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Editor’s Letter: Are restructurings going away?

While transaction activity on the secondary market this year has been strong, one area of the business has grown more challenging: Fund restructurings are tougher to complete, at least as initially intended.

Restructurings generally give LPs in older private equity funds the choice to sell or roll with the manager into new vehicles created to house remaining assets. More recently, such transactions have also offered LPs a so-called status-quo option, in which they don’t have to do anything.

Since at least last year, restructurings have had a hard time getting done, either because LPs don’t approve them or because LPs choose not to sell into the processes.

One prime example of a failed restructuring process was First Reserve, which last year tried to restructure its 11th fund. In that case, several factors led to the deal failing: The two lead investors in the deal, Pantheon and Intermediate Capital Group, backed off the deal when it generated only $88 million of existing-LP sales. The two firms had a minimum target of selling LPs of $175 million, with a maximum of $400 million.

Investors in a restructuring expect a certain amount of existing-LP sales to make the deals worth the effort.

LPs in the transaction, including California Public Employees’ Retirement System, disagreed with the reference date used to value assets. LPs “didn’t want to sell at a price that was struck at the market low,” one LP told Buyouts at the time.

A more recent process that has encountered LP resistance comes from Fenway Partners. Fenway is attempting to restructure Funds II and III without including a status-quo option to existing investors who don’t want to sell or roll into a new vehicle on reset terms with the manager. The firm is working with Moelis & Co on the process.

This lack of a neutral option is seen as anachronistic and not friendly to LP interests. And it makes sense. LPs who have been stuck in a fund that is either beyond its agreed-upon term or approaching the end of its life with no real end in sight should have the ability to stand pat and wait for the GP to close the fund. They should be able to simply say, “no more fee extensions, no more chance for carried interest — exit the investments and be done with the thing.”

There is no moral reason a long-suffering investor in a fund that can’t close for whatever reason and likely hasn’t lived up to expectations should have to decide between selling at a loss or giving a manager more time, fees and chance to earn carry. What kind of choice is that?

Restructurings have become harder to complete because LPs have gotten more vocal in advocating for their rights in these situations. That’s partly the result of the SEC keeping watch on every new innovation GPs concoct to make more money. But primarily that results from LPs realizing that in many cases, these investments benefit only the GP, with no real advantage for LPs.

These days, GPs have to come up with restructurings that benefit all parties, that give LPs full options to back out if they feel uncomfortable and that don’t pressure investors to do anything. This makes it much harder to complete restructurings, but it’s a necessary burden.

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky