Restructuring private equity funds that are close to, or have reached, the end of their fund lives is a growing business for firms that invest on the secondary market — a business that could double by the end of this year, industry insiders say.
Restructurings breathe new life into so-called zombie funds, allowing managers to turn around an underperforming fund and possibly raise a new one later. Secondary managers see these restructurings as an expanding source of transactions.
For limited partners, it is a way to get out of these funds — which are nearly dead but still collecting fees — albeit many times it means getting out at a discount. Limited partners that stay are taking a bet — in effect doubling down — that the general partner that has so far disappointed them can turn around the portfolio and produce a return.
Many secondary private equity managers and brokers expect the value of restructurings to double this year. In the first half of this year, 30% of private equity secondary market transactions were generally partner-led deals, mostly restructurings, according to Dallas-based secondary market broker Greenhill Cogent LP. GP-led transactions amounted to $3.6 billion in the six months ended June 30, compared with $2 billion in all of 2013, the first year for which Greenhill Cogent has data.
In a fund restructuring, secondary investors invest new capital to cash out existing limited partners of a fund reaching the end of its life.
In some cases, the private equity manager will seek to extend the fund and alter the terms, such as the management fees or carried interest hurdle rate, the minimum return the firm must earn before the manager can collect carried interest, said Paul Verbesey, Washington-based partner in law firm Goodwin Procter LLP.
David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC, said his firm's clients are faced with a restructuring decision “almost every week now.”
Secondary private equity managers anticipate the increase despite more scrutiny of restructurings by the Securities and Exchange Commission and limited partners.
“We are seeing a lot more of the restructurings,” said Frank Morgan, partner and president of Coller Capital-U.S., who is based in New York. “There were a lot of funds raised in 2006 to 2007 just before the global financial crisis and those are bumping into their 10-year fund lives. It's not surprising the numbers (of restructurings) are coming up.”
Coller expects its restructuring business to double from last year. Mr. Morgan estimates Coller Capital invested about $3 billion to restructure private equity funds over the past 14 months.
In one of the firm's largest such transactions, Coller led the $1 billion restructuring last year of $2.7 billion Irving Place Capital Partners III, a 2006 vintage private equity fund, Mr. Morgan said.
Investors in the Irving Place fund include the $188.7 billion California State Teachers' Retirement System, West Sacramento; $48.5 billion Pennsylvania Public School Employees' Retirement System, Harrisburg; and Oregon Investment Council, Tigard, which oversees the $68 billion Oregon Public Employees Retirement Fund, Salem. Officials at all three funds declined to comment on their investment or how the restructuring affected their portfolio.
Coller also helped restructure private equity firm J.C. Flowers & Co.'s 2006 buyout fund, the $7 billion J.C. Flowers II.
The Oregon Investment Council is also an investor in J.C. Flowers II. Other investors in the fund include the $101.8 billion New York State Teachers' Retirement System and the $43.5 billion Teachers' Retirement System of the State of Illinois, Springfield.
Calls to those funds were not returned by deadline.