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With traditional exit opportunities increasingly difficult to come by, private equity continuation funds have attracted a lot of interest in recent years, but this Proskauer memo says that there are questions that GP’s need to answer prior to launching a continuation vehicle (CV) if they want to maximize their chances of success.  This excerpt discusses the key terms that should be considered at the outset of the process:

The lead investor will negotiate the terms of the transaction on behalf of the CV and the wider investor group. Sponsors should still give thought to key terms early in process.

One key term is whether to offer reinvesting selling fund investors a status quo option with respect to economics. While investors are generally expected to participate on new terms, sponsors have increasingly offered status quo management fees to reinvesting investors. This aligns with the ILPA guidance and is therefore receiving greater scrutiny from selling fund LPACs.

For carried interest, all investors typically participate in the same arrangements, often through tiered profit structure with a number of return multiple and/or preferred return tests. This promotes alignment between sponsors and buyers and demonstrates sponsor conviction in the underlying asset.

On the transaction side, the allocation of costs and expenses among the sellside and the buyside is often a key negotiated point. Some costs clearly belong on one side or the other: CV establishment and lead investor costs are borne on the buyside by the CV, and election-process and other sellside process costs borne by the selling fund. Some costs however, are not so clearly apportioned, and the precise apportionment of those can become heavily negotiated. Having a clear idea of the broader transaction budget and the apportionment of costs is therefore an important consideration, particularly to the extent allocated to the sellside where those costs will usually impact the net proceeds available for reinvesting selling fund LPs.

The memo says that other questions that should be addressed include whether the asset & business plan is a good fit for a CV transaction, the sponsor’s ability to demonstrate alignment and transparency on valuation and conflicts, how to manage LP communications and timing, and how to convincingly demonstrate sponsor alignement.

– John Jenkins