PE Funds Maxing Out On Secondary Sales
The mad rush to sell commitments to private equity funds on the secondary market isn't without consequence. PE firms are keenly aware that no more than 2% of a fund’s LP interests can sell on the secondary market. If they do, the fund is no longer protected by safe harbor laws that guarantee that all-important “private” status and, more importantly, “private” taxes. If more than 2% trades on the secondary market, it could be audited and deemed a publicly-traded partnership, or PTP. Examples of PTPs include publicly-traded mutual funds. The PE fund is no longer a flow-through vehicle and, as a result, returns end up being taxed twice (GPs get taxed on the income, LPs get taxed on it after distributions). There also are safe harbors for up to 10% if it is sold in large “block transfers;” ultimately this relates to how many LPs there are. Understandably, some firms are concerned about the number of commitments that their LPs will sell on the secondary market. “The other side of the coin is so draconian,” as one source said. But GPs typically have veto power over secondary sales written into their partnership agreement. So, in order to keep their safe harbor guarantee, a number of firms have told eager-to-sell LPs they’ll just have to wait. Get in line for 2009. One lawyer I talked to said there’s a mega-buyout firm that has a two-year waiting list of eager-to-sell LPs.
