An important characteristic of GP-led secondary processes is to give existing limited partners the ability to remain “status quo” by rolling their interests in an older fund into a continuation pool without any economic changes.
This so-called “status quo” option has gone a long way in helping get LPs comfortable with GP-led liquidity processes. The only change the status quo LP would see is an extension of the term. Continuation funds generally run for three-to-five years.
As LPs have gotten more comfortable, GP-led deals like fund restructurings have gone mainstream, with many blue-chips firms using secondaries to sort out older funds. GP-led deals were about 39 percent of an estimated $18 billion total deal volume in the first half, Evercore reported in its first-half volume report.
But a recent GP-led process, run by Summit Partners, did not include this LP-friendly option and still moved forward with great demand. The Summit deal, and some others in the market, seem to indicate a shift in how the market approaches these transactions.
It’s a sign, sources have told Buyouts in recent interviews, that some deals are either structured such that the status quo option makes no sense, or that the prices being offered are rich enough that status quo can be skipped.
The expectation is that status quo options will continue to be offered in some deals while others, like Summit’s process, will go without, sources said.
“This is a 2020 shift in the secondary market,” said a secondary market advisor. “It’s the result of extremely high quality trophy assets hitting the market … if these deals are getting done for assets the sponsors have done really well on, and if they’re getting to a realized 3x to 4x-type gain, LPs will be fine.”
Allowing LPs to remain status quo started to come into the market a few years ago, as GPs tried to get existing investors comfortable with restructuring processes that moved assets out of older funds and into continuation vehicles.
Giving existing LPs only two options – to sell their interest in a fund, potentially at a discount, or to roll with requirements to kick in new capital or at the very least agree to reset management fees and carried interest, could seem coercive, sources said.
Thus, GPs started to build in the ability for existing LPs to stand pat – to hold their same interests in the fund, on the same terms, as they moved into the continuation fund. The only change in this case was timing – while the original fund might have been at year eight or 10, the continuation pool clock was reset with a fixed deadline.
The option became so popular for LPs, the Institutional Limited Partners Association last year codified it in its best practices for fund restructurings.
“ILPA clearly defines best practice as including a ‘status quo’ option with respect to the choices being offered as part of the election,” ILPA said in a statement to Buyouts. “Specifically, this means that LPs should be given the choice to roll into a new vehicle with no changes in terms/economics, aside from the extension of the fund term itself.”
LPs who don’t participate in deciding whether to sell or roll, known as the election period, should be automatically treated as status quo, according to ILPA guidelines.
Summit’s secondary deal has some unusual characteristics that led the GP to not include the status quo option.
The deal, which is approaching final close and could total $1.5 billion or more, seeks to move around 23 assets out of multiple older funds into a continuation pool. Summit is offering existing LPs in the older funds the ability to sell at what’s being described as a good price, or roll their interests into the continuation pool.
Rolling LPs would have to commit to having an additional 10 percent capital call, meaning they would be committing new capital to the continuation vehicle, according to an LP source who has seen the deal.
Such an arrangement can be tough for some LPs, like public pensions, who would have to present the plan to their investment committees for authorization to commit more capital, the LP source said.
“Some groups clearly don’t want to deal with going back to their investment committees,” the source said.
Because Summit’s deal included multiple funds, offering a status quo option wasn’t on the table, a source with knowledge of the deal explained.
“The origins of the status quo is where you have one fund which is just continuing into the SPV, usually at the end of the fund life, and you’re creating a vehicle to continue it. In a situation like that, you want to give people the option to roll over and retain their exposure,” the source said.
Summit’s situation is different: “there is no one fund to one fund, this is many funds … this is like selling the fund in secondary buyout.”