Secondaries market update: Defining the new normal - legislating for GP-led transactions at the start of a fund's lifecycle

There has been a growing focus on general partner-led secondary transactions in recent years with many forecasting the Covid-19 pandemic as a trigger for a significant increase in the volume of such transactions, as general partners (GPs) explore ways to provide liquidity to their limited partners (LPs) in a potentially challenging environment for exits.

Current sentiment suggests that a GP’s ability to exit an asset through the public markets is unlikely to be viable for some time. In addition, there are fears that a mismatch between sell side and buy side pricing expectations (stemming from different views and hopes on the speed of economic recovery) will make secondary buyouts and trade sales challenging to execute in respect of all but the best assets in the immediate future. Hence, the interest in GP-led transactions which can: (i) create opportunities for GPs to generate liquidity for LPs; (ii) allow a GP to retain control of assets which need more time to develop or recover as a result of the Covid-19 pandemic; and (iii) create new financing commitments for further capital to be made available to invest in portfolio companies.

Our view is that GP-led transactions will be a key part of the “new normal” and that the Covid-19 pandemic will accelerate the trend of GP-led transactions becoming an established portfolio management tool.

Since GPs want the flexibility to pursue GP-led transactions and LPs are increasingly accepting of such transactions, a logical evolution is for GP-led transactions to be catered for right from the start of a fund’s lifecycle with funds being raised on terms that explicitly envisage and facilitate their implementation by a GP. This kind of thinking had just recently started to appear in the market, but we might expect it to become an increasingly common feature of the fundraising process. It is interesting to note that in more tightly held, property development funds (which are in some senses closer to joint venture arrangements) there are well-worn paths to allow partner buyouts and trigger realisation processes at set points in the development fund’s life cycle. 

Clearly there are limits to the extent to which a GP can “bake-in” the ability to run a GP-led process in fund documents, as LPs will be wary of ceding too much power to the GP to run processes that have inherent conflicts of interest. Similarly, GPs do not necessarily want to tie their own hands about exit processes and realisations.

That said, there are a number of areas that GPs may focus on to smooth the path towards a GP-led restructuring.

The first (and least controversial) might simply be an express acknowledgement in the fund documents that a GP-led transaction is a potential outcome as an alternative to traditional exits so that expectations as between LPs and the GP are clear in that regard from the outset.

Clearly, any kind of GP-led transaction is going to generate advisory costs and expenses as agents and legal and financial advisers are deployed to market and implement the transaction. Therefore, another area of focus for GPs may be to expressly provide for those costs to be borne by the fund (and not the GP) to the extent that they are not borne by any specific groups of LPs (such as those participating in the GP-led transaction).

Given the wide range of forms that a GP-led transaction could take (ranging from LP tender offers to single asset continuation funds), it is difficult to cater at the outset in detail for all the potential permutations of a GP-led transaction. GPs may therefore look to obtain powers in the fund documents to amend those fund documents at the time of a GP-led transaction to facilitate the implementation of that specific GP-led transaction (for example, in relation to distributions in specie, or the restrictions on raising or managing another fund). Obviously, an unfettered discretion is unlikely to pass muster with LPs, so any such power would need to have parameters, such as no material adverse effect to LPs not participating in the GP-led transaction or the application of an appropriate LP approval threshold or LP Advisory Committee (LPAC) oversight.

In relation to approvals, GPs might also seek to create specific consent frameworks for GP-led transactions to clarify the powers and role of LPs and any LPAC in any such process. This could include legislating for any conflicts of interest at the LP level, particularly given the number of LPs who are active in the secondaries market and who may therefore be sitting both as an existing investor in the fund and also as a bidder in a competitive GP-led process looking to underwrite a continuation fund or a tender offer. Interestingly, although the ILPA guidance on secondary transactions urges GPs to give (and LPACs to adopt) more interventionist powers and responsibilities in relation to potential GP-led secondaries (as a way of controlling and mitigating conflicts and safeguarding LP interests more widely), we have not seen LPACs clamour for this type of oversight and directional control. What could be expected, following on from North American trends, is for LPACs in EU funds to start asking more firmly for the fund to cover legal costs and expenses incurred by separate counsel, who are appointed to advise the LPAC on its role during any particular GP-led secondary.

Timing is another area that GPs may look at. Given that a significant number of GP-led transactions are a response to a fund coming to the end of its life, GPs may wish to consider providing for an additional fund term extension right to enable the completion of a GP-led transaction.