Lehman buyout arm to spin out

Lehman Brothers Merchant Banking will partially spin out as an independent firm, while the failed bank will retain ownership of a portion of the funds. Limited partners in Lehman’s most recent buyout fund have been given the option to reduce unfunded commitments by 25%.

Lehman Brothers Merchant Banking, the $4.8 billion buyout private equity arm of bankrupt Lehman Brothers Holding, has reached an agreement with its bankrupt parent to spinout as an independent firm.

Lehman Brothers Holding will keep a significant stake in the buyout unit, retaining ownership of $1.2 billion of investments across two funds and holding on to about $230 million of its limited partner stakes.

Lehman Brothers’ most recent buyout fund, the $3.3 billion Merchant Banking IV, which closed in 2007, will emerge as an independent entity owned by management, which is led by chief Charlie Ayers.

As part of the deal, South African billionaire Johann Rupert’s investment vehicle, Reinet Investments SCA will assume $250 million of unfunded commitments in the funds. Lehman also will offer some of its LPs the option to reduce unfunded commitments to the $3.3 billion fund by up to 25 percent. Lehman’s investors include the Pennsylvania Public School Employees Retirement System. Other private equity firms, including TPG and Permira, have also allowed their LPs to reduce unfunded commitments.

“We wanted to accommodate the needs of the LPs,” a source at Lehman said. “There are some LPs that want to stay in for 100 percent of their commitments and others that would like to see reductions of their unfunded commitments due to their own situations.”

The LPs have worked with private equity advisor StepStone Group and law firm Kirkland & Ellis through the sale process. “StepStone and Kirkland & Ellis played a very important part in coordinating and organising the LPs of the different funds, and we worked well with them to make sure we were taking into consideration the needs of the LPs,” the Lehman source said.

Lehman has been in the process of selling its private equity, venture capital and real estate funds since the former investment bank filed the largest bankruptcy in history in September. A Lehman management group won a bankruptcy auction in December for the bank's investment management division, including Neuberger Berman, beating a $2.15 billion bid from private equity firms Bain Capital and Hellman & Friedman.

The investment management division included some private equity assets like secondaries, some funds of funds and co-investments, as well as start-up private equity businesses including Lehman's debut infrastructure fund, which was targeting $1 billion.

About 90 parties expressed interest in the merchant banking group, the Lehman source said. While the structure of both the Neuberger Berman and the merchant banking deals happen to be management spinouts, Lehman “will continue to explore traditional sale transactions for other assets and businesses going forward”, the source said.

The company expects to close sales of its $800 million venture funds group and the $9.7 billion private equity real estate group in the first quarter of 2009.  The venture funds are in the “late stage” of the sales process, the source said.