When private equity investors look to shuffle their fund commitments or assets, the process is anything but simple. Any foray into the secondaries market invariably means a new round of due diligence and negotiations – all of which will demand attention from both buyers and sellers involved in the deal.
This issue is becoming more pressing as a raft of new regulations forces some of the industry’s largest institutional investors to reassess their private equity portfolios. European banks in particular may have to shed a substantial number of assets in response to the new Basel III capital requirements, while the so-called “Volcker-rule” in the US will severely restrict the private equity operations of their US counterparts.
A recent deal portending the scale of bank-driven activity occurred in June, when French group AXA Private Equity agreed to purchase a $740 million portfolio of fund commitments and direct investments from UK bank Barclays (see p. 60). Since banks have historically accounted for more than one-quarter (26 percent) of private equity deals, according to a study carried out in 2010 by Harvard Business School, it clearly won’t be the last deal of this type.
But before the wheels can even start to move on a secondaries transaction of this kind, GPs may encounter a number of logistical problems, according to David de Weese, head of global secondary transactions at Paul Capital. Earlier this year the firm acquired around 20 growth-equity and buyout interests from Bank of America Merrill Lynch – a deal so complex that it required Paul Capital to “move the bank’s scattered private equity assets across multiple jurisdictions to create a single vehicle holding all the acquired fund interests”.
The challenge, de Weese says, was deriving a fair value for the portfolio. Under the bank’s ownership the assets were financed and managed by different departments, making it almost impossible to get a simple snapshot of the portfolio’s overall historical performance. Consolidating all of the assets under one distinct management team also required separate negotiations around the fund’s fee structure and other key terms and conditions. In the end, Paul Capital’s due diligence period stretched over two years – a lengthy process that involved establishing tax-efficient vehicles to move assets across borders and fact-checking underlying company data.
To further complicate matters, banks tend to have a broader range of concerns than most sellers when disposing of their private equity assets. Unlike (for instance) pensions and endowments, banks will consider “how the deal impacts the level of regulatory capital they are required to hold; [they] may also be more focused on how the transaction ultimately gets booked in their P&L statement”, says David Atterbury, a principal at secondary and fund of funds manager HarbourVest. Other LPs, in contrast, are more straightforward to negotiate with, since their main consideration is usually economic – i.e. the level of cash received.
As a result, numerous stakeholders within the bank can be involved in negotiations, warns Atterbury. “Human Resources may get involved if the deal involves a spin-out team; compliance and in-house counsel may have their own concerns about how the process is managed; the accountants will need to inspect how the bank’s P&L statement is affected, and so on.”
On the other hand, banks can sometimes allow buyers greater flexibility. Thanks to their large balance sheets and complex operations, often they can more easily afford to retain a particular fund interest that a buyer doesn’t want included in a portfolio sale, says Atterbury. “Pension or insurance firms are typically more rigid in their decision to offload fund stakes”.