There’s been much talk about the potentially huge market for end-of-life fund restructurings; last year, secondaries advisor NewGlobe Capital Partners pegged it at more than $75 billion across the US and Europe. But although many LPs already find themselves in this dreaded scenario, we haven’t seen many successful solutions, especially in Europe.
So last year, when GMT Communications realised it had to restructure its €365 million Fund II, a 2000-vintage, it knew it had a big job on its hands. Fund II ran into difficulty during the economic downturn when it struggled to sell some of the remaining assets before the end of the fund’s life, despite securing two extensions. It also became clear that the fund, which had a deal-by-deal carry structure, would have to ‘claw-back’ some of its early proceeds to investors, because it wouldn’t meet its hurdle rate. Given that some of the carry partners had left the firm, the prospect of dealing with this situation was clearly a daunting one.
Nevertheless, GMT decided to confront the problem, hiring Park Hill to restructure the fund in October 2013. Fast forward nine months and GMT had successfully completed a deal with two secondaries players – understood to be Lexington Partners and Newbury Partners – to give the fund a new lifeline. Here’s how.
1. FINDING VALUE
First, the firm had to unlock the value of the fund, which had a large amount of cash on its balance sheet. “Buyers naturally apply an incremental discount to a set of assets under the threat of a fire sale, as well as a material discount to idle cash on a fund’s balance sheet as a non-appreciating asset,” says Pablo Calo, a managing director at Park Hill, who ran the process. “Furthermore, valuation of the contingent claw-back obligation in its current state was challenging, and its existence led to a potential misalignment of interest.”
GMT gave its LPs three options: to sell, roll over into a new fund, or keep the status quo. First Park Hill ran a process soliciting bids for the LP stakes in their existing structure and liquidation status, as well as soliciting distinct bids for the portfolio companies in isolation, according to Calo. “This enabled [us] to dissect value components and work with the advisory committee to lay out the plan for the restructuring of the fund, the release of its balance sheet cash at par, and the establishment of guidelines for negotiations with carry holders for the settlement of the contingent claw-back obligation.”
Fifteen buyers expressed an interest; 10 were invited to perform due diligence, after which GMT received nine bids. Three parties went into the second round, with two parties coming out on top in the final round. GMT declined to comment on the deal value, but it is understood the overall price was approximately 90 percent of NAV, including claw-back amounts.
To the investors who chose liquidity, the deal meant GMT was able to deliver a positive return for the fund as a whole. “This means investors [in the 2000 fund] haven’t lost money,” says Timothy Green, one of the managing partners at GMT. “It’s not a return to write home about, but it is a return, and that’s something we are relatively happy about.”
According to GMT, returning capital on a vintage year 2000 TMT fund is something that only three funds worldwide (including Fund II) have managed to achieve.
2. SETTLING THE CLAW-BACK LIABILITY
The contingent claw-back obligation was another big hurdle for GMT. “For various reasons, including difficulty in collecting and the misalignment they generate in the meantime, claw-backs have little value in the eyes of secondary investors,” explains Calo. “However, the fund restructuring enabled the claw-back to become accretive to the cash price received by selling investors, and an interim distribution to those electing to roll over.”
The biggest problem, however, was that this part of the deal involved former employees of GMT, including some ex-partners, who had a sizeable proportion of the carry. Some of these people had left the firm five or ten years earlier.
“There were some very difficult discussions,” Green admits. “While it was clearly defined in their contracts, the reality is that people don’t expect that call. It took a long time, but in the end we managed to get all carry holders to participate in the settlement including all ex-employees.” GMT declined to comment on how much they repaid, but it’s understood to be more than €10 million.
3. NOT FORCING LPS DOWN A PARTICULAR PATH
When GMT started to look at a restructuring, it quickly realised that there were not that many examples in Europe. “There were a few processes in the US, and they had not necessarily been well received,” says Green. “There was a feeling among the investor community that they had solutions forced upon them.”
As such, he says, the fact that GMT offered LPs three options – i.e. to sell, roll over, or keep the status quo – was vital to the success of the deal. Approximately 75 percent of LPs agreed to sell their stakes, while 25 percent opted to roll over. “None of them chose [to keep the status quo]; but it was critical to offer it to them, so investors didn’t feel they were forced into something,” says Green.
Deals like this can only succeed if they are fair and transparent, adds Calo. “Problems can emerge if the GP is secretly trying to create a deal, which was clearly not the case with the GMT II restructuring.”
4. PUTTING LPS FIRST
GMT also came up with a way to resolve another big sticking point in restructuring situations: investors’ reluctance to give more upside to a manager that has failed to deliver after 12 years.
“When you bring in a new investor, the LP wants to make sure the GP is properly incentivised,” says Green. “But we tried to keep the process separate, trying to get the best deal. And then afterwards we renegotiated our own economics [with the new investors],” says Green.
GMT now has three years plus two one-year extensions to divest Fund II. What’s more, its 2006 fund, a €342 million vehicle, has already returned 70 percent of the capital from that fund. The overall performance is top-quartile for that vintage year, based on EVCA methodology, according to Green. The firm hopes to return to market in the second half of this year.
The GMT restructuring shows that a successful outcome can be achieved, insists Calo. “LPs need to know that the process run is fair and for their benefit. GPs need to understand that there’s a life after a fund restructuring.” And any stigma attached to such deals will eventually disappear, he adds. “[Ten years] ago selling an LP stake had a stigma to it. Today, it is a portfolio management exercise accepted by everyone.”
Restructurings like this can be difficult, admits Jeffrey Montgomery, one of GMT’s managing partners. “But given the successful outcome of this one, there is an opportunity for the industry to use it as a road map.”