Research

By Matthew Griffin, White & Case

In the past, managers encountering issues realising value to investors within the terms of their funds were left with few options. The maturing of the secondary market increasingly provides managers with the opportunity to obtain capital to restructure and reorganise their funds and management arrangements by way of transactions that were unheard of a decade ago. Such restructurings, often called “GP-led restructurings,” turn to a maturing fund secondary market with significant amounts of capital to deploy in secondary transactions and a willingness to enter into complex transactions to provide greater returns to investors.

GP-led restructurings involve providing a liquidity option for existing investors to allow them to exit a fund through either a sale of their interests or a realisation of the value of their interests as part of a fund restructuring. In the first instance, there is an acquisition of the interests of investors wishing to exit and in the second instance there is a provision of funding to such investors to enable a realisation of their interests. The liquidity is provided by one or more secondary investors, which may include existing investors or new third party investors. The mechanics are considered further below.

Investors wishing to exit through a liquidity event may be prepared to compromise long-term value for liquidity and certainty, which presents the opportunity for secondary buyers or existing investors wishing to increase their exposure to the fund.

GP-led secondary restructurings
Although each GP-led restructuring is situation and document specific, there are certain basic types of transactions which have emerged. One element that they have in common is that they are complex and generally present difficult conflict and logistical issues. Accordingly, they should not be approached casually. Intermediaries usually play a key function. The key intermediaries have the rolodex of potential purchasers and expertise in advising on the dynamics and implementation of GP-led restructurings. Lawyers are also critical to not only document, but also to advise on the complex securities law and conflict of interest issues which arise in each such transaction.
GP-led restructurings can be implemented in a number of ways, but the two most common are:

Purchase of fund interests: A tender offer is made by a secondary buyer for some or all of the interests in the fund. It may be that the tender price is set through an initial buyer bidding process, perhaps facilitated by an intermediary, where buyers are asked how much and on what terms they would be prepared to acquire some or all of the fund interests. A buyer is then selected by the manager. That buyer makes a tender offer to acquire interests from some or all fund investors. The mechanics of the offer may vary from deal to deal. The buyers and sellers will then enter into purchase agreements, under which the buyer will acquire the interests at one or more closings. As the manager is intimately involved in a GP-led restructuring, the buyer may look to the manager, rather than the sellers, to provide certain comforts concerning the fund interests being sold, such that the purchase agreement between buyer and seller can be relatively short form. Regardless of how short form the purchase agreement, sellers are likely to engage their own counsel and may seek to negotiate a bilateral deal with the buyer. This can make the process lengthy and difficult. Some buyers insist upon a take it or leave it approach, with the risk that they do not acquire as many interests as they may wish. The secondary buyer may commit additional powder to a new vehicle to support existing investments, follow-ons or provide a new lease of life to the manager for making new investments. That vehicle may be open to existing investors as well. It may also be possible for the secondary buyer and existing investors to provide debt to the fund to support existing and follow-on investments on a preferred basis to the other fund interests. Whether through a new vehicle or injection of debt, the additional funding arrangements are likely to require approvals under the fund documents and raise questions about the value at which such investment is made relative to earlier investment by the existing fund. In addition to the bilateral negotiation issue, another complexity is the difficulty amending any terms of the existing fund document, for example, to reset the economics to provide incentive to the manager. In many, if not almost all, GP-led restructuring cases there is no carried interest
payable, so some reset of economics may be considered preferable to properly align investor and investment team interests. However, changing the economics of a fund often requires the consent of affected investors. It may be possible that some investors agree to such changes and others do not, which could result in different classes of investor.

Transfer of Assets: A buyer or manager wishing to avoid multiple bilateral negotiations with selling investors, or wanting to implement a different deal to the existing fund terms may agree to effect a GP-led restructure through the transfer of assets to a new fund vehicle. In these cases, the manager forms a new fund vehicle, sells the fund assets into the new fund, provides existing investors with an
opportunity to roll over their interest into the new fund, the secondary buyer provides capital to the new fund (or existing investors increase their capital), such additional capital is then applied to the asset purchase price and used to pay out the investors wanting liquidity. This structure has the advantage of being able to amend the terms of the fund but there are a number of complexities with this mechanic. There may be tax implications arising from the asset sale and roll-over of existing interests, there may be issues arising
with respect to the portfolio companies (which could include regulatory issues if they are regulated, issues with debt covenants, issues under portfolio company shareholder agreements and governing documents) and there may be issues with not providing investors with a status quo option if the terms of the new fund vehicle vary too much from the existing fund vehicle. The lack of a status quo option also places great stress on the valuation and asset purchase price, which would need to fairly compensate those electing to exit and consequently, may not make the restructuring as attractive to a secondary purchaser as the fund interest purchase mechanic above. The sale of the assets is likely to be a cross-fund transaction under the fund documents, and there will likely need to be conflict approvals under the fund documents. Despite the above hurdles, these transactions are implemented. In the US, merger laws are sometimes used to facilitate the implementation of this form of GP-led restructuring.

Conflicts of Interest
Both deal structures described above have complex logistical and conflict issues, and will usually require investor or advisory committee consents. Earlier this year, the US SEC indicated that GP-led restructurings are on its radar, particularly from a fees and conflict of interest perspective, and specifically, whether investors choosing liquidity are getting fair value relative to the benefits to the manager and any incoming buyer. The SEC has also indicated that it is preparing fund restructuring guidelines. Conflict issues arise from the outset, including in the choice of buyer. Even if the manager runs an auction process to select the buyer, if the manager chooses a buyer based on the best deal for itself rather than the investors, it may leave itself open for challenge. For investors one of the major issues is information asymmetry. Both the manager and the buyer are likely to have more information about the fund, its investments and the restructure arrangements than the investors. There is no easy way to balance those scales. But critical in any process is transparency and the provision of information for investors to make informed choices. In addition, fair and equal treatment of investors is often required directly or indirectly by regulators of the manager. Thus, it is likely necessary to provide updated accounts and disclosure to investors prior to implementing any GP-led restructure.