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Short election periods for secondaries frustrate LPs

At SuperReturn North America, the debate continued between LPs and GPs on the length of election periods in GP-led secondary transactions.

At SuperReturn North America, investors debated the merits of a key element in secondary transactions: the election period.

Private-market industry leaders and institutional investors gathered in a dimly lit ballroom in Times Square to discuss asset allocation, fundraising in a dislocated market and co-investments. One Monday panel addressed the length of the election period on GP-led secondary transactions, a source of contention between GPs and their LPs.

The term refers to the amount of time a GP gives an LP to decide whether to liquidate its investment or roll the stake into a continuation vehicle. Panelists said some GPs don’t allot sufficient time for their LPs to make this call, while others argued that LPs should be better prepared for time-sensitive secondary opportunities.

On average, GPs give their LPs about four weeks to make their decision, said Niraj Agarwal, head of real assets at New Jersey Division of Investment.

But he said sometimes GPs have given the state pension fund two weeks to make its decision.

While guidelines from the Institutional Limited Partner Association direct GPs to provide LPs at least 20 business days to consider the proposal, this decision takes time—often more than two weeks, the panelist agreed.

For some LPs, a short election period can be detrimental to the relationship with the GP.

“I was with one of my clients … last week, and he said ‘we’re keeping a naughty list of those GPs who are doing this to us. And we’re reminding them of it when they come back,’” said Mina Pacheco Nazemi, head of diversified alternative equity at Barings, where she originates, underwrites and monitors continuation vehicle opportunities.

A typical GP-led transaction begins with a PE manager deciding to hang onto one or more of its assets as the fund approaches the end of its life. A secondary deal enables the GP to retain assets for longer, particularly in unfavorable exit environments.

From 2021 to 2022, US PE exit values declined 66.3%, a product of a closed IPO market and declining asset valuations, according to a PitchBook analyst note about the evolution of secondaries. As a result, the secondary market grew tremendously over the past three years with LPs and GPs becoming more reliant on these deal types to generate liquidity. From 2020 to 2021, global annual secondaries transaction volume more than doubled.

This elevated activity means that LPs and GPs alike are confronted with more bespoke and complex transactions than ever before.

After the GP negotiates the terms of a secondary transaction with potential buyers, the GP presents the limited partner advisory committee with the transaction.

Here, an LP has a few options: It can either sell and receive a pro-rata portion of its stake in the asset; it can hold, which means its interest will go into the new continuation vehicle; or in some cases, it can do a combination of both.

The process requires the LP’s staff to evaluate the deal terms and be comfortable underwriting the investments within the time constraints of the election period, Agarwal said. In short, LPs want to be sure they’re not overpaying if they decide to hold.

“The challenge comes from your entry into the continuation vehicle. Is it a fair price compared to what the commingled fund has done historically?” Agarwal said.

At the same time, when a GP initiates a secondary transaction, it’s working against the clock to negotiate stronger prices with secondary buyers who plan to buy LPs out of their stakes in the fund, according to Joseph Smith, a partner at law firm Schulte Roth & Zabel, where he represents PE fund sponsors.

“If you slow down the transaction for one particular LP, you’re slowing it down for everybody,” he said.

Also, Smith said the GPs perform the bulk of the due diligence before they present the LP with the deal, so most LPs shouldn’t need a long election period.

“It’s prepackaged due-diligence,” he said. “If you’re the kind of aggressive LP who gets dirt under your fingernails, you ought to be able to react with some alacrity to a good secondary opportunity.”

Nazemi, of Barings, agreed and said that by the time an LP receives an election, the deal is “pretty much done.” A solution to this dilemma is for LPs and GPs to maintain communication.

“You can have a conversation with your LPs,” she said. “Explain to them that you’re thinking about doing this versus just springing an election on them and giving them two weeks to react to it.”

Featured image of Times Square in New York by Maremagnum/Getty Images

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