Friday Letter: Making fund restructurings work

There's a stigma attached to dealing with end-of-life funds – but facing them head-on will lead to the best outcome

It is a scenario LPs dread: being stuck in a fund containing unrealised assets that is fast approaching the end of its life cycle, with no liquidity in sight.

Unfortunately, it’s also a scenario that many of them face. Last year, NewGlobe Capital Partners, a secondaries adviser, estimated the market for end-of-life funds to be worth more than $75 billion across the US and Europe.

But although a number of secondary players are actively looking to pursue such fund restructurings, in practice there have been very few successful examples, especially in Europe.

That’s why the recent case involving UK-based group GMT Communications, which PEI revealed this week (link), is particularly noteworthy.

The firm’s Fund II, a €365 million 2000-vintage, got off to a decent start, but ran into difficulty during the economic downturn. Despite a couple of extensions, it struggled to sell its remaining assets before the end of the fund’s life – and because the fund had a deal-by-deal carry structure, it quickly became clear that it would have to repay some of its early proceeds back to investors (the lesser-spotted claw-back process).

Now, however, it has been able to give the fund a new lease of life with help from two secondaries players – understood to be Lexington Partners and Newbury Partners.

So why did this process succeed where others have failed?

One reason is that LPs didn’t feel railroaded down a particular path.

As part of the process (which was run by Park Hill Group), GMT offered three options to its LPs: sell up, roll over into a new fund, or maintain the status quo. In the end, about three-quarters went for option one, and the rest for option two.

This actually played an important role in the success of the deal, according to GMT. When it first started to talk to LPs about restructuring the fund, their overriding complaint about previous situations of this kind was that they’d had solutions forced upon them.

One oft-cited example of this is the restructuring involving Motion Equity Partners. Prior to striking a deal with HarbourVest in January, Motion had been in similar talks with the Canada Pension Plan Investment Board; but the latter couldn’t persuade all the other LPs to roll over into a new vehicle.

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. Clearly, lots of LPs worry there’s a conflict involved when a GP is trying to negotiate a secondaries sale on the one hand, and optimise its own economics on the other.

GMT addressed this by splitting the deal into two stages: first it ran a traditional secondaries process in which the highest bidders were chosen, and then it negotiated its own economics afterwards. To the investors who chose liquidity, the deal meant GMT was able to deliver a positive return for the fund as a whole (which, according to the firm, is something only three 2000-vintage TMT funds have managed to achieve worldwide).

It also helped, of course, that GMT had a more recent fund that was performing well: its €342 million 2006 vehicle has already returned 70 percent of the capital and its overall performance is top-quartile for that vintage year, based on EVCA methodology, according to GMT.

As a result of all this, GMT was able to strike a deal on the 2000 fund – and with its slate wiped clean, it can now focus on trying to raise around €350 million for a new fund later this year.

Dealing with end-of-life funds is always going to be a lengthy, complex and often combative process; that’s inevitable when there are so many competing interests at stake. But GMT’s successful outcome shows that it can be done – as long as GPs are willing to be proactive, face the situation head-on, and show their investors plenty of flexibility.