The way a general partner deals with end-of-life funds has a bearing on how limited partners view their next fund. In other words: handle the tail end well and investors will give you high marks for fund management skills.
This has become increasingly relevant as the huge amount of capital raised in 2006, 2007 and 2008 has passed its 10-year life and extension periods. As the deal-making and value creation process was hampered by the global financial crisis, many of these funds are now left with more in the way of assets than they otherwise should be. What to do with them?
GPs have options. Given the vibrancy of the private equity secondaries market at the moment – in the third quarter of this year five secondaries funds raised more than $10 billion between them – there is no shortage of capital looking to acquire second-hand fund stakes or assets. GPs can facilitate a tender offer for LPs looking to sell stakes. They can move the assets from the old fund to a continuation vehicle, giving LPs the option to roll into the new fund. And if it is follow-on capital, rather than just time, that is the issue, then there are preferred equity providers happy to come up with solutions. And of course, they can just seek further fund extensions.
It is a dynamic and rapidly evolving area. This is why we dug into it in our 2018 pfm Fees and Expenses Benchmarking Survey. Sister publication pfm has conducted the survey every two years since 2014, and the 2018 version is the most comprehensive ever. It is a valuable benchmarking source looking at topics ranging from travel expenses to broken deal fees.
What we found on the subject of end-of-life funds was there is a worrying number of partnerships out there that are not well prepared if they outlive their stipulated fund extensions. Fifty-one percent of the CFOs who responded to the survey said they do not stipulate fee and expense arrangements in their LPA beyond the extension periods. It is, instead, negotiated at the time of extension. Is this smart? Not according to Tom Angell, partner at WithumSmith+Brown, one of the sponsors of the survey. “It is safe to say that a lack of vision early in the process could yield negative outcomes – from a failed transaction and significant expenses to angry investors and regulatory scrutiny – if fee and expense arrangements are left open for negotiation at the time of the extension,” he writes in our special report on the results.
It is a similar story for the emerging trend for fund restructuring – moving the assets to a new fund, with new terms. Only 16 percent of respondents said their LPA stipulates who pays for the costs relating to a potential fund restructuring. 53 percent said it is decided at and when the situation arises. This matters because these processes require significant external advice, as well as the costs related to setting up a new vehicle. LPs may be slightly less enamoured with the process if they find out late in the day that they are paying for it via their fund assets.
“In essence,” writes Angell, “the plan is no plan at all.”
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To see pfm’s coverage of the results, click on Fees & Expenses Survey 2018.