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Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
Secondary Market Presentation
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Secondary Market Presentation

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Presentation on Secondary Market Sales of LP Interests and Portfolio Companies

Presentation on Secondary Market Sales of LP Interests and Portfolio Companies

Published in: Economy & Finance, Business
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  • 1. THE SECONDARY MARKET - THE NEXT DEAL FRONTIER C. Craig Lilly 600 Hansen Way Palo Alto, California 94304-1043 650.843.3232
  • 2. WHAT IS THE PE SECONDARY MARKET? Primary transaction: investors in PE funds acquire their LP interests directly from a fund Secondary transaction: an existing investor in a fund seeks to sell the LP interest to a buyer. This creates a secondary market for that interest.
  • 3. Capital Raised (1995 through 2008) Capital Raised by Secondary Fund Specialists
  • 4. Ten Largest Secondary Funds Ten Largest Secondary Funds as of April 2009
  • 5. SECONDARY MARKET IS GROWING RAPIDLY • Many institutions are rebalancing their private equity (“PE”) investments to rebalance portfolio or reduce their unfunded liabilities, or seeking cash to finance operations. • “Denominator effect”: this is an asset-allocation problem that is forcing the selloff of billions in PE and alternative investments. As the public markets and the prices of liquid assets have plummeted, the value of the overall portfolio, or the denominator, has shrunk. Thus, some institutions have an over-allocation in certain types of investments and must sell those investments. • Rising numbers of LPs in default of capital calls seeking negotiated sale or exit. • Because the sale of LP interests provide liquidity to sellers, they are being discounted - some buyers are bidding as little as 40 to 50 cents on the dollar.
  • 6. 2009 SECONDARY MARKET STATISTICS • Estimated $45 billion in secondary interests expected to be offered for sale in 2009/ next 12 months • Estimated 22 secondary funds to raise $32 billion in next 12 months • Third most popular investment sector (source: Probitas Partners 2009 Institutional Investors Survey)
  • 7. HISTORY / MILESTONES • The Venture Capital Fund of America (founded by Dayton Carr in 1982) was likely the first investment firm to begin purchasing PE interests • CalPERS agrees to the sale of $2.1 billion portfolio of legacy PE funds to Oak Hill Investment Management, Conversus Capital, Lexington Partners, HarbourVest, Coller Capital and Pantheon Ventures (2007)
  • 8. HISTORY / MILESTONES (Continued) • ABN AMRO sells a portfolio of PE interests in 32 European companies managed by AAC Capital Partners to a consortium comprising Goldman Sachs, AlpInvest Partners and CPP for $1.5 billion (2008) • Goldman Sachs Group Inc. closes new $5.5 billion fund to buy PE investments on the secondary market (GS Vintage Fund V) - this is the largest secondary fund ever raised (2009)
  • 9. TWO GENERAL STRUCTURES 1. Sale of Limited Partnership Interests: The most common secondary transaction, this category includes the sale of an investor's interest in a PE fund or portfolio of interests in various funds through the transfer of the investor's limited partnership interest in the fund(s) 2. Sale of Direct Interests: This type of sale refers to the sale of portfolios of direct investments in operating companies, rather than limited partnership interests in investment funds
  • 10. STRUCTURE CHART - SALE OF LIMITED PARTNERSHIP INTERESTS
  • 11. LEGAL ISSUES: LONG TERM COMMITMENT • PE investments are illiquid - federal securities laws and the fund's governing agreements impose significant transfer restrictions • The life of a fund is generally 10 years plus - investors do not have redemption, withdrawal, or transfer rights • Investors have long term capital commitment obligations, and there are significant penalties for default • Secondary buyers, with the fund’s consent, offer liquidity for investors looking to sell an individual interest in a fund, or a portfolio of fund interests
  • 12. PURCHASE BY SECONDARY BUYER • Buyer assumes the obligations/ capital commitment of the seller under the fund's governing document • Buyer provides representations and warranties to the fund similar to those that would be included in a subscription agreement for a primary purchase of an interest • Buyer may seek to obtain the benefits of any side letter or right to appoint an advisory committee member • The purchase price paid for a LP interest is typically based on the fund's net asset value (e.g., price could be at a discount, premium or par to NAV)
  • 13. KEY NEGOTIATING POINTS 1. Purchase price 2. Purchase and sale agreement 3. Transfer documentation - includes fund manager; cooperation of fund manager/ GP is critical
