In April 2019, the Institutional Limited Partners Association (“ILPA”) released a set of considerations for Limited Partners and General Partners with respect to General Partner-led secondary fund restructurings (the “ILPA Memo”). The ILPA Memo can be viewed here.
The ILPA Memo provides useful guidance for all parties on the key elements of General Partner-led secondary transactions. ILPA’s release on this topic signals that the community of institutional investors accepts that these transactions, having become prevalent in the marketplace (while varying in form and scope), are better addressed by implementing best practices than expecting them to disappear. Implicit in ILPA’s release is an acknowledgement that such transactions have the potential to benefit all parties involved, assuming Limited Partners have reasonable post-transaction options, are involved in a fair process, and are provided fulsome transparency. Below is a summary of the ILPA recommendations and some reflections on how these may impact current practices in respect of General Partner-led fund restructurings.
Limited Partner Engagement and the Role of the Limited Partners Advisory Committee (“LPAC”)
ILPA recommends that the General Partner should engage the LPAC as early as possible in the process. In particular, ILPA recommends that the LPAC be presented with a clear rationale for the fund restructuring, as well as an opportunity to give input as to the process and review all conflicts of interest (and in particular, any conflict relating to benefits accruing solely to the General Partner or its affiliates).
In practice, it is typical for General Partners to engage with the LPAC and large Limited Partners to “test” the premise and proposed terms of a fund restructuring early on in order to gain comfort that the fund restructuring is likely to gain the necessary approvals prior to expending significant time or expense. ILPA’s recommendations are unlikely to change the timing of the LPAC’s engagement by the General Partner or the key issues it considers in a meaningful way, but they may lead to a more formalized list of topics on which the LPAC provides input.
ILPA recommends that the LPAC, and ultimately the Limited Partners, should be provided with sufficient information and disclosure to make informed decisions with respect to any consents being sought and elections being made in connection with a General Partner-led secondary. Specifically, ILPA recommends that General Partners endeavor to provide the LPAC and Limited Partners with the same diligence information that was provided to the acquirer, including data room access for diligence materials and access to the General Partner, transaction advisor and portfolio company management. In addition, ILPA recommends providing materials that would allow the LPAC to determine whether the process for pricing the deal was fair (potentially including a fairness opinion), as well as any conflicts that may have affected the transaction price. Finally, ILPA recommends that Limited Partners be provided disclosure on any fund terms that will be different post-transaction for both Limited Partners who “roll” as well as acquirers.
ILPA’s recommendations on disclosures are consistent with existing best practices for General Partner-led secondary transactions. However, they provide a helpful roadmap to ensure that the information and conflicts disclosure most meaningful to Limited Partners will be addressed appropriately in any such transaction.
ILPA emphasizes that Limited Partners should be afforded sufficient time to review the proposed transaction and make any elections. The process should comply with any applicable provisions of a fund’s Limited Partnership Agreement, and any amendments should comply with existing voting thresholds required by such Limited Partnership Agreement.
In practice, a well-run General Partner-led fund restructuring should have reasonable timelines and should always include a deep dive into the Limited Partnership Agreement by counsel to determine what consents are required and what amendments will need to be approved.
ILPA, consistent with its acknowledgement that General Partner-led fund restructurings tend to be unique and varied, makes limited suggestions as to specific terms related to the transaction.
ILPA suggests that expenses should be allocated to those parties that benefit from the transaction, and specifically, that the General Partner should bear a portion of the expenses where the General Partner will benefit disproportionately from the transaction (e.g., where there is a staple). ILPA makes some specific expense allocation suggestions, including that expenses for acquirers and rollover Limited Partners be capped and subject to monitoring for reasonableness. While ILPA’s suggestions are thoughtful, they do not necessarily take into account that: (a) the allocation of expenses is often the subject of negotiation with the acquirer, and the General Partner may not be in full control of how expenses are allocated; (b) General Partner-led secondaries are often complex and expenses can be meaningful; and (c) where a General Partner-led secondary is being undertaken in a distressed situation, the General Partner may have limited resources to take on a meaningful portion of the expense burden itself. In practice, General Partners most importantly should continue to have fulsome and detailed disclosure as to how they intend to allocate expenses, and they should disclose such information prior to obtaining consents or seeking elections.
In addition, ILPA recommends that Limited Partners should have a “status quo” option, whereby they can participate in the new structure with no change in economic terms and with no obligation to participate in follow-on investments. In addition, ILPA suggests that Limited Partners that fail to respond or make an election should default to this “status quo” option. These suggestions are consistent with existing best practices, including the principle that such transactions should not be coercive to Limited Partners. However, it is worth noting that even when electing the “status quo” option, Limited Partners must often sign on to certain less material changes to a fund’s terms, such as a longer fund duration and additional or modified Limited Partner remedies. With respect to follow-on capital, ILPA acknowledges the reality that existing Limited Partners who choose a “status quo” option may be diluted post-transaction, but suggests that certain protections be built into the valuation of follow-on capital to ensure any such dilution is fair and appropriate.
Advisors to the Transaction
ILPA recommends that an experienced advisor should be engaged to solicit bids for a transaction, and that the engagement letter provide that the advisor represent the interests of the fund, and not just the General Partner, in the proposed transaction.
In addition, the LPAC should receive fulsome disclosure as to the terms of the engagement and access to the advisor, as well as the right to hire its own legal advisor (generally as a fund expense). In practice, while individual Limited Partners often hire their own advisors, many General Partner-led fund restructurings have proceeded without the LPAC hiring its own advisor at the fund’s expense. Whether ILPA’s recommendation will become more common over time is likely to be a balancing act between institutional investors desire to vet a proposed transaction fairly and fully, and Limited Partners’ general desire to manage costs, which already tend to be meaningful in General Partner-led fund restructurings.
- Fund sponsors should be prepared to provide substantial transparency at all stages of a proposed General Partner-led secondary transaction and should expect substantial (and perhaps increased) involvement and input from LPACs and Limited Partners (and potentially more direct engagement from advisors to LPACs and Limited Partners).
- The ILPA Memo is intended to encourage the formalization of the process for General Partner-led fund restructurings. While the ILPA Memo does not generally introduce concepts that a sponsor considering (or counsel advising on) such a transaction should not have been mindful of prior to its release, it is helpful in creating a roadmap of key issues that all parties should bear in mind.
- While the ILPA Memo is incredibly useful in framing key issues, each General Partner-led secondary transaction is unique, and therefore the specific process, terms, disclosures and considerations should be considered in light of the underlying facts and circumstances applicable to such transaction. Counsel and General Partners should continue to think about how the nuances specific to their transactions may raise novel or different issues than those set forth in the ILPA Memo.