The Institutional Limited Partners Associations (ILPA) recently published its much-anticipated guidance paper, ‘GP-led Secondary Fund Restructurings: Considerations for Limited and General Partners’. In this report, ILPA recommends a number of general parameters for GP-led secondary transactions, while at the same time noting that given the unique nature of these transactions, they may not be universally appropriate. This article explores how existing fund documentation may require deviations from some of these recommendations and how future limited partnership agreements (LPAs) can work to better accommodate ILPA’s proposals.
As lawyers acting for GPs considering secondary transactions, we frequently evaluate LPAs drafted over ten years ago, prior to when any market for GP-led secondaries existed. These historic LPAs often contain no specific provisions with respect to these transactions and commonly include language that may be unhelpful when structuring these deals.
For example, GP-led transactions frequently provide LPs with the option to receive either cash from the sale of the fund’s remaining assets, or an in-kind distribution of interests in a continuation vehicle formed to continue to hold those assets. However, many historic LPAs do not permit such a distribution of non-marketable securities nor the non-pro-rata distribution of fund assets among LPs. Similarly, many historic LPAs require the allocation of all expenses to investors in proportion to their participation in the relevant assets, which would prohibit the specific allocation of certain transaction expenses (i.e. the financial advisor’s success fee) to certain investors (i.e. sellers). ILPA guidance states that LPs electing not to participate should not be allocated relevant costs, though it goes on to state that non-response should be treated as an election to participate in the continuation vehicle.
Whenever an LPA amendment is required, care should be taken to navigate historic LPA amendment provisions, which could require unanimous consent of LPs in certain circumstances.
In addition, the ILPA guidelines refer to conflicted members of the limited partner advisory committee (LPAC) recusing themselves from decision making in connection with a GP-led secondary transaction. However, many historic LPAs do not contemplate recusals, and in fact treat abstentions as “no” votes.
The limitations of these LPAs in a GP-led secondary broadly fall into two categories:
- The LPA is silent and does not address the point at hand
- The LPA provisions are restrictive of the process and structure of the transaction.
In both scenarios, the challenge now facing GPs launching new funds is to strike a balance between (i) ensuring the parties have appropriate flexibility within the LPA at the outset to accommodate a GP-led secondary, and (ii) ensuring the LPs (whether ultimately sellers or rollers) have comfort that they will receive fair treatment in a potential secondary transaction – the details of which will not be known at the time of the LPA’s drafting.
GPs must consider how to revise the LPA to address a few key questions, including:
- Timing and content of disclosures to potentially conflicted limited partners
- Should the GP have flexibility to allocate expenses, and make in-kind and cash distributions to only some LPs?
- Do the broader LP voting mechanics ensure that a transaction can run efficiently without derailing the timetable?
- Can non-marketable interests be distributed to LPs in connection with such a transaction?
- What happens to existing side letter provisions for investors rolling their interests to a new vehicle?
- As a last resort, is the amendment provision to the LPA overly prohibitive if the final transaction is not as contemplated when the LPA was agreed?
Above all, given the LPAC’s significant involvement from the outset of the transaction – paired with the general assumption that all such transactions will represent a conflict of interest and require consultation with the LPAC – it is critical to ensure the LPAC governance provisions are sufficiently robust to address a GP-led secondary. Though these provisions have evolved significantly in recent years (including addressing problems caused by LPAC members abstaining from votes or being conflicted themselves, as well as the potential engagement of outside counsel by the LPAC), there is still scope for improving the operation of these provisions in the context of such a transaction.
Planning for a future potential GP-led secondary at the time of fundraising is also not restricted to the main LPA, and GPs should consider whether revisions to internal arrangements are appropriate; particularly regarding carried interest holders who may no longer be with the GP at the time of the relevant secondary transaction.
Although a GP-led secondary may be some years away at the time of fundraising, it remains the best time to consider addressing these issues.
Theodore Cardos is an investment funds partner in the London office of Kirkland & Ellis LLP. Ted’s practice primarily involves structuring, negotiating and documenting complex business transactions in the private funds secondary market, including traditional portfolio sales, structured secondaries, synthetic secondaries (i.e. bundled secondary directs), stapled secondary offerings and fund recapitalisations. Ted also advises private funds in connection with direct co-investments and other transactional matters. Ted was recognised as a ‘Next Generation Lawyer’ in the Legal 500 UK in both 2017 and 2019, and was recently named in Private Equity International’s ‘Future 40’ list of the next leaders of private equity.
Andrew Shore is an investment funds partner in the London office of Kirkland & Ellis LLP. Andy primarily advises private investment fund sponsors in relation to the structuring and establishment of private investment funds investing across all major alternative investment strategies, in addition to the carried interest and co-investment plans associated with such funds. Andy also advises on a broad range of other transactions relating to private investment funds, including secondary transactions, fund restructurings, co-investment arrangements, management team spin-outs and management company transactions.