VSS pursues secondary offering gaining popularity, scrutiny

  • VSS looks for staple as part of Structured Capital funds restructuring
  • SEC is scrutinizing stapled secondary deals
  • Seen as way to get liquidity for LPs, new capital for GPs

The process, known as a “stapled secondary,” involves VSS finding a new investor to buy out existing limited partners in its two mezzanine funds, called Structured Capital Funds I and II. The new investor would also provide a slug of capital for new investments, to seed a Structured Capital Fund III, according to a person with knowledge of the process.

The new capital for Fund III is known as a “staple.” Staples, and GP restructurings, have increasingly become a tool for GPs. Funds that live beyond their contractual lives can be considered for restructuring processes that take out existing LPs.

And those GPs having trouble raising new capital can consider staple transactions as ways to get new capital to make new investments.

At the same time, stapled secondaries have become the subject of scrutiny from the SEC, which believes these types of deals can be unfair to existing limited partners.

SEC takes a look

At a conference in May, Igor Rozenblit, co-head of the Private Funds Unit in the SEC’s Office of Compliance Inspections and Examinations, said stapled secondaries and restructurings can provide LPs with “two bad options.”

Rozenblit seemed to be talking about GP restructurings when he said LPs are left with the option of either selling their interest to a new investor – likely at a discount – or rolling their interest into the new vehicle created to house existing portfolio companies. LPs who choose to roll their interests usually have to accept that the same GP will continue managing out the portfolio, possibly with a reset stream of management fees and even carried interest.

Staples come with potential risk of conflict between the LPs and GPs, who have ultimate control over who they let into their funds. A GP may decide to present a new investor that is offering a staple of new capital but is low-balling on the price it will pay for LPs’ interests in the fund.

“If, as a manager, I say, ‘I’m not allowing transfer unless you give primary capital,’ then I’m sort of taking advantage of that contractual term with LPs,” said Simren Desai, vice president at intermediary Setter Capital. “If that results in a lower price on the secondary sale, then I can see how it could attract scrutiny.” 

Several secondary market professionals said these types of deals generally turn out well for both sides. They give existing investors a “liquidity option,” especially if the LP has been in a fund longer than desired.

Stapled secondaries are a “creative solution that helps everyone in the end,” said Sam Green, private equity investment officer with the Oregon State Treasury. ”As an LP … depending on your view of the manager, you can either double down and hold, or get liquidity.” 

Green added: “You do have situations where a manager has not been that successful, can’t raise another fund [and] this is a viable way to address the LPs that don’t want to be with the manager anymore.”

VSS deal

Evercore is running the VSS Structured Capital funds restructuring and staple, according to the person with knowledge of the deal. The status of the transaction is not clear.

VSS closed its first Structured Capital fund on $123 million in 2005 and Fund II on $312 million in 2009. The funds are fully deployed, though Fund II has some flexibility with recycled capital, the person said. Fund II generated a 24.27 percent internal rate of return and a 1.76x multiple as of Dec. 31, according to alternative assets data provider Bison, citing data from the Indiana Public Retirement System.

VSS has been trying to raise a Structured Capital III, according to SEC filings in May. Two filings for Structured Capital III show the fund has raised $19 million and $63 million; it’s not clear if those are separate filings or if the fund has raised a total of $63 million. It’s also not clear if those amounts are tied to the stapled secondary deal.