Weil has recently seen a boom in its practice of representing alternative asset managers and investors in purchases and sales of interests in alternative asset funds or the managers of such funds, especially in the following areas: Secondary Transactions, Structured Secondary Transactions, Spinoffs, Minority Investments in Asset Managers and Fund Sponsors and transactions involving CLO Managers. This latest boom is primarily driven by the desire for liquidity among founders of alternative asset managers and their investors as well as new or increased regulatory pressures on the industry.
- Secondary Transactions: A secondary transaction involves a limited partner of an illiquid investment fund (such as a private equity or venture fund) selling its interest to a buyer. The fund manager does not play a material role in a secondary transaction, other than the approval of the transfer. The secondary market is mature, and there are several well-established buyers. The volume of secondary transactions in 2014 reached $47 billion in 2014, an 80% increase from the prior year, according to a study by Evercore. We believe the primary drivers of this increase are the liquidity desires of limited partners – driven in part by the longer hold periods of investments by funds – and the desire of many limited partners to reduce the number of alternative asset managers in which they invest. For example, CaLPERs announced in June 2015 that it intended to reduce by two-thirds the number of private equity sponsors to which it will allocate capital in order to reduce fees and the costs of monitoring all those sponsors.
- Structured Secondary Transactions: A structured secondary transaction involves the sponsor of an illiquid fund identifying a buyer who will offer to purchase limited partnership interests in an illiquid investment fund (or a successor vehicle) or the entire portfolio held by such fund. They differ from secondary transactions in that the principal driver is the sponsor’s active involvement in the process. Historically, a structured secondary was a solution when a fund reached the end of its contractual life and would otherwise be required to sell its remaining investments in a hurry (possibly at distressed pricing). The sponsor would ask the limited partners to extend the time period for selling the remaining investments and arrange for limited partners who sought immediate liquidity to sell to a secondary buyer. Lately, we have seen structured secondary transactions that occur earlier in the contractual life of a fund when a fund reaches the end of its investment period, but the sponsor is not yet ready or able to raise a successor fund (usually due to a lack of realized performance in the current fund). The sponsor will ask its limited partners to extend the time period for making new investments and arrange for limited partners who do not want to participate to sell to a secondary buyer. This type of transaction is often necessary for the sponsor to retain its professionals to continue to manage the existing portfolio, which is important for the limited partners as well. For the transaction to make sense, the secondary buyer and the retaining limited partners must believe that with more time the sponsor will be able to successfully raise and invest its next fund. These transactions provide substantial benefits to the sponsor and therefore pose potential conflicts of interest which need to be navigated (which the SEC recently noted in public comments).
- Spinoffs: Many bank holding companies (BHCs) continue to spinoff investment teams that manage alternative asset portfolios. BHCs are motivated to do so principally for regulatory reasons, including the Volcker rule, increased regulatory capital requirements for alternative assets, and pressure from regulators to streamline operations in order to simplify risks and assure that the BHC is not “too big to fail.” These spinoffs are often accomplished through a variation on a structured secondary, in which a secondary buyer will provide the spun-off team with new capital for investments and buy all or a meaningful portion of the BHC’s existing portfolio managed by the spun-off team. The BHC will often retain the spun-off team to manage any remaining portfolio.
- CLO Transactions: Sponsors of collateralized loan obligation funds (pools of loans or bonds held by a partnership that sells different tranches of debt to fund its investments) are subject to various new regulations that require the sponsor or a qualified affiliate to retain 5% exposure to such funds. The regulators intent is that risk retention will improve the quality of assets purchased by CLOs and reduce the systemic risk posed by lax underwriting of debt. These risk retention rules went into effect in EU countries in July 2014 and will become effective in December 2016 in the United States (December 2105 for certain packages of mortgages). Many CLO sponsors do not have the capital to retain such large exposures, and those managers are beginning to look for partners that can provide such capital.
- Minority Investments: Minority investments in alternative asset managers, particularly hedge funds, are on the rise. In addition to large institutional investors such as Affiliated Managers Group and the Man Group Plc, several investment funds have been raised (notably Goldman Sachs’ Petershill, Blackstone’s Strategic Capital Holdings, Neuberger Berman’s Dyal Capital and Foundation Capital Partners) to make such investments, allowing limited partners to invest in privately held sponsors rather than their funds (similar to the investments made in publicly traded sponsors such as Apollo Blackstone, Carlyle and KKR, among others). Although many hedge fund founders are happy to monetize a portion of their interest, there are other factors at play which are likely even more important in driving these investments. The hedge fund sponsors want exposure to a new group of limited partners who may allocate capital to their funds once they establish a long-term relationship. Minority sales can also help institutionalize a sponsor firm and create a path that leads to meaningful equity ownership by the next generation of management and a path to future liquidity for the founders.
Some of the trends noted above will play out in time: BHCs will eventually spinoff their alternative asset managers, and CLO sponsors will either find new sources of capital or be replaced by others that can. However, we believe that M&A involving alternative asset managers is a long-term trend. The private equity and hedge fund industries are maturing, and we expect to see substantial consolidation going forward. The largest sponsors are attracting larger commitments from the largest investors, which are being allocated across several strategies. This approach is allowing large investors to negotiate better terms and monitor fewer alternative asset managers. This trend is causing a shake-out among the remaining sponsors, and an M&A transaction can often provide a solution.
Weil has an active practice representing alternative asset managers and investors in purchases and sales of interests in alternative asset funds or the managers of such funds. Weil’s market leading private equity, private funds, investment management, structured credit, regulatory and tax practices collaborate seamlessly to provide this highly specialized set of inter-disciplinary practice skills and experience to its clients.