  • 14. PURCHASE PRICE • The purchase price is based on the value of the interests being sold as of a set date - the cut-off date • The cut-off date is tied to the date of the most recent NAV calculations and the purchase price is driven by the NAV - currently at discounts to NAV of 40% - 50% (note: FAS 157 implications) • At the closing, the purchase price has a dollar-for-dollar adjustment for capital contributions made by the seller (increase in purchase price) and distributions received by the seller (decrease in purchase price) since the cutoff date. • Buyers prefer to receive a distributions shortly after closing (vs. price reduction) - allows increase in IRR computations
  • 15. PURCHASE AND SALE AGREEMENT: KEY POINTS LP CLAWBACK • Seller indemnifies a buyer for any obligation (or a “clawback”) to return distributions that were made prior to the cutoff date • Mechanism to calculate liability for clawbacks not attributable to a particular distribution • Liability will be shared pro rata based on the amount of distributions each of the buyer and seller received
  • 16. THRESHOLD FUNDS • Portfolio sales - funds that the buyer will require to be transferred to it before the buyer will be required to close on any other funds in the portfolio • As sellers become more distressed, they may structure transactions so that when a buyer buys a fund managed by a top-tier manager, the buyer also must purchase a less-desirable fund
  • 17. STAPLED TRANSACTIONS / “STAPLED SECONDARIES” • A “stapled” transaction means a secondary buyer purchases an interest in an existing fund from a current investor and makes a new commitment to the new fund being raised by the GP. These transactions are often initiated by PE firms during the fundraising process (according to a recent market study, 74% of GPs/ sponsors are interested in a stapled transaction). • The decision makers for a secondary purchase versus primary purchase are frequently different • Buyers will have more leverage to avoid this in 2009 - managers will want to accommodate transfers to reputable buyers, especially if there is a risk of default by the seller
  • 18. MATERIAL ADVERSE CHANGE (“MAC”) CLAUSES • A closing condition that no material adverse change has occurred between signing and closing • MAC clause appear to have broadened and are heavily negotiated • The buyer's ability to walk away from a recent, major transaction due to an alleged MAC provides another example of the increased negotiating power of buyers in 2009 • No case law to report or interpret
  • 19. TRANSFER PROCESS WITH FUND MANAGER • The buyer needs to consider issues associated with its investment in the underlying fund - the fund needs to determine if admission of the buyer will trigger regulatory or other issues (e.g., ERISA, etc.) • Generally requires Fund’s consent - may involve waiver of ROFR, legal opinions, certifications, timing restrictions, representations, etc. – review governing documents • Cherry - picking is difficult: generally, entire LP/ company portfolio is sold
  • 20. TRANSFER PROCESS WITH FUND MANAGER (Continued) • Some funds only process transfers at end of quarters • Tax, ’40 Act, HSR and other considerations • Assignment of any side letters rights or new side letter
  • 21. TRANSFER ISSUES THAT REQUIRE FUND’S COMPLIANCE – Investment Company Act of 1940 – Unrelated business taxable income and effectively connected income – ERISA - fund qualification as a venture capital operating company or real estate operating company – Anti-money laundering regulations / OFAC compliance – Indemnities – Reserves for capital commitment and back - stop by seller – Payment of expenses and legal fees
  • 22. OTHER TYPES OF DIRECT PORTFOLIO SALES • Secondary Direct – The sale of a captive portfolio of direct investments to a secondary buyer that will either manage the investments themselves or arrange for a new manager for the investments • Synthetic Secondary / Spinout - Under a synthetic secondary transaction, secondary investors acquire an interest in a new limited partnership that is formed specifically to hold a portfolio of direct investments • Tail-End – This category typically refers to the sale of the remaining assets in a PE fund that is approaching, or has exceeded, its anticipated life. A tail-end transaction allows the manager of the fund to achieve liquidity for the fund's investors.
  • 23. CONCLUSION • LP interests are selling at significant discounts due to defaults or portfolio re-allocations • Buyers have one of the best opportunities in the history of this asset class to purchase at attractive prices • Currently, many potential sales are failing as sellers are unwilling to accept steep discounts - sellers’ expectations will moderate and the number of executed transactions will increase in the second half of 2009 as the pricing gap narrows • Shared appreciation structures may be useful for sellers experiencing “sticker shock”
  • 24. C. Craig Lilly 600 Hansen Way Palo Alto, California 94304-1043 650.843.3232 This presentation is intended only as a general discussion and should not be regarded as legal advice. For more information, please contact Craig Lilly at 650.843.3232.

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