The way a general partner deals with end-of-life funds has a bearing on how limited partners view their next fund. In other words: handle the tail end well and investors will give you high marks for fund management skills.
This has become increasingly relevant as the huge amount of capital raised in 2006, 2007 and 2008 has passed its 10-year life and extension periods. As the deal-making and value creation process was hampered by the global financial crisis, many of these funds are now left with more in the way of assets than they otherwise should be. What to do with them?
GPs have options. Given the vibrancy of the private equity secondaries market at the moment – in the third quarter of this year, five secondaries funds raised more than $10 billion between them – there is no shortage of capital looking to acquire second-hand fund stakes or assets. GPs can facilitate a tender offer for LPs looking to sell stakes. They can move the assets from the old fund to a continuation vehicle, giving LPs the option to roll into the new fund. And if it is follow-on capital – rather than just time – that is the issue, then there are preferred equity providers happy to come up with solutions. And of course, they can just seek further fund extensions.
A couple of recent data points gathered by our research team provide some interesting food for thought in this area.
According to the 2018 Fees and Expenses Benchmarking Survey conducted among PE firm CFOs by sister title pfm, there is not much provision in fund docs for the end of the fund’s life when it comes to who pays what. Around half of the CFOs who responded to the survey said they do not stipulate fee and expense arrangements in their LPA beyond any stipulated extension periods. It is, instead, negotiated at the time of extension. Is this smart? Not according to Tom Angell, partner at WithumSmith+Brown, one of the sponsors of the survey. “It is safe to say that a lack of vision early in the process could yield negative outcomes – from a failed transaction and significant expenses to angry investors and regulatory scrutiny – if fee and expense arrangements are left open for negotiation at the time of the extension,” he writes in pfm’s special report on the results.
It is a similar story for fund restructurings – moving the assets to a new fund, with new terms. Only 16 percent of respondents said their LPA stipulates who pays for the costs relating to a potential fund restructuring. Just over half said it is decided at and when the situation arises.
“In essence,” writes Angell, “the plan is no plan at all.”
Indeed another data set – this one taken from our soon-to-be published Private Equity International LP Perspectives survey – suggests disquiet among investors on this front. A majority of LPs have now been party to a fund restructuring proposal. Of these, more than a third said they did not have sufficient time to make a decision, while a similar proportion said they had insufficient information. Most divisive, however, were the costs: nearly two-thirds of LPs said the costs of the process were not fairly divided between the GP and the fund.
This matters because these processes require significant external advice, as well as the costs related to setting up a new vehicle. LPs may be slightly less enamoured with the process if they find out late in the day that they are paying for it via their fund assets.
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