LPs push back on Fenway revamp, which lacks a status-quo option

Limited partners in two Fenway Partners funds are pushing back against a restructuring plan that does not give existing investors the option to remain on the same terms as they had, three sources told Buyouts.

This so-called status-quo option has become routine in most restructuring processes and is viewed as friendly to LPs. It means existing LPs in a fund don’t have to sell their interests, nor do they have to roll their interests with the GP on new terms.

Several sources said LPs in the Fenway funds that are part of the restructuring — Funds II and III — are not happy with the proposal because of the lack of a third option and also because of pricing. Fenway’s Fund II is a $909 million vehicle raised in 1998 and Fund III raised about $700 million in 2006. Both funds are weak performers.

A vote on the process was expected this month, sources said. Generally LPs vote on whether to approve a restructuring and then decide whether to sell or stick with the GP.

Fenway is working with Moelis & Co on the restructuring. Prudential is the lead investor in the process, sources said. Spokespeople for Fenway, Prudential and Moelis declined to comment. 

Under Fenway’s proposed restructuring, LPs in the funds can choose to sell their interests at a discount or roll their interests, on reset terms, into a new vehicle that would house the assets that remain in the funds.

Discounts on the sale of fund interests would look like this: For Fund II, the offer is 42 percent of net asset value as of year-end 2016; for Fund III, the offer is 65 percent of NAV as of year-end, according to a source who has seen the restructuring proposal.

The proposal does not include a provision for new or existing investors to offer fresh capital for new investments, known as a staple. The plan does include, however, repayment of capital the GP collected before LPs received their agreed-upon profit share, known as a clawback, sources said.

Most troubling to some LPs is the lack of the status-quo option, which would enable existing LPs in the funds to simply do nothing. In restructurings, LPs sometimes don’t want to sell at a discount, but they also don’t want to give the GP a new fee stream or reset chance to earn carried interest. They simply want the GP to invest out the fund on the terms agreed to when the pool was launched, according to an LP unconnected to the Fenway situation.

“I just have a real problem when at the last hour a GP decides to propose they need more than what they’ve been representing all along,” the LP said. “As if the original deal wasn’t sweet enough.”

Adding a third option to restructurings began to gain ground in the past two years as LPs became more vocal in restructuring negotiations. In 2015, Igor Rozenblit, co-head of the Private Funds Unit in the SEC’s Office of Compliance Inspections and Examinations, warned GPs against providing LPs with “two bad options”: selling at a discount or sticking with a potentially underperforming GP on reset terms.

The challenge of providing a status-quo option for managers is making that work along with the new structure that emerges out of a restructuring. In some cases, the manager can offer existing investors the ability to roll into the restructure vehicle on the same terms as before, with the exception that the restructure vehicle will have an extended fund life.

Another way a manager could satisfy status quo LPs is to leave a strip of the fund, or a strip of assets, out of the restructuring, according to a buyer in the secondary market.

Fenway Partners has been exploring restructurings for several years. Fenway and Fortress Investment Group ended talks on a fund-restructuring process for Funds II and III in 2015, the Wall Street Journal reported.

The firm and several of its partners settled with the SEC in 2015, agreeing to pay a combined $10.2 million to investors harmed by its failure to disclose payments to an affiliated consulting firm.

Action Item: Check out Fenway’s SEC settlement here: http://bit.ly/1NSaEky

Boston Red Sox pitcher Drew Pomeranz delivers a pitch against the Baltimore Orioles at Fenway Park on May 3, 2017. Photo courtesy Greg M. Cooper-USA Today Sports