Early on in the investment period of its current fund, Greenpark Capital was approached by the Europe-based general partner of a private equity fund of funds with whom the Greenpark team had enjoyed a longstanding relationship. The GP enquired whether Greenpark would be interested in assisting them in relation to a traditional secondaries portfolio they were interested in purchasing as part of their fund’s investment strategy. The general partner had a strong track record in investing in funds on a primary basis but was less familiar with secondaries investing, so wanted to work with a secondaries specialist. They felt this would have significant advantages at various stages of the transaction. As both sides agreed with this view, it was decided that the deal would be split between Greenpark, the fund of funds, and one of its clients. As a result, Greenpark undertook the due diligence and pricing and worked together on a nearly day-today basis with the general partner of the fund of funds.
Seller and reason for sale
Most secondaries transactions are still the consequence of internal developments at sellers’ organisations rather than the (perceived) lack of performance of the funds being put up for sale. These internal reasons include: a required reduction in exposure to the asset class, regulatory requirements, having difficulty paying outstanding capital calls, the threat of being taken over, strategic developments, a change of personnel, housekeeping and locking in a return. The owner of the funds in the above project, let’s call it Project NN, was a large U.S. institution that for regulatory and strategic reasons had sold a significant number of private equity fund holdings via several transactions over the past few years. Project NN was one of these deals but, unlike some of their other secondaries transactions, this deal was undertaken on a non-auction basis.
As with some other recent secondary transactions, the seller was less concerned about which of their fund positions would be part of the transaction than the impact the sale would have on its balance sheet, both in terms of resulting write-downs as well as overall size. To achieve their objective, the seller provided the buyers with a list of funds, covering both Europe and the U.S., out of which the appropriate deal was to be selected. For a transaction to be acceptable, it was stipulated by the seller that the total discount to book value was not to exceed a certain percentage and the total size of the deal should be within a certain range.
This posed a major challenge to the bidding syndicate, as discounts are simply a consequence of the pricing of a transaction according to normal valuation methods (see below). Not only does the pricing need to be suitable, but many buyers – including Greenpark – also require that the funds comprising a transaction be largely funded. Fortunately, the list of funds out of which a selection could be made included a number of older vintage, high quality funds that enabled the bidding group to make an offer that was within the range acceptable to the seller. Not surprisingly, these were all buyout funds with an average late 1990s vintage year. In other words, there was a very reasonable likelihood that a large part of the investee companies’ exits would be completed within one to five years.
Valuation and pricing
The valuation and pricing of the private equity funds potentially involved in the transaction was undertaken using our usual methods, which take into account both quantitative and qualitative aspects of the underlying funds and their management teams.
The information required to start building an accurate picture of the funds usually comes, in the first instance, from the latest quarterly accounts and investment reports for the funds. The most recent audited accounts are also important sources, as are extensive discussions with the general partners regarding the underlying investee companies in general, exit plans for the portfolio, if any, and any developments since the most recent report.
This information is subsequently validated by market research, analysis of comparables and reference to Greenpark’s own company and analysis databases, resulting in as solid an assessment of the underlying portfolio companies as possible within the limited period of time that is typically available in a secondaries transaction.
For this project, as soon as the seller had provided the information requested Greenpark analysed the quantitative information as follows:
- Past and current financial performance as well as the projected key financials for each of the underlying investee companies in approximately 20 funds.
- Potential exit valuations of portfolio companies based on comparables and industry multiples.
- For funds that are invested in public companies: stock market performance.
- The investment date and time discount.
- Outstanding capital contributions to the fund.
- Outstanding management fees for the fund.
- Outstanding carried interest on the fund.
- Amounts distributed by the fund to its LPs to date.
On the qualitative side, Greenpark reviewed:
- The performance and strategic outlook for the underlying investee companies.
- The “exitability” of the underlying companies, reflecting (i) company progress since investment, (ii) GP / financial shareholders control over a potential exit (for instance, a majority family-owned company where the family is against an exit does not represent much exit value in the transaction), (iii) market conditions in the companies’ industries, and (iv) position of the companies in their industries and their appeal to a trade buyer. Apart from one investee company which was highly likely to achieve the scheduled IPO given its standing in the market, IPO exits for the majority of the portfolio were dismissed.
- Potential exit timing.
- What incentives there were for the GP involved to achieve exits sooner rather than later.
- The GP’s quality, standing in the market, need/wish to raise next fund and returns to date.
It should be noted that the general partners of the funds selected from the seller’s portfolio were extremely helpful in providing the additional information needed from them as well as in pre-approving us as the buyer should we be able to negotiate successfully with the seller. Some of these GPs put the consent to transfer on their board meeting agenda within a few weeks of Greenpark contacting them.
Secondaries transactions always involve not only negotiations with the seller, but also with the general partners involved, as fund documents generally provide that no transfer can take place without a) the general partner’s consent to the transfer as such and b) their agreement to the transfer documentation.
On Project NN, negotiations with the seller focused on the composition of the deal in the light of the seller’s requirements.
On the basis of the analysis undertaken by Greenpark, a significant number of the funds under review did not make it to the final portfolio for a variety of reasons. These included: fund strategy, expected fund performance, investee companies’ exit horizons, prices paid by the funds versus value today; and, for those funds which had quoted companies, the divergence between book valuation of the stock and its current stock market valuation. The end result was a portfolio of around one third of the funds reviewed, covering Europe and the U.S. The portfolio was very much buyout oriented, very diversified by vintage, industry and geography, making up the required deal size and allowing for a discount to book value that was acceptable to both the seller and the buyer.
As is usual, the gross purchase price was agreed as of a certain valuation date. Two major exits occurred during the negotiations post the agreed valuation date, and the proceeds of these exits were deducted from the agreed purchase price as they had already been distributed to the seller. All contributions made by the seller post the valuation date were added to the agreed purchase price.
The sale and purchase agreement was drafted by the seller and, having sold a number of portfolios before, this was in a semi-standard format, designed for a speedy closing of the transaction.
Some of the general partners involved could not legally approve more than one transferee, while other general partners simply preferred to deal with a single purchasing entity. This necessitated the setting up of a syndicate vehicle, which would be the purchasing entity on behalf of the buying syndicate.
When it came to transfer documentation, some funds provided their own assignment and assumption agreement and others had some very specific requirements for amendments to the transfer documents that were proposed by the buyer. Agreement on all of these issues was reached within a few weeks.
The effective date of transfer was another subject of discussion with one of the funds. For internal reasons, this GP could accept only June 30 and December 31 as transfer dates. The buyer could not pay for this fund position without the transfer becoming legally effective and the seller did not wish to be potentially left with this holding. It was therefore agreed that all transfer documents in relation to this fund would be signed as at June 30 by all parties, including the general partner, after which the documents would be held in escrow until the transfer became legally effective. The purchase price for this particular fund position would be paid on that date.
Although this transaction had, as secondary deals invariably do, a number of challenges, the transaction came to a successful closing thanks to:
- the effectiveness of the syndicate approach and structure;
- the flexibility of both the seller and the buyer regarding fund positions making up the deal, provided that the seller’s size and balance sheet requirements were met;
- the ongoing cooperation by the underlying fund GPs during all stages of the transaction, resulting in the sale and purchase of a quality portfolio at an attractive price.
Greenpark Capital, based in London, provides tailored liquidity solutions to limited and general partners looking for an early exit from private equity investments.
The preceding article was extracted from Routes to Liquidity, a 224-page Research Guide recently published by Private Equity International. To order your complete copy click here or call the order hotline on +44 (0)20 7906 1181.