The most important structural change in the global secondary market recently, according to Jason Gull at Adams Street Partners in Chicago, is that general partners are taking more of an interest in the transfer process.
This is not because GPs have suddenly turned into control freaks. But the rapid growth of the secondary market since the late 1990s has meant that many private equity firms are now seeing regular turnover in their investor base. Gull, who co-leads Adams Street's global secondary investment activities, says the distractions that come with these transactions have made many firms more mindful of their inefficiencies.
Before the secondary market came into being, limited partners wishing to dispose of a fund interest didn't have many options other than asking the GP to help identify a suitable buyer, typically from within the partnership.
But when dedicated secondary funds arrived on the scene to create a market for second-hand fund positions, the process changed. Recalls Gull: “Now a limited partner would distribute information to potential buyers, run a simulated auction to see how bad the illiquidity discount would be, accept a bid from an interested buyer and then tell the GP about it. The GP would often be the last to know, and asked not to tank the deal. Some managers came to see this as a real hassle; others saw it as an opportunity.”
A handover of a partnership interest from one limited partner to another is a distraction to the manager because it involves requests for information about the fund in question, information that both the GP and the other limited partners in the fund may well consider confidential. Says Gull: “GPs are increasingly sensitive to confidentiality issues. This is reflected in the language used in partnership documents, which is becoming more stringent and in some cases is being negotiated heavily.”
Most managers also insist on being able to veto a proposed trade of a fund interest. GPs do this because:
This is why offering memoranda and limited partnership agreements (LPAs) contain language specifying the general partner's role in the event of a transfer. Provisions differ between partnerships, depending on how fully they assert the GP's right to grant and withhold consent at their discretion.
Some GPs still take pleasure in making transfers difficult, although the leading firms are usually helpful. But some GPs are not grown up about this. They destroy a huge amount of goodwill in these situations, and they gain nothing
To illustrate: the offering document for Blackstone VI, the $15.6 billion (€12.2 billion) vehicle that closed this summer, states that “a limited partner will not be permitted to assign, sell, exchange or transfer any of its interest, rights, or obligations with respect to its limited partnership interest, except by operation of law, without the prior consent of the General Partner, which consent may not be unreasonably withheld.” In similar fashion, the offering memorandum for Candover 2005 asserts that “the manager has absolute discretion” over the transfer procedure, but goes on to say consent may not be unreasonably withheld.
By contrast, the relevant passage in the memorandum of Charterhouse Capital Partners VIII merely states that the sale, assignment or transfer of a limited partnership interest requires the GP's written consent, “which may be withheld at its discretion”. Neither does the offering document of CVC European Equity Partners IV say that the manager has to be “reasonable” when withholding consent to a transfer.
In practise, views differ as to how often general partners make use of their statutory rights to intervene in a secondary exchange. A number of private equity firms, including Kohlberg Kravis Roberts and the Whitehall real estate funds franchise of Goldman Sachs, are widely thought of as innately conservative when it comes to transfer requests from within their investor base. The head of IR at a well-known ([A-z]+)-based mid-market firm says he has rejected a number of investors wanting to acquire stakes in one of the firm's existing funds after they had turned down invitations to participate in a new one.
Some LPs confess to a sense of intense irritation over the issue. Says an international fund of funds manager: “Some GPs still take pleasure in making transfers difficult, although the leading firms are usually helpful. But some GPs are not grown up about this. When we make a primary commitment to a fund, we never get asked, will we be able to fund it. But when we buy a secondary position, the question somehow comes up. We typically get the deal done, but it can be very cumbersome. Some GPs destroy a huge amount of goodwill in these situations, and they gain nothing.”
However, others point out that it would be misleading to think of such cases as common. Michael Harrell, co-chair of the Private Equity Funds Group at law firm Debevoise & Plimpton in New York, says: “There may be cases out there, but I have seen hundreds of transfers, and no GP I know has ever said no because they didn't like the identity of the buyer or because they couldn't be bothered. In my experience, GPs are very accommodating when it comes to transfers.”
Gull says a growing number of general partners have taken to helping sellers in their funds find the best possible replacement: “The easiest way for managers to deal with the issue is to say fund interests can only be transferred to other investors in the fund. But many are now becoming more entrepreneurial. GPs will make suggestions as to who the seller should talk to, and they will specify how much information they will make available, where it will be accessible, whether the LPA will be included etc. For the seller, this means that a lot more legwork is required to ensure they don't end up with a blown deal.”
For some buyers, such GP engagement will undoubt edly be a hindrance, but others stand to benefit. Some hope that the trend will help make the transfer process more efficient. Says Ivan Vercoutère, a partner at Swiss private equity and hedge fund investment specialist LGT Capital Partners: “50 books going out in a secondary auction is not a trend that is likely to last, in part because sellers don't want to affront the GPs of the funds being sold, and also because the GPs recognise the proposed sale as an opportunity to select suitable candidates to bring into the partnership.”
Stephen Can, co-head of secondaries at Credit Suisse in New York, agrees: “The trend is toward limited auctions, with three to seven parties participating, which can be relied upon to deliver a fair price.”
This last point is important too: a general partner's effort to keep a lid on the number of participating buyers will not necessarily limit the seller's potential to achieve an attractive valuation. What it can do instead is make the transfer process less of a headache for everyone involved.
“Wide auctions maximise process, but they don't necessarily maximise price,” says Gull. Most market practitioners should welcome the ongoing trend towards more narrow processes – albeit with the possible exception of the auctioneers.