General partner-driven stapled transactions, a small but growing corner of the private equity secondary market, are drawing the attention of the Securities and Exchange Commission because of potential conflicts of interest and lack of transparency for limited partners.
The transactions under scrutiny involve the general partner initiating the sale of any remaining portfolio companies from an older private equity fund to a new fund. These deals often require approval from only the advisory committee of the existing fund.
These general partner-led transactions are the latest iteration in the private equity secondaries market. They have become a tool for general partners to wind down old funds while seeding new ones with existing limited partner capital or assets.
Industry insiders say they could lead to breaches of the private equity managers' fiduciary duties to put investors' interests ahead of the managers' and to make certain disclosures to the limited partners that are selling their interests. The concern is that the pricing of the secondary transaction could be affected by the potential relative unattractiveness of the new fund.
“Stapled transactions are often used in situations where a GP may be having a hard time raising a new fund, and by combining a sale of remaining assets in a current fund, with a requirement of the buyer to commit to a staple, the GP can simultaneously provide liquidity for investors and secure an anchor investor for its next fund, regardless of how the prior fund performed prior to the sale,” said Mary Hornby, managing director and general counsel at New York-based private equity funds-of-funds firm Abbott Capital Management LLC.
In separate speeches last month, two high-ranking SEC officials said the agency is concerned about these transactions and agency officials expect that stapled private equity secondary market transactions will be an area of focus for its office of compliance inspections and examinations.
Most of the time, private equity managers seek subscription agreements with limited partners in the existing fund, giving them a choice of whether to cash out of the fund or continue to invest with the manager in a new fund.
In the first iteration of stapled transactions, deals were initiated by a limited partner seeking to sell its share to another LP. As a condition of the GP's approval, which is often required, the GP requires the new LP to commit to another of the general partner' funds, or to a future fund.
Under a GP-led stapled transaction, the GP initiates the sale, and the portfolio companies in the old fund are transferred to a new fund, which can be formed under different terms, including a new hurdle — the return a manager has to earn before taking its share of the profits. These asset-sale transactions can occur with the approval of only the advisory committee, which can leave the rest of the limited partners in the dark until the deal is done, Ms. Hornby explained.