What Is the Difference?
On August 23, 2023, the Securities and Exchange Commission (SEC) adopted new rules (and amendments to existing rules) under the Investment Advisers Act of 1940 (Advisers Act) that enforce the SEC's objective to protect private fund investors by increasing transparency, competition, and efficiency in the private funds market.
One of the more technical sweeping changes includes a new requirement for SEC-registered advisors who execute a general partner (GP)-led secondaries transaction to obtain a fairness opinion or a valuation report from an independent advisory firm. In addition, the GP must provide a summary disclosure of material business relationships the GP has or has had with the advisory firm within the prior two years. In the context of these new rules, there are different GP-led structures where the SEC would mandate an independent fairness opinion or valuation report. Still, in certain instances, there would be no mandatory requirement (i.e., tender offers, cross-trades, etc.).
While the SEC observes that GP-led secondary transactions can provide advantages to both GPs and investors in terms of liquidity generation and increasing the timeline to optimize the value of future exits, it is important to consider the inherent conflicts of interest given that the GP is involved on both sides of the deal and can have objectives in the transaction that are different and not aligned with those interests of the limited partners (LPs). Some examples of conflicts of interest include:
- Inherent: Most secondary transactions are a transfer of assets from one GP-managed vehicle to another, effectively creating a situation where the GP is "selling" an asset in its role as fiduciary to existing LPs who are interested in exiting and selling their proportionate interests to the continuation fund. Simultaneously, the GP acts as a buyer by virtue of its role as fiduciary to the continuation fund and the new LP participants.
- Prolong/Reset Economics: GPs benefit economically from leading a secondary transaction. GPs benefit by extending the horizon of management fees they can receive. Also, GPs can reset the cost basis at a lower value and potentially crystallize carried interest.
- Staple Deals: To add to the web of conflicts, GPs may offer "stapled" co-investment opportunities for other funds managed by the GP as part of a secondary transaction. A stapled secondary is where an external LP purchases fund interests from current LPs, while also committing to a new fund managed by the same GP.
To mitigate the potential impact of these various conflicts of interest, the SEC's new rules prohibit an advisor from completing a GP-led secondary transaction without first obtaining a fairness opinion or valuation report from an advisory firm that is independent.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
