[ad_1]
October 30, 2023 – The first half of 2023 saw a drop-off in overall secondary transaction volume in private fund liquidity transactions with a specific drop-off in general partner led continuation vehicle secondary transactions (i.e., transactions initiated by fund managers or sponsors to acquire assets from existing funds using a new continuation vehicle and referred to herein as “GP-led deals”). However, an acceleration in deal volume in the secondary market is anticipated towards the back end of 2023 as public markets continue to recover and while the M&A market still remains somewhat ‘soft’.
Among the GP-led deals that have been completed year to date, clear trends in the legal technology being utilized by sponsors to structure and complete transactions have been observed. These new structures and features are seen as reflecting the continuously adapting nature of GP-led deals.
The aim of this article is to highlight five of the key legal trends that have been identified in GP-led deals.
Cash-out AIVs
Recently some sponsors have cashed out selling limited partners through an alternative investment vehicle, formed within the continuation fund complex, known as a “Cashout AIV.” The Cashout AIV is used to extinguish and ‘cash out’ the selling limited partners’ interest in the selling fund instead of paying cash directly out of the selling fund to selling limited partners. This may also involve cash being paid to selling limited partners over scheduled intervals, rather than all in one installment.
For those unfamiliar with this approach (including the payment outflows), the structure might appear straightforward. However, this subtle shift in deal structure may alter the rights in the transaction agreements causing certain recovery rights and other protective measures to be impaired. Moreover, certain safeguards in the selling fund limited partnership agreement, which often enhance the representation and warranty package negotiated in the transaction documents, might be impacted by this structure.
A careful examination of deal structures and transaction steps is recommended for lead buyers, sponsors, and advisors to ensure that these nuances don’t inadvertently dilute or alter the terms of agreed-upon transaction arrangements.
Additional governance rights
In GP-led deals, governance and removal rights typically associated with blind-pool commingled funds aren’t generally considered necessary. Instead these are replaced with targeted governance and removal protections needed for the specific needs of the new secondary or buyside capital.
There has been a noticeable push from the buy-side for greater transparency around the portfolio asset, particularly board observer seats and information rights. Although historically, continuation fund documents didn’t always embrace such provisions, the landscape seems to be evolving, with a noticeable emphasis on more transparency and alignment.
Investor advisory committee composition
Since the inception of GP-led deals, there has always been a push and pull between the interests of “rollover” investors and “new money” investors, and a primary point of negotiation centers on the structure and decision-making in the continuation fund’s investor advisory committee.
Sponsors typically have several competing objectives when setting the advisory committee, such as retaining rollover investors on advisory committees to maintain positive investor relations with existing investors; preventing any single investor from having disproportionate influence on the committee; and satisfying the demands of larger new money investors who seek majority advisory committee representation to reflect the more targeted concerns of the new money investor base.
Historically, an approach has been adopted where the influence of each advisory committee member is determined by the size of their financial commitment, rather than just the number of members. However, over time, more nuanced methods, like adjusting vote weights or introducing veto rights for specific decisions, have been devised to better harmonize the interests of both investor groups concerning the committee’s structure and decision-making.
RWI
Representation and warranty insurance policies in GP-led deals have been viewed as an important and cost-efficient tool to help bridge the gap between lead investors and sponsors, specifically with respect to the indemnity and recovery package in certain GP-led deals.
However, recently, sponsors have signaled to the market early in bid processes a preference for bids that don’t include the introduction of a representation and warranty package and allow for a true walk-away deal (i.e., a deal allowing the sponsor to wind up and liquidate the selling fund without having to hold back or reserve any proceeds for any potential future claims). This trend marks a notable shift from just a few years prior when intense competition in GP-led deals led sponsors to expect such policies to be put in place with buyers required to share in the associated costs.
ILPA’s guidance, true ‘status quo’ and side by side funds
The long-awaited guidance on secondary transactions was released by the Institutional Limited Partners Association (“ILPA”) in the middle of 2023. While many practices and principles, long recognized by seasoned secondary practitioners, were reaffirmed by the guidance, certain concerns for sponsors have been raised, particularly relating to investors keen on maintaining their exposure to the underlying assets involved in the GP-led deal, known as “Rollover Investors.”
Historically, only one ‘option’ was provided to Rollover Investors wishing to retain their exposure to underlying assets in GP-led deals. This option was realized by creating a separate class of LP interest in the continuation fund, ensuring the ‘status quo’ from the selling fund was maintained for these investors. Over time, it has been noticed that sponsors introduce new features in continuation funds, resulting in either an enhancement of rights or the imposition of additional obligations on Rollover Investors.
Consequently, there has been a perception that Rollover Investors are not being offered a true ‘status quo’ option, in particular without any additional funding obligations.
There has therefore been a recent trend of sponsors offering separate ‘side-by-side’ vehicles to offer Rolling Investors as close to their original fund terms as possible (allowing for some shift in duration and conflicts resolution). While perhaps an elegant solution, it does mean sponsors owe duties to two different clients — the ‘side-by-side’ vehicle and the new money continuation fund — and so advisors must remain vigilant to ensure transaction documents have ample safeguards against potential discrepancies and misalignments.
Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias. Westlaw Today is owned by Thomson Reuters and operates independently of Reuters News.
[ad_2]
Source link