GP-led secondaries question 6 icon

The concept of a status quo option is misleading because a true status quo option would mean staying in the existing fund and retaining exposure to the asset without any change. “In reality that doesn’t work given the commercial drivers at play when a sponsor decides to pursue one of these deals,” says Debevoise & Plimpton partner John Rife. “Generally, the GP will need more time than they have in the existing fund, and they may often need more capital than is available to draw.

“What LPs typically mean when they refer to a status quo option, however, is that the economic terms remain the same as they would have if the asset had continued in the existing fund.”

Yet retaining the existing terms might not always make sense, depending on where the fund is in terms of carry. “If investors have not yet received their preferred return, LPs would be taking an economic hit if the economics are reset, and so the market is to give those LPs the ability to keep their economic deal through the continuation vehicle,” Rife explains. “It is less clear whether this is the preferable option if the fund is in the carried interest, meaning the sponsor will take 20 percent of whatever proceeds are achieved down the line. In that case, it is often better for existing LPs to re-set the economics and require the GP to generate a fresh preferred return so that the LP is participating in the same waterfall as the new money investors.”

In some instances, a true status quo option may not be possible. For example, where a sub-set of the remaining assets of a fund are sold, the portion rolled into the continuation vehicle is typically not cross-collateralised with the original fund or may be subject to dilution if the secondaries buyer provides new follow-on capital. “In these scenarios, the GP will then typically present an option to LPs allowing them to roll on as close to a status quo basis as can be achieved,” explains Valérie Handal, a managing director at HarbourVest.

“Most GP-led deals offer existing LPs the option to rollover the proceeds they receive from the transaction into the new continuation vehicle, thereby maintaining their exposure to the companies being sold and benefiting from the future value accretion of the assets,” Handal adds. “While the terms of the continuation fund may not be identical to the selling fund, the rolling LPs may benefit from more attractive economics in the new vehicle as the negotiated terms tend to involve lower management fees and a ratcheted carried interest structure linked to the performance of the assets.”

However, the transaction will have crystallised the assets’ value for carried interest calculations in the selling fund. In some instances, carried interest will be paid to the GP as a result of the sale, hence the rolling LPs do lose the cross-collateralisation of the assets in the selling fund. If the transaction involves additional capital for follow-on investments, the rolling LPs may have to accept dilution unless they increase their commitments pro-rata to the additional capital provided in the new vehicle.

“The key consideration from a GP’s perspective is ensuring that the transaction terms are not coercive so as to effectively offer no meaningful options for LPs”

Michael James
Cleary Gottlieb

Conversely, in other instances, the new buyers may seek a certain minimum size of exposure as a condition to their participation in the transaction, which may prevent rolling LPs reinvesting all of their proceeds.

Cleary Gottlieb partner Michael James, meanwhile, says that while offering a status quo option has historically been common and is also the preferred approach according to the Institutional Limited Partners Association’s guidance, the market has shifted away from this position slightly and a significant number of deals are now being done without offering a status quo option.

“The key consideration from a GP’s perspective is ensuring that the transaction terms are not coercive so as to effectively offer no meaningful options for LPs,” James adds. “In other words, the GP should not coerce the selling fund LPs into a transaction by offering the choice between an unattractive exit price and a roll option with materially less favourable terms.”