Most private equity investments offer liquidity through the ability to transfer to a third-party with consent from the general partner of the fund, which can be given if the third-party is eligible to participate in the investment, and the proper representations, warranties, and covenants are agreed to by the transfer parties. For any investment manager or investor in a private equity investment considering the secondary sale process, there are a number of common questions that should be considered. Without thinking through the potential issues and discussing them with counsel, there is a higher likelihood of avoidable delays and mistakes.
This FAQ list provides general information on the transfer process and will make any reader better understand the intricacies of the transfer process in their discussions with internal business teams, counterparties, and their counsel.
Do you need a big legal team to handle a large secondary transaction from either the sponsor, buy or sell-side?
No. If scaled appropriately, nearly any secondary transaction can be handled in a timely manner with high quality and client service with limited relative cost.
Why would anyone sell private equity assets?
Increasingly, the secondary market is creating enhanced liquidity opportunities for sellers whereby sales are completed at a premium to cost. In addition, state plans and other big institutional investors and plans may have internal policy requirements to balance certain portfolios or meet investment guidelines or thresholds that may be renewed or changed throughout the year.
Does the timing of the closing impact the transfer process or the terms?
Our latest major secondary closed over New Years. The business teams were able to coordinate currency fluctuations in advance and legal teams were already holding signatures in escrow so everything was smooth sailing into 2024. There is no impact to the terms or process of the secondary transaction based on a quarterly or year-end closing as all necessary closing items should always be handled well in advance of closing (to the extent possible).
What are the standard key terms in most large private equity secondary transaction Purchase Agreements and General Partner (“GP”) Consent Agreements (“GP Consents”), and what is considered market to include?
We list out the main categories of key terms and add a few details where particularly relevant:
- Purchase Price Payment Timing
- Excluded Obligations
- Impacts of Liquidations in the Executory Period
- Coverage for Expenses, Fees, and Taxes
- Side Letter Rights (including LPAC rights)
- Reps and Warranties
- Seller’s Post-Closing Tax Reimbursement
- Seller’s Post-Closing Limits on Clawbacks
- Governing Law and Jurisdiction
Note: GP Consents may be one document, or a GP may require a Buyer and Seller to sign a GP Consent form and a separate form of assignment. The terms listed below may be included in one or both of those documents. In addition, GPs are not usually in the position of needing to consent to any requested changes to their form of consent except where a Seller or Buyer has a particularly high amount of leverage (e.g., due to other investments) or due to legal requirements.
- Consent Subject to Compliance with the LPA
There may be other obligations in the LPA that should not be overlooked by a Seller and Buyer including legal opinions, government consents, lender consents, or other third-party consents.
- Free and Clear of all Encumbrances and Liens
There may be certain liens or other restrictions under the LPA on the interests being transferred that should be carved out of any representations about title transferring free and clear of any liens.
- Continuing Liability of a Seller
There is usually some continuing liability to a Seller. For example, certain fundamental representations made by a Seller or representations made with respect to a Seller as to a point in time (e.g., eligibility status), may survive.
- Release of Seller
This is one of the more common asks from Sellers. GPs are able to push back on this to extent if they have a high degree of leverage. Releases are usually limited to a large extent by what is reserved as continuing liability of a Seller (as described above).
- Limiting GP to Consent Role Only
The GP should intend to avoid being involved in disputes between a Seller and Buyer.
- Confirm Commitment Amounts Transferred
This is a place where errors are common between parties. Each counsel should take care to check these figures multiple times.
- Reps and Warranties Considering Limitations to Knowledge and Materiality
This is a negotiated point and will depend on the representation or warranty and the specific situation. For example, if there is a third party administrating a certain aspect of a party’s business, limiting a representation or acknowledge a party’s knowledge as to certain actions delegated may be warranted.
- Requests of Parties Limited to Reasonableness
It is common to receive and accept these requests.
- Coverage for Expenses, Fees, and Taxes
This is a negotiated point between a Buyer and Seller. Sellers can usually have Buyers pay for this if they make it clear that is the expectation from the outset.
- Several Liability for Unaffiliated Buyer and Seller vs. Joint and Several Liability for Affiliated Buyer and Seller
There is rarely a valid reason for a Buyer to not agree to joint liability when affiliated with a Seller, except in rare instances where there may be separately managed accounts or funds that have contractually required segregation of asset and liability provisions.
Certain Buyers may have contractual or legal obligations to their investors related to disclosure of fund or portfolio-level information (e.g., investment strategy, net income, names of investments). These are usually prescribed by the GP at the outset of a fund formation and kept consistent throughout the life of a fund.
- Supremacy of Purchase Agreement as Between Buyer and Seller
The GP has the GP Consent control in disputes as between the GP and either or both a Seller or Buyer.
- Governing Law and Jurisdiction
Clients may not want to, or may not be legally capable of, overlooking governing law or jurisdictional requirements. Legally required changes are usually approved.
What are the procedural steps needed to ensure a smooth closing of a private equity secondary transaction from the perspective of each party as listed below?
- Business Team: Review Requests for Purchasers from Sellers or Brokers (1–4 weeks)
- Business Team: Assess Economics and Risks of Secondary Asset (1 week)
- Buyer’s Counsel: Review LPAs for Legal Opinions or Other Requirements that Increase Costs (1 week)
- Buyer’s Counsel: Negotiate Purchase Agreement with GP and Seller and Circulate Signatures in Escrow (2–3 weeks)
- Buyer’s Counsel: Negotiate GP Consent with GP and Seller and Circulate Signatures in Escrow (2–3 weeks)
- Buyer’s Counsel: Complete eligibility questionnaires, AML process, and AIV/direct investment selection process with the GP (2–3 weeks)
- Business Team: Wire Capital to Seller and Release or Ask Buyer’s Counsel to Release Signatures (1–2 business days depending on currencies)
- Business Team: Assess Holdings and Decide Based on Economics and Risks of Investments to Identify Buyers (2–4 weeks)
- Seller’s Counsel: Review LPAs for Legal Opinions or Other Requirements that Increase Costs (1 week)
- Seller’s Counsel: Negotiate Purchase Agreement with GP and Buyer and Circulate Signatures in Escrow (2–3 weeks)
- Seller’s Counsel: Negotiate GP Consent with GPs and Buyer and Circulate Signatures in Escrow (2–3 weeks)
- Business Team: Confirm Capital Received from Buyer and Release or Ask Seller’s Counsel to Release Signatures (1–2 business days depending on currencies)
- Fund Counsel: Review Purchase Agreement Between Buyer and Seller to Confirm No Indirect GP Obligations or Reps and Commitment Amounts Being Transferred (1 week)
- Fund Counsel: Receive and Approve Accredited Investor, Qualified Purchaser, ERISA, Tax, Bank Information, Wire Information, CRS, etc. Questionnaire (1 week)
- Fund Counsel: Negotiate Terms of GP Consent with Buyer and Seller and Circulate Signatures in Escrow (2–3 weeks)
- Fund Counsel: Confirm Buyer Signs Subscription Agreement and Joinder to LPA (1 week)
- Fund Counsel: Request and Receive Lender Consent (if any) (2–4 weeks)
- Fund Counsel: Confirm Buyer and Seller Signatures Released and Funds Wired Before Release GP Signatures (1–2 business days)