Private Equity: Perspectives of Limited and General Partners - Jean-Marc Cuvilly, Triago

um yes on swine apologizes for not being able to make it he was looking forward issues over in Dubai so I'm a partner at SRI hago I'm based in our New York office my understanding so far you've looked at the private equity world really through the eyes of the investors the general partners today we're really going to be taking a look at it through the perspective of the limited partner so the investors in the funds we have a fictitious case study on this endowment and foundation but what what it covers is pretty realistic and it does deal with the issues that we face with our clients on a daily basis so what you'll be doing is really stepping into the role of a private equity portfolio manager at one of these endowments and foundations Oh that's right let me just first give you a quick introduction of triage oh so you guys know what we do on tuan founded the firm in 1992 really to raise capital for European general partners folks that had investors in Europe but we're really looking to diversify their LP base with more institutional investors which at the time were mostly in the United States so we essentially introduced general partners to large institutional capital here in the u.s. we started doing the same thing a few years later opened up an office in New York raising capital for general partners here in the US looking to access LPS in Europe as well as Asia and the Middle East we have three offices now Paris is our main office where most of our folks are I'm in New York with eight other folks and then we've got our office in Dubai back in 1999 we did our first secondary transaction in the sense that we helped a limited partner that was looking for some liquidity options and from that point on we established a dedicated secondary practice so today we really have two businesses with our primary business which is raising capital for GPS and our secondary business which is advising limited partners on liquidity options this sort of shows sort of our interaction with the general partners and the limited partners on different sides of business not sure what else is in here these are some of the fundraising clients that that we've had mostly middle market firms raising anywhere say from 500 million to 3 billion that's that's pretty much our bread-and-butter and we've worked with buyout venture real estate mezzanine as well as the energy sector these are some of the partnerships we've transferred more recently on the sec they're Eastside hopeful we'll be some names that that are familiar to you so in terms of my background yes I graduated from Princeton with a degree in economics I worked on at JPMorgan and the fixed income research desk for four years got my MBA at UCLA Anderson School and went came back to New York and worked for Merrill Lynch on their private equity placement group and I joined trio go four years ago and I had their secondary advisory practice here in the US so um let's dive into the case and I'd really like to make this as interactive as possible so if you don't mind I'm just going to sort of randomly pick on people and there's no wrong answers so please don't don't hesitate maybe someone can start with just sort of a quick overview of what the case was about and what what are some of the issues that the underlying issues that are going on at this point Matt okay in general the case kind of focuses on this endowment Lago endowment they were faced with kind of a denominator effect situation whereby private equity became an inordinately large share for their portfolio I relative to where they wanted it to be so at this point in time they went the the portfolio manager went and started to look at his options for trying to reduce that discrepancy back to the levels it should be yet he looked into secondary transactions which I guess he's kind of learning more about them and I can continue ago I guess the kind of the bottom line is that he saw or he heard rumors that secondary transactions would be done at a very disadvantageous kind of price for a seller sure but as he's going along in the process realizes that those rumors aren't actually true he's considering number one using secondary secondary sales to reduce his exposure to firms that he does not want to be exposed to potentially also opportunistically as a buyer for other firms that he missed on the first time around exactly exactly and if I recall they did look at the secondary market a couple of years ago when prices were better but decided that selling didn't really make sense at that time now they might be regretting that a little bit but since since the prices were better but nevertheless they have this issue if you were on the board the trustees of this endowment what do you think are some of the the issues you'd be thinking about if what's-his-name is it Rick mr. Johnson decided that or came to you and said he's considering selling some of those private equity funds as a potential trustee as a trustee or board member what are some of the questions you'd want to be asking about doing a secondary sale what are some of the concerns you might have let's say anyone has somebody else I'm good obviously you know as you mentioned you're really going to be concerned about price relative discount from far more as Marge yeah that you're going to be receiving but in addition to that it's also going to be that I'm being associated with the transaction these are complex negotiated deals uh-huh Jedi suit yeah those are two good points so price and timing that's good points anything else yep but also like to think about the confidentiality issues how much information goes out in the market what kind of image you wanna give very important yep of course because of obviously when you go into one of these these funds the information that you receive is is quite confidential and you can't share yeah question and when no key sells what rotational my we're participating in future well I was GP that was actually one of the points I wanted to bring up or wanted someone to bring up so reputational issues right because as you point out if you're an investor in a fund let's say GP XYZ what how is that going to affect your your relationship with GP XYZ if you then sell that fun are