The M&A Alternative
In today’s private equity market, we are increasingly seeing the popularization of a new type of “exit” for portfolio companies – single asset sales or end-of-life fund recapitalizations. As the industry matures, GPs and LPs alike are becoming more comfortable with this kind of transaction, which provides another alternative to GPs outside of the typical exit options. Given this interest, in this post we will be discussing when and how such situations arise, as well as why it is an attractive transaction for all parties involved.
Single asset sales or secondary recapitalizations are typically used for end-of-life sale processes. These are situations in which the fund is reaching the end of its fund life but still has a few portfolio companies remaining in the fund. There are a number of reasons why the companies may not have been sold, but essentially it can be broken down into three themes – the company may need more money to grow, the company may need more time to grow, or the company may be an outperformer (the “crown jewel”, so to speak), which makes the GP unwilling to sell the company until it hits peak performance. In these situations, it is not uncommon for a GP to pursue a secondary transaction instead of selling the company in suboptimal conditions.
In simple terms, a secondary recapitalization is a transaction in which the GP creates a new fund capitalized by a new set of LPs. This new fund then buys the portfolio of assets from the old fund (or a subset of the assets). There are a number of intricacies and competing interests to balance, most notably the conflict of interest on the part of the GP. Essentially, the conflict arises due to the fact that the GP is on both the selling side as well as the buying side of the transaction. This conflict of fiduciary duties to the existing and new LPs can create hairy situations for GPs, but they are usually mitigated by having a third-party valuation advisor find a “fair-market” value for the assets. Additionally, LPs that would like to continue their exposure to the underlying assets being recapitalized are usually presented with a rollover option into the new fund.
This transaction is attractive for end-of-life scenarios because it offers a win-win solution for all parties involved. Existing LPs who are “fatigued” from exposure to those assets get the liquidity that they need, while the GP gets the additional time or capital (or both) that it needs. Additionally, this type of transaction offers an advantage that other exit types don’t – specifically that the GP is allowed to remain in control of the assets. This can be comforting to LPs as it neutralizes any change of control risks and avoids the ramp-up period that a new GP would face. The GP is also able to draw a new set of management fees for the assets, which helps incentivize them to continue their time and attention spent on the assets.
One concern that GPs voice when considering such a transaction is the associated stigma. This has proven to be an outdated concern, however, as a number of large, blue-chip GPs have completed such transactions. Furthermore, given the rich pricing available in the secondaries market, GPs can often expect to get good terms (both in terms of pricing and economics) from the new fund. In 2017, middle market buyout funds had an average pricing of 92% of NAV while large cap buyout funds had an average pricing of 94% of NAV.
As the capital markets evolve, so too do your “paths to exit” on any individual or pool of assets. We are always happy to explore these opportunities with you. Have a great weekend!
Sixpoint Partners, LLC, is a registered broker/dealer, member FINRA (http://www.finra.org) and SIPC (http://www.sipc.org). Sixpoint Partners Asia Limited is licensed by the Securities and Futures Commission (http://www.sfc.hk).