General partner-led restructurings comprise an increasing portion of secondaries deals across asset classes, panelists agreed at a forum at law firm Goodwin’s New York office.
Real estate lags private equity in secondaries volume and sophistication, but one secondaries advisor noted that the amount of dry powder in the primary and secondaries market has jumped, and he expects real estate to follow private equity in the expansion of GP-led restructurings.
One lawyer estimated GP-led restructurings comprise about a quarter of the $55 billion in secondaries transactions in 2017, compared with 10 percent the year earlier, but no two transactions unfold the same way.
A panelist said one of the most successful types of GP-led restructurings can be an asset-level transaction, in which LPs can either roll over their interest to a new vehicle or exit their interest. In this transaction, the secondaries buyer may also make a commitment to a successor vehicle via a stapled secondaries deal. Goodwin advised on such a deal for a 2005-vintage fund, with two panelists explaining the behind-the-scenes process for how the deal was executed.
Starting the process
The Goodwin-advised vehicle had most of its value concentrated in a single asset, with the general partner in carry but no longer earning a management fee. While the fund no longer required additional capital, the manager wanted to buy more time for the asset, which needed three or four years to reach its full potential. Through a secondaries deal, the GP also hoped to start earning a management fee again, as well as collect capital for its next fund.
The asset-level deal took about eight months from start to finish. In the first five months, the GP hired an intermediary to shop the deal. Out of 120 identified potential buyers, the advisor narrowed the list to 26 buyers. After opening up access to its deal room, the GP received seven bids and selected the winner based on a high – but not the highest – bid and the buyer’s ability to take on the entire deal.
The GP spent the next three months negotiating the deal, including a new waterfall, governance and partnership agreements. Once the buyer and the seller agreed on terms, LPs had 20 days, which Goodwin noted was a relatively short period of time compared with other negotiations, to decide if they wanted to take part in the secondaries deal or sell their interests and exit the structure.
The make-up of the LP base has a significant effect on the success of GP-led deals, according to Phil Tsai, global head of secondaries market advisory at UBS, who also spoke at the panel.
“We like when there are six to eight LPs that make up the majority of the fund versus 30 plus. Those things matter – it’s like herding cats if there are too many because it increases the risk you won’t get to the necessary approval and selling thresholds.”
Structurally, the deal involved four steps. First, the GP rolled its portfolio companies into a new vehicle. Next, the fund distributed new vehicle interests to the LPs and GPs from the original fund. Thirdly, the new LPs contribute the cash to the new vehicle, and finally, the LPs and the GP of that new fund have the option to redeem their interests in the new fund.
LPs could exit the new structure entirely, or if they wanted to stay in the new vehicle, they had two options: they could retain the old vehicle’s fee structures or they could have the same terms for the new vehicle as the secondary buyer. This last option would give them a lower waterfall but would reinstate the management fee, an option few LPs opted into. One Goodwin lawyer said the GP gave LPs three options to address concerns of the Securities and Exchange Commission, and ensure LPs are not forced into a bad deal.
“That’s why we gave the LPs the option to go in on the same terms,” the lawyer said.
The secondaries buyer also committed capital to the GP’s new fund.
The secondaries deal was successful for all sides, a Goodwin lawyer said, because the GP sealed a capital commitment for its next fund and extended its value-creating opportunities from the previous vehicle, while the LPs could either realize their capital or take part in additional value generation.