A key theme is that as the SACF model has become mainstream, the types of transaction being done are becoming more akin to typical M&A processes. This requires a shift in mindset for all stakeholders: it cannot be assumed that a SACF transaction will run akin to a super-charged fundraise transaction and secondary buyers are not typical “passive” institutional LPs.
Given the number of stakeholders and that these transactions play out in real-time in front of the GP’s investors and the selling fund’s advisory committee, they are (perhaps) a bit more high-profile for a GP to execute than, say, an IPO or trade sale.
A crucial component of a successful SACF transaction is therefore how the GP and its intermediaries communicate and when they do so and the message given. It won’t always be one group of stakeholders either: depending on the structure of the selling fund and portfolio company, these groups may be disparate and include the advisory committee and/or wider LP base from the selling fund, the portfolio company’s management team, and possibly other interested groups such as co-investors and debt providers. GPs need to prepare appropriately and communicate early to avoid disappointment.
Given the sophistication of some secondary buyers in this space, GPs should not be surprised to find certain houses actively tracking their portfolios and stepping forward to politely ask whether a certain investment is suitable for a SACF transaction; and also asking at the same time to meet incumbent management teams. A number of secondary buyers operate with a corporate M&A mindset and the level of engagement and preparation required for executing a transaction with these secondary buyers should match that (both from the GP and the incumbent management team).
Just as GPs now view SACFs as an exit alternative, so too do incumbent management teams. Even where existing equity documents allow the transfer to a continuation fund as a “permitted transfer”, management teams are aware that the secondary buyers need them to be stable and content; there will commonly now be some form of liquidity to management when a SACF transaction closes, and secondary buyers will want to see some or all of this rolled over into the new investment (as detailed below).
This can present tax structuring issues in certain geographies for older investments, where the tax efficient exit for management was predicated on a proper third-party “exit”: careful pre-planning can help alleviate those issues but needs to be spotted and dealt with early in the process.
It is still remarkably rare for secondary buyers to insist upon or negotiate key person protections and the similar wide suite of governance protections that they might get in a typical blind pool primary. GPs still win the argument that as the SACF is holding one asset, and the secondary buyers have been able to diligence the asset and the GP, they can make up their minds about whether or not to back the deal.
Apart from suing the GP or bringing forward some form of “cause” removal in extreme circumstances, the secondary buyer does not have many levers to pull if it is dissatisfied with the SACF’s performance. It is relying almost entirely on the power of incentives, and the amount of money (re) committed to the asset by the GP (and the management team underneath).
The typical assumption was that secondary buyers would require a 100% net rollover for GPs, with underlying managers potentially not realising any proceeds. As the market has matured, and pressure amongst secondary buyers for top assets has intensified, there has been a bit more movement on this front. Some secondary buyers actively trumpet their willingness to allow GPs to take some carry off the table if the transaction takes the selling fund through the preferred return. At the portfolio company level, a number of management teams have rightly pointed out that in a sale to another PE house they would only seek to rollover 50% of their net equity whereas secondary buyers often expect them to roll in the region of 70% (or more). New arrangements with rolling management teams will force GPs to re-write the MIP (and secondary buyers will often actively take an interest in that process).
Another group testing assumptions are the GP’s co-investors. These groups, who often have fee free and/or carry free co-invest positions in portfolio companies going through a secondary process, have woken up to the fact that typically, their position is to be dragged out with the selling fund. The GP may extend an offer for them to “rollover” into the SACF alongside the secondary buyers, but their investment will now be on the same terms (and so definitely not carry/fee free). Co-investors, like incumbent management teams, are more willing to flex their muscles on this point when going into a co-investment and in some cases are winning the right to be consulted on any future SACF transaction involving their position, even if they can’t outright veto the transaction or guarantee to carry on with fee free/carry free investment. But it is another conversation that the GP has to clear out in advance of the main transaction.
With increasing opportunities and the scale and size of SACF transactions, comes inevitable and increasing risk. These transactions are fraught with inherent conflicts of interest for the GP, which the intermediaries, LPACs and advisors all try to quantify and mitigate. But parties are increasingly focusing on where their risks lie in the transaction. Selling LPs are the most obvious group who may feel aggrieved by a transaction that appears to undervalue their asset and gives the GP a lower base from which to earn a new carried interest with the new secondary investors. Transaction documents are more fulsome in their disclosures, and selling LPs and rolling LPs can expect to sign numerous waivers and acknowledgements and be firmly encouraged into the data room established for the transaction, so as to better enable the GP (and secondary buyers, who are aligned on the point) avoiding future recriminations. In those rare circumstances where a continuation fund has involved quasi-retail or actual retail investors in the selling pool and rolling pool, much greater care has had to be taken to ensure that all regulatory duties of disclosure and fair dealing have been complied with.
A standard process will often involve the manager setting up a VDR, inviting various secondary buyers into the VDR and asking them to offer their best terms for the continuation fund asset. As part of this, the secondary buyers will be expected to confirm what terms they expect to apply to the transaction documents between selling fund and continuation fund (for example, in terms of excluded obligations and step in rights for the secondary buyers), and what terms the continuation fund itself should have (for example, in relation to the waterfall and fund economics). In a typical M&A auction process, the seller will use competitive tension and the timetable to drive the best terms in this way.
But given the increase in the size of SACF transactions in general, GPs are now finding that it is rare to be able to execute on one of these deals with just one or two “lead” buyers. Whilst one buyer may be picked as the “lead” during the bidding stage to help drive terms, other firms will inevitably join the process to help build up the funding. GPs and their intermediaries need to manage this and set the rules of engagement early, to avoid co-ordination failure when trying to negotiate with three or more disparate buyers over the long-form documents. It is very typical to now insist that one law firm represents the lead buyer position and takes on board comments from the syndicate, so that the seller does not have to deal with multiple overlapping comments. But GPs also have to understand this dynamic: it is no good being overly brusque with a potential bidder at the term sheet stage and setting them to one side, as they may well be back in the tent when the detailed negotiations start (and they may still be hung up on their particular point which no other investor is excited about).
As SACF transactions more closely resemble M&A deals and there are multiple buyers, it is increasingly common for GPs (with help from underlying management teams) to prepare financial and legal vendor due diligence, both to assist the multiple buyers with their diligence (and streamline that process for the sell-side) but also to underpin the warranties and associated W&I insurance policy in the sale documentation that have become ever-presents on these transactions. If GPs don’t get on the front-foot with these diligence items, they face being inundated with DD requests from the buy-side, which risks extending what is often a compressed transaction timeline.
Given the complexities of communication, stakeholder engagement, multiple levels of negotiation and risk mitigation it may seem a no-brainer that the first thing a GP will do when contemplating a SACF is arrange a beauty parade of the various sell-side advisors and pick an experienced intermediary to organise the transaction. We are starting to see some larger GPs run processes themselves, without the use of an intermediary, both to prepare the asset for transfer and to identify (amongst their existing LP base or known contacts) likely buyers. This may not be suitable for every GP or every asset; and where a GP is nervous about valuations, it will typically want the assistance of an external intermediary; but it is a further sign of the maturity of the market for these SACF transactions.
