On the eve of the financial crisis, private equity sponsors were increasingly participating in club deals. Many mega-deals at that time necessitated equity checks in the billions of dollars, and the only way that most private equity sponsors could write those checks was to team up with other sponsors. The club deal was a hallmark of the era.
When the financial crisis hit and the deal market fizzled, sponsors no longer needed to join forces to write such large checks. With a dormant debt market, mega-funds gravitated towards the middle market and club deals waned. And in any event, there were other reasons for sponsors to be wary of club deals, notably the attention that they had received from plaintiff’s lawyers and regulators.
For years, club deals were all but dead. Recently, however, club deals have seen a resurgence, albeit in a new form. While there are recent examples of traditional private equity sponsors teaming up in club deals that are reminiscent of the pre-financial crisis days, club deals have been reborn with a twist. Instead of teaming together with other funds, many private equity sponsors are joining forces with non-sponsor financial investors. Often these deals will feature a sponsor and one or more of its limited partners, who are writing larger equity checks, and who are becoming increasingly comfortable taking on a more active investing role. In some cases, these investors will be passive and pooled together through a vehicle managed by the sponsor, but we are increasingly seeing sovereign wealth funds and family offices very much functioning as private equity funds, with control rights and a seat at the table.
And so while the new club deals are to be distinguished from the go-go clubbing of the mid-late aughts, there are some lessons to be learned from that bygone era.
- Interim Investor Arrangements. In our experience, interim investor agreements were very rote documents before the financial crisis, where decision-making was broadly delegated through majority rule. The current investing climate is potentially challenging, from a financing and regulatory perspective, and co-investors should be thoughtful in planning for the unforeseen during increasingly long executory periods. Sponsors should work with their advisors to ensure that they have considered the range of possible outcomes during the pre-closing period, and planned – and drafted their interim investors agreement – accordingly.
- Governance. Governance arrangements for a board with multiple investor representatives seems straight-forward enough. If there are an odd number of directors, deadlock should by definition not be a problem. Managing boards with representatives from multiple financial investors (sponsors or otherwise) can, however, be challenging. While in theory, majority rules, in practice, the board will want to form a consensus, and that can be time-consuming. Boards structured in this manner will all but inevitably lead to gridlock and interfacing with (and appeasing) them can be a distraction for management. Your lawyers may tell you that a governance structure is unambiguous, but consider how that governance structure will play out in the real world.
- Exits. Investors in the new club deals should be thoughtful about preferred exits amongst their co-investors and cognizant of potentially divergent interests, particularly with a non-sponsor investor who may have very different time horizons and objectives from traditional private equity funds. Also be cognizant of post-IPO arrangements: sponsors that jointly control a private company and are working in harmony can suddenly be at odds when they find themselves minority owners of a public company.
- Fees. As all sponsors are keenly aware, the SEC and other regulators are increasingly focused on deal fees and monitoring fees. In the pre-crisis era, sponsors generally took the same fees in a deal regardless of common practice (e.g., a sponsor that may not have taken fees would be virtually forced to do so in a deal where another sponsor took such fees). Given the current climate, sponsors should ensure that they are on the same page regarding these fees and complying with whatever their best practices are in this regard.
In the deal world, as with everything, history does repeat itself, and it is up to financial investors and their advisors to ensure that we do learn from it. Fortunately, with some thoughtful planning, clubbing can be a very pleasant experience for sponsors (and their advisors).