship they’re not expecting to manage, and then to be facing a complex decision on whether to sell or roll over. But these deals represent genuine reputational risk to GPs, and this is something they really don’t want to jeopardise,” concludes Maini.