We continue to see a significant number of fund-to-fund transactions as GP’s increasingly look at this as an alternative liquidity option.  Over the last few years, where the frequency of these transactions has increased, we have seen the market adapt to how the management arrangements are catered for, both from a process perspective and shareholder terms that govern such scenarios.

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 managed by the same general partner, which can be used to extend the hold period of the asset.

Management terms

As is the case with a sale to a third party institutional investor, clarity regarding management’s financial commitment and appropriate incentivisation in the new structure are an important part of the transaction. A few years ago, when fund-to-fund transaction activity initially took off, we witnessed a broad range of approaches to integrating the management terms discussion into the process. Over time we have seen the market largely gravitate to a common approach whereby the senior management and the Sponsor agree the principal terms, usually via management term sheet, during the preparation phase.

This approach gives management early clarity regarding the treatment of their incentive arrangements and the Sponsors, and their advisors, the ability to inform the parties in the process that management are committed to the transaction and that new incentive arrangements have been agreed that will align management with the new investor base during the next investment cycle.

Evolution of legal treatment

Historically under the terms of 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 arrangements and allocations for the management team, in a similar manner to how it would be done if it was a sale to a third party.

Key takeaways

• In new deal terms today, fund-to-fund transactions need to be either defined as an Exit Event or have special provisions permitting some liquidity and top up. A key consideration 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 crystallization of the existing deal structure and creation of a new structure and incentive
• While the structure is in large part 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 and creating new a incentive within an existing framework. It is also hard 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 re-examination of the incentive arrangements to ensure that they align with the shareholder and company objectives for the next phase. Expected time horizons, share of future value created and allocations are a few terms that need to be re-examined.
• It’s an opportunity to “reset the clock” and lock in management value created to date and rebalance the incentives to reward managers who will be key to driving the next phase of the business plan.

At Jamieson we have advised on many of the recent GP led fund to fund transactions that have taken place in the past year including Kyriba, Biocomposites, IFCO, Nineteen Group, Alkeme Inc., Normec Group, Ontic. 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