The challenge of retiring an old private equity fund

These situations frequently come with challenges, one of the biggest of which is the discount LPs are generally presented with by parties trying to buy out their interests in the old funds.

This type of scenario unfolded in recent months with Veronis Suhler Stevenson’s third fund, a 1999 vintage that raised $1 billion. VSS III invested in 15 companies in sectors such as business media and telecom. The fund has two investments left: Access Intelligence and User Friendly Media. 

A little-known private equity secondary firm, Traveller Capital Advisor, proposed to partner with VSS Managing Partner Jeff Stevenson to buy the remaining stakes of Fund III LPs for 60 cents on the dollar. The Traveller offer was pulled when news came to light that could potentially positively affect one of Fund III’s remaining portfolio companies, Stevenson said. He declined to say which company the news pertained to.

Traveller led the attempted acquisition of the investor stakes, according to an Oct. 28 letter sent to Fund III investors that was obtained by Buyouts. Traveller President Drew Crichton confirmed the offer, which included Stevenson.

The deal called for Traveller, a Dallas firm that specializes in small secondaries, and Stevenson to buy LP interests for “cash consideration equal to 60 percent of the Seller’s net capital account balance as of June 30, 2014,” the letter states.

Stevenson noted that Traveller approached him “recently” with the proposed deal. “I agreed to participate to a limited extent to get the buyer, Traveller, comfortable with the deal,” he said.

The funds

Based in New York, VSS has raised more than $3 billion for four private equity funds and two structured capital funds since its founding in 1987. The firm targets investments in sectors such as information and business services, healthcare IT and education.

It hasn’t raised a new buyout fund in 10 years. Its 15-year-old Fund III performed well, producing an average IRR of 6.56 percent and a 1.39x average multiple, but its vintage 2005 Fund IV (which collected $1.3 billion) has generated a negative 4.23 percent average IRR and a 0.80x average multiple, according to data provider Bison.

Of late VSS has been focused on its better performing structured-capital funds, which primarily invest in non-control, minority positions and provide debt and/or equity.

VSS Structured Capital I raised $123 million in 2005 while Structured Capital II collected $312 million in 2009. VSS Structured Capital I produced a net IRR of 15 percent as of Sept. 30, while Structured Capital II is generating a net IRR of 19 percent, according to a source with knowledge of the funds’ performance.

VSS is currently in the market with VSS Structured Capital III LP, which is seeking $300 million to $400 million, and expects to hold a first close on the new fund in early 2015, the source said.

Why sell

Veronis is “approached all the time” about potential transactions, Stevenson said. There is currently no secondary planned for Fund III, he said. VSS III “is an older fund so we will look to either exit through a third-party sale or possibly a secondary down the road,” he said. “That’s to be determined but nothing is imminent.”

The Traveller proposal was not a “typical direct secondary” where a firm buys out the remaining portfolio of a fund, Stevenson said. No new fund was envisioned with the Traveller transaction, he said.

Instead, the Traveller offer was made to individual LPs of VSS III who had the option to take part or not, he said. The Oct. 28 letter is addressed generically to “Dear VSS III Investor,” but Stevenson said the offer did not go to all LPs. Instead, “most” investors received the communication, “particularly the smaller ones,” he said.

VSS III has distributed $1.5 billion to investors, he said. The pool has less than $18 million of remaining LP net asset value. The average VSS III account is small, around $250,000, which makes it increasingly difficult to sell, Stevenson said. He added that many individual LPs have already sold their remaining stakes in Fund III.

“[The Traveler offer] was an easy way to create liquidity, and those LPs who wanted to stay in were unaffected,” he said.

Asked if his involvement in the proposed deal created any conflict, Stevenson said investors who were troubled “could go sell to someone else.”

Exits

Three LPs who aren’t investors in Fund III said the offer of 60 cents on the dollar was too low. The secondary market has been “very hot” for the last six to nine months, the LPs said. Stakes in firms with lots of activity, like KKR or Blackstone, are trading for 95 cents on the dollar, while less desirable names are going for 80 to 85 cents, one of the investors said.

Companies are also selling for high prices in the M&A market. When asked why Veronis didn’t just sell the remaining two Fund III portfolio companies, Stevenson said each holding would be difficult to sell for different reasons. “There’s not a ton of buyers,” he said.

VSS did exit one Fund III holding. In February, it sold its remaining stake in Ebiquity, a publicly traded provider of marketing performance measurements. VSS also found buyers for several Fund IV companies in 2014. The firm produced $400 million worth of proceeds in 2014, Stevenson said. Exits include Advanstar Communications, CSC Media Group, and Tranzact. “We had a huge year,” Stevenson said.

The proposed Fund III deal represents a type of secondary transaction colloquially called a “tail-end” secondary, essentially the cleaning up of an old fund with LPs eager to eliminate the administrative burden of monitoring a fund with only an investment or two remaining.

The VSS deal is different from the restructurings of older funds that have come to represent a growing part of the secondary market.

Both types of deals – tail-end sales and restructurings – as well as traditional portfolio sales are all helping to drive record deal volume on the private equity secondary market. Estimates for the final tally in 2014 are above $30 billion, and several secondary sources said the final months of the year have been very busy.

Barring some catastrophic economic event, the secondary market will continue to break activity records as LPs get more sophisticated and become more comfortable with the idea of getting quick liquidity for their holdings, even at discounts.