The parties that bear the costs the costs can vary according to the structure of the deal
The ultimate cost of a GP-led secondaries process largely depends on the transaction's size and complexity. "Principal costs include those associated with third-party advisers and legal due diligence, and structuring, and are contingent on the transaction's successful closing," says Christiaan van der Kam, head of secondaries at Schroders Capital.
Sophie Smith, a counsel at Cleary Gottlieb, adds that the financial adviser costs will typically be split into a transaction fee, which will either be a flat fee or a percentage of the transaction value, and a placement agent fee.
"How the fees are borne is often deal-dependent, but with respect to the transaction fee, this is generally borne either by the selling fund as a whole or by the LPs who elect to cash out as part of sell-side expenses. Such costs will not typically be borne by the continuation vehicle."
The question of whether these costs are borne by all LPs in the selling fund or just those cashing out will depend on the flexibility to charge fees on a non-pro-rata basis, as prescribed in the LPA, explains Debevoise & Plimpton partner John Rife. "It also depends on the motivation behind the deal. If the transaction is being driven by LPs requiring liquidity, it makes sense that the costs are borne by those LPs. But if the transaction is being driven by sponsor or whole fund considerations, the situation may be different."
The placement fee, meanwhile, is usually borne by the continuation vehicle and in that case, there will likely be a dollar-for-dollar offset against the management fee payable by the continuation vehicle LPs or by the portfolio. "In addition, the establishment costs of the continuation vehicle will typically be borne by the continuation vehicle itself, often subject to a cap, whereas the cost of negotiating the transaction documents will often be split equally between the liquidating LPs and the continuation vehicle," Smith explains.
"Allocation of expenses between the selling fund and the continuation vehicle is a heavily-negotiated point between sponsors and lead investors and is ripe for scrutiny by regulators, particularly in light of the recent SEC [US Securities and Exchange Commission] proposals," Smith adds.
Of course, not all GP-led deals are structured in the same way, which can have a significant impact on the overall cost. "There is a huge difference between the cost of selling a strip portfolio to a new vehicle and a tender offer where all that is happening is that a secondary buyer is acquiring an LP's stake in a fund," says Rife.
"Continuation vehicles can also be structured in very different ways," Rife adds. "You can have an all-cash transaction where the rollover option isn't really a rollover- it's a reinvestment option, although there doesn't have to be actual cash movement. But you also see more structured approaches where one of the objectives is to avoid a taxable event for the LP. In that scenario, it is more complicated. There is a contribution in kind and then a distribution in kind, together with a subscription and redemption process. That is obviously a more expensive option."
Do GPs need to hire a third party to obtain a valuation and fairness opinion in a GP-led?
Proposed reforms in the US aim to make an independent fairness opinion a requirement in GP-led deals.
In addition to setting a price through either a competitive auction process or the sale of a minority stake, it is increasingly becoming standard to engage third parties to conduct an independent valuation or fairness opinion.
"In many transactions, the broad array of bids received for the assets from potential secondary buyers provides sufficient assurance that a market price has been achieved," says HarbourVest managing director Valerie Handal. "In some more complex [deals], a valuation report and fairness opinion from a third-party provider may be useful for LPs."
Rob Campbell, head of North America for ICG Strategic Equity, adds that the decision tends to be made on a case-by-case basis and that selling LPs typically do well out of these deals. "As single-asset transactions are frequently centred around a GP's high-performing assets, selling LPs typically crystallise a highly attractive return, often in excess of three times."
Ultimately, the decision as to whether to engage an external adviser, often a bank, to conduct an independent valuation and fairness opinion currently lies with the limited partner advisory committee.
"The LPAC has to approve these transactions so it will depend on whether an independent valuation and fairness opinion is deemed necessary, or if the LPAC considers a competitive bidding process to be a better indication of true value," says Cari Lodge, a managing director and head of secondaries at CF Private Equity.
Help or hindrance
However, regulatory rumblings in the US suggest this may not always be the case, and opinion is divided as to whether this would be a good thing. "In the US, the SEC is making it a requirement that a fairness opinion is sought, but I would say that LPs and GPs typically do not materially value them, because while they provide verification, they are not really seen as adding all that much. The process of price discovery is seen as more important," says Immanuel Rubin, a partner and head of European secondaries at Campbell Lutyens.
Joseph Marks, a senior managing director and head of secondaries at Capital Dynamics, believes the proposed SEC rules would be a positive development. "I think it gives protection to the manager as much as the buyer, and we are starting to see fairness opinions included as part of most of the deals we see today," he says. "That brings additional transparency to the process and supports LPs in making their decisions."
"These rules are in comment period, they are not finalised," adds Pantheon's global head of private equity secondaries, Amyn Hassanally.
"But a number of transactions already include a fairness opinion so the SEC is simply looking to standardise something that already exists in the market today while giving LPs comfort that there will always be a third-party validation that the price being offered is fair. If approved, LPs will have two forms of third-party validation in order to make an informed choice as to whether to roll or sell."