NASDAQ recently became the latest exchange to launch an online platform for the trading of alternatives fund stakes, giving secondaries buyers another source of dealflow. NPM Alternatives will initially focus on feeder funds.
The platform has been recognised as a 'qualified matching service', which means fund managers who register with the exchange won't be affected by publicly traded partnership regulations.
So what is PTP and why is it worth side-stepping if you can?
In essence, it is a US tax-related issue that means funds structured as a partnership may be treated as a corporation and may be subject to negative tax consequences if interests in the partnership are “traded on an established securities market” or are “readily tradable on a secondary market or the substantial equivalent thereof”, according to the letter of the law.
There are several safe harbours to this rule: if the fund has fewer than 100 partners, for example, or if the total of the stakes traded within the tax year is less than 2 percent. Likewise, if there is only one trade during the tax year – regardless of the size – or if trades are executed through qualified matching services, such as NASDAQ's, then PTP regulations are avoided.
So if a stake worth 3 percent of a fund changes hands, it's not an issue. If two trades worth 1.5 percent each happen in the same tax year, however, then PTP comes into play.
As the secondaries market has grown, PTP has become more important.
“These are fundamental issues for funds and people take these issues very seriously,” Matt Saronson, a Debevoise & Plimpton partner, tells us.
He adds he has seen conservative GPs withhold consent on a secondaries deal because the transaction would cause the fund to exceed the 2 percent limit. In those cases, trades have had to be delayed until the following year.
PTP issues may, therefore, cause a buyer and seller to pause a deal and consider the commercial implications, such as whether delayed cashflows to the buyer would make the transaction less attractive.
“You only need the issue in one fund for the seller and buyer to stop and think about the impact on the deal,” says Ted Craig, a partner at alternatives-focused law firm MJ Hudson. “If it's a prized fund in the deal that the buyer was after, a delay in the transfer could cause issues.”
PTP rules were originally designed to protect small retail investors investing in tax shelters in the 1980s. While sources we spoke to were not aware of any partnerships being treated as a PTP, the potential consequences are heavy as LPs in a fund may have to bear the higher tax burden.
“It would be the end of your firm,” said one New York-based advisory firm source who has worked on deals where PTP has been a potential issue. “It's certainly something you want to avoid.”
And it's not just US-domiciled funds that need to watch out – any entity that is treated as a partnership for US tax purposes, irrespective of where it is formed, is potentially subject to being treated as a PTP.
Ultimately, there are always ways around these issues, and structures can be put in place to give buyers economic exposure to a fund stake they are acquiring even if the legal documentation doesn't come into effect until the following year.
But PTP can cause unexpected speed bumps for buyers and sellers, and in an environment where speed on some deals is key, market participants will do well to ensure PTP doesn't slow transactions down.