“In my beginning is my end.”
TS Eliot may not have been thinking about managing private capital when he wrote it, but the opening line from ‘East Coker’ (the second of his Four Quartets) is increasingly relevant to those in the business of private funds.
When raising a new fund, general partners need to recognise this and demonstrate their experience in dealing with their end-of-life funds.
The topic has come to the fore in recent years as the glut of capital raised between 2006 and 2008 reached its 10th birthday and the natural end of its fund life. Given that those 10 years were punctuated by the global financial crisis – and a dramatic slowdown in investment and realisation pace – many funds have been left holding more assets than they, or their original limited partnership agreements, have accounted for.
As a result, managers of these funds are exploring different ways to bring them either to a close or revamp them to allow the manager to keep working with the assets. These processes are cutting-edge and fraught with conflicts; disparate groups’ needs must be taken into account. They can get messy and while there is some precedent, it is clear that there is no established best practice on how they should be managed.
Even straightforward fund extensions are not necessarily that straightforward. “While the extension is covered explicitly in the LPA, the economic issues surrounding extending a fund’s life – management fees, for example – tend to be left to be negotiated at the time of the extension,” writes Julie Corelli, a fund formation lawyer at Pepper Hamilton. LPs may push for “no carry growth” in the extension period, notes Corelli. “Careful attention needs to be paid to what GP behaviors are incentivized during the extension period.”
At the more complicated end of the spectrum are so-called “GP-led restructuring” deals. Some of the most interesting examples are happening in Europe – see the largest such deal yet, sealed in March, involving Nordic Capital’s 2008 flagship fund. The fund still contained nine unlisted assets at the end of its 10-year term. Limited partners were given the option of rolling over their exposure to the assets into a five-year continuation vehicle or cashing out, with Coller Capital and Goldman Sachs Asset Management as buyers. Around 60 percent of the investors cashed out, equating to around €1.5 billion in net asset value.
The US tends to be where the private equity market evolves, so it is surprising that Europe is ahead of the curve in this regard. It is, in part, a legal issue; the Securities and Exchange Commission has been vocal about scrutinising GP-led restructurings and so-called stapled deals (where a GP arranges a secondaries transaction on an existing fund and boosts fundraising activity by “stapling” commitments to a new fund). Chief financial officers will be keenly aware that robust valuation methodology is core to managing any such transaction.
One in five GPs is expecting to restructure or recapitalise a fund this year, according to a delegate poll at our CFOs and COOs Forum in New York, and more than two-thirds will seek extensions.
“In succession/Houses rise and fall, crumble, are extended, destroyed, restored…”, the poem continues.
When these managers are considering their options, they should heed Eliot’s words, as he appears to have had a good sense of how private fund management would develop.