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Aon Retirement and Investment Blog

Private Equity Fund Restructurings: A Complex Type of Secondary Transaction

When investors think about secondaries, they typically think of the most common transaction type – the purchase of illiquid limited partnership interests from a limited partner who made the original commitment. The secondaries market has evolved significantly over the years with increased sophistication. Although the selling and buying of limited partner interests still accounts for the majority of the secondary market, other types of secondary transactions can potentially generate higher returns but have significantly more complexity. These other types include general partner fund restructuring, which occurs when a secondaries fund manager or other limited partner acquires a portfolio of underlying companies from an older vintage private equity fund (usually toward the end of fund life in years 8+) and places them in a newly created and capitalized limited partnership.
Typically, the existing general partner manages the newly created limited partnership, aiming to create value and exit the underlying portfolio companies. The new limited partnership structure allows the general partner to reset management fees, carried interest, and governance terms. A restructuring typically includes an injection of capital into the new partnership. Limited partners in the original partnership have the option to sell their stake in the existing limited partnership interest to the secondaries fund or roll over their interest into the newly formed limited partnership.
Fund restructurings are growing as a secondary transaction type. Currently, many fund restructuring candidates are 2006-2008 vintage private equity funds approaching the expiration of their terms. Limited partners in these funds may be fatigued and seeking liquidity solutions. At the same time, 2006-2008 vintage funds could have exposure to underlying investments that may generate strong returns if given more time and additional capital, such as in a fund restructuring transaction. These transactions may generate strong returns for secondaries funds, which are often able to purchase both the underlying portfolio companies and some of the existing limited partnership stakes at a discount to net asset value.
The chart below shows the dramatic growth of fund restructuring transactions in recent years:

These transactions, however, can be challenging to close and are likely to have conflicts of interest. In order for the secondaries firm to close the transaction, both the secondaries firm and the general partner must agree on the transaction terms.
In many cases, existing limited partners, who no longer support the general partner, are comfortable with the transaction and choose to sell their limited partnership stake to the secondaries fund. In other cases, they can be contentious. Limited partners may be presented with two unattractive options – sell their limited partnership interest at a discount or roll over their stake into a newly formed partnership with new money diluting their original interest.
Investors who have exposure to a fund that is a candidate for restructuring should weigh their options carefully during these transactions. An investor may choose to sell its interest at a discount if it no longer supports the general partner. Alternatively, an investor may choose to roll over its interest into the new partnership if it believes that the portfolio companies associated with the restructuring have significant upside and that the general partner can successfully create value and exit the investments. The investor, however, must weigh this choice with the potential for dilution and the risk that the previously unsuccessful general partner may not drive portfolio growth and an eventual exit for the portfolio companies. In addition, in some restructuring transactions, limited partners who choose to roll over their interest into the new partnership may be required to contribute additional capital to the new vehicle. An investor who chooses to roll over its interest must recognize that it could potentially be contributing additional capital to a general partner that has not met expectations and could fail to create value in the future.
The secondaries fund closing the transaction must be highly skilled in negotiating with all parties. In addition, a marked information disparity impacts pricing. The general partner has a significant portfolio company information advantage over limited partners in valuing the portfolio and therefore the transaction. In addition, limited partners of the existing partnership must pay for any intermediary fees associated with the transaction, raising key fiduciary concerns in light of the general partner’s duty to the limited partners.
Attractive fund restructuring opportunities can also be hard to source and carry risks for new secondary investors. In many instances, general partners who continue to manage these aged funds have underperformed, which could cause the general partner to discontinue raising funds and a significant amount of investment professionals to depart the firm. These changes call into question the firm’s ability to manage the remaining portfolio companies going forward. In other cases, the general partner may have been generally successful, but has one fund that has been impacted by factors outside its control, a notable example being the 2008 global financial crisis. There could be some remaining underlying portfolio companies in these damaged funds that could generate strong returns with an additional injection of capital and more time to exit. These transactions can be hard to close since the general partner has a significant amount of leverage in negotiating transaction terms.
Investors can benefit from fund restructurings by investing in a secondaries fund that can execute on these transactions. Currently, traditional secondary transaction pricing is high, making fund restructurings an attractive way for investors to gain access to secondaries through these hybrid transactions. Out of the large universe of secondaries funds including both broad-based and niche firms, we believe only a small group of fund managers has the skill set needed to participate in fund restructurings. Managers have different approaches to completing these transactions, which need to be carefully evaluated before committing capital. Most secondaries funds that complete fund restructurings will fund the transaction and rely on the general partner both to grow and manage the assets. Some secondaries funds will rely on the general partner to manage and exit the assets, yet closely monitor portfolio company fund progress and be prepared to manage the assets directly should the general partner not perform. Investors interested in gaining exposure to secondary fund restructurings should weigh their options carefully before investing in a strategy focusing on these complex transactions.
Amy Hauke is a Senior Consultant in Aon Hewitt’s Private Equity research team working out of the Chicago office.

The information contained above should be regarded as general information only. That is, your personal objectives, needs or financial situation were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of acting on this information, particularly in the context of your own objectives, financial situation and needs.Nothing in this document should be treated as an authoritative statement of the law on any particular issue or specific case, nor should it be treated as investment advice. Use of, or reliance upon any information in this post is at your sole discretion. It should not be construed as legal or investment advice. Please consult with your independent professional for any such advice. The blog content is intended for professional investors only.

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