We have seen a significant increase in the number of fund to fund transactions in the last 18 months.  We have advised over a dozen deals and we expect to see many more in the coming months as GP’s look at these transactions as a way of providing liquidity whilst continuing to own the asset.  In addition, as a result of the frequency in these transactions, it has become an issue to be addressed in the initial agreements at the time of the initial acquisitions by the private equity firm, so if there is a later fund to fund transfer, it will have been contemplated.

A ‘fund to fund’ deal is a transaction where the company remains under the ownership of the same private equity house. This type of transaction can take several forms One where the Sponsor sells from one fund vintage to another (often in conjunction with the sale of a minority stake to a third party investor).  Another, where the ownership is transferred to a continuation fund owned by LPs from the original fund, which can be used to extend the hold period of the asset.  A third is one where the Sponsor sets up a special purpose entity controlled by it, with both new and former investors, to acquire the business.

Implications for Management teams

Under the terms of almost all Shareholder Agreements neither of these transactions would constitute an “Exit” or trigger liquidity rights for the management team. However, in the majority of the transactions we’ve been involved in the Sponsor has agreed to treat the transaction as a new deal including partial liquidity, rollover and new incentive terms and allocations for the management team, in a similar manner to how it would be done if it was a new deal.

Key takeaways

• In new deal terms today, fund to fund transactions need to either be defined as Exit Events or have special provisions permitting some liquidity and top up. A factor is whether distributions are being made to the current LP’s and whether the transaction results in GP carry being triggered
• In our experience the majority of fund to fund transactions have been structured via a Newco with the crystalization of the existing deal structure and creation of a new structure and incentive arrangements
• While the structure is mostly driven by tax considerations, trying to retain the existing structure, rather than rolling all equity into a Newco, can make the transaction significantly more complicated, primarily due to the tax implications of providing liquidity outside of a sale transaction. It is also harder to change the current incentive arrangements which may be necessary due to management team changes (e.g. joiners, leaver, managing transition arrangements etc.)
• A fund to fund transfer can necessitate a reexamination of the incentive arrangements to ensure that they align with the shareholder and company objectives for the next phase and through to the ultimate exit for the Investor. Expected time horizons, share of future value created and allocations are a few terms that need to be reexamined.   Others include:
  • Longer term hold and the need to introduce synthetic liquidity arrangements
  • Pursuit of a dividend strategy then management participation of at the time or catch-up basis (including treatment of ratchets)
  • Multiple investors (traditional and sovereign wealth funds) and the definition of an Exit for new incentive purposes and who funds the incentive
• It is an opportunity to “reset the clock” and lock in management value created to date and to make changes to the management team and rebalance the incentives to reward the key managers driving the next phase of the business plan

At Jamieson we have advised on many of the GP led fund to fund transactions that have taken place in the past year including [Belron, International Schools Partnership; IQ-EQ; IFS; IVC and Eurofiber].  As such we are ideally placed to advise exiting management teams, on the range of issues they need to address to help them negotiate the optimum terms over the next investment period

Andrew Cox is a partner in the firm with extensive experience in fund to fund transactions