you going to be able to enter into their next fund or are they going to lock you out forever those are all types of things that you have to think about so well so those are those are exactly the types of things that the board members of this endowment would be wondering so the other the other question now is we understand the markets have stabilized the endowment is not as over allocated as it was before why is it that they still are complicating contemplating this sale Oren okay so right next year thing also because to concentrate the measurement timing of the LP finds in less number of finds yeah that can bring a greater return sure so it's a portfolio management issue in terms of administrative costs making sure that they have a reasonable portfolio they can monitor yeah pause and really ask exactly exactly and let's remember that they the markets been relatively quiet so they haven't been that many capital calls but it's the possibility that those calls could increase going forward anything else yep roses concern about motivation on certain GPS that's rights which were very far-reaching threshold that's right exactly so he's thinking that there's some of these groups that are just not going to be motivated to do anything and so the performance going to suffer mmm the endowment also has distribution convenience to the beneficiary something dumb that in that particular year was difficult to do because there was very many exits it's exactly right exactly anything else okay the other thing you might want to consider is right now the markets relatively quiet what happens if there should be a rush to selling let's say some financial institutions decide that they have to get out of private equity and suddenly they dump a lot of paper on the market that's of course going to affect pricing as well so you sort of have to consider all these things in terms of timing a potential sale so we've decided to sell the the board is is backing the decision everyone wants to move forward what are some of the options that this endowment has in terms of carrying out this portfolio sale what are the different types of ways they can go about it any volunteers yeah there's a list of some of the investments that they were considered non-core in the second position what type of assumption jean making about how accurately or recently are fairly portfolios have been mark-to-market sure well yeah that I mean and that's a good question that the issue is you only have the latest quarterly information so basically you're counting on your general partners latest quarter reports and so you have to essentially evaluate that we're going to go into that when we talk about essentially evaluating the portfolio but that's the point to keep in mind that you only have the latest quarters reports and you do have to keep in mind what has happened since that latest quarter so yep got that I have a couple conflicting issues so from a pricing standpoint you want to invite as many people and players as you can right into maybe an auction or something where you can provide them without a good information for the participate yeah but then back to the confidentiality and reputation or it may be you don't want to spread out the word too much yeah and finally there's also the legal part within your contract so within each of the GPS you work with or my partnership contract might have restrictions to charlie being able to sell to other investors within that on there sure so if I summarize what you said number of options maybe one of them is to run your own auction right that's one of the things and then we can talk about the pluses and minuses of that one the other one that you alluded to is maybe you can just contact one buyer and deal with them one-on-one we can talk about the pluses and minuses of that one the other thing you can do is you can approach GP about interest yeah or approach a G point about exactly exactly so that's the third option yep or they can contact E I go and you guys can try you go I was waiting for someone to say hey okay so those are your four options essentially and I wonder which one will choose so what are the pluses and minuses let's take the first option what are the pluses and minuses of actually I'll go with contacting the GP right away what would be the pluses and minuses of that the plus side you might get approval to start looking at a lot fewer problems if you can go through them yeah won't be as concerned about you spreading out to people they didn't want on the phone yeah approve the summaries you keep the relationship going with them yeah all you have a bet you can help meet the pricing aspect of it the absence the person finding you as normal to pay I imagine they feel they can get legitimacy information which is it maybe from today so just the whole thing some seem like they've identity the time for you if I don't you get it right sure sure and and let's also remember that the GP does have the final say in terms of the transfer so if they work with you you're pretty sure that they're going to say yes or transfer what would be a minus though of working with the GP approaching the GP what one of the things also good did you probably don't have anything to gain to participate in this sale that's exactly right I mean the GP if they want to help you out they will but essentially once you decide to sell your interest and those of the GP have diverged because you're trying to get the best price for your assets the GP is probably going to be more concerned with getting an LP they like into the fun regardless of the price they're not necessarily going to go around and and and manage a full process for you it's not what they're getting paid for so so that that's the issue you may have some you may have some divergence in terms of overall goals yeah yeah these are functional case costly you need the selling healthy and pushing this extraordinary house essentially the price that they buy at because at the moment that they buy it they own the interest outright however the position is at the point how funded it is I'll just the distributions are in the past so it's not really that that's gone they basically by the time X and everything that happens after time X is their return so for the GP secondary of either a lower price yes well they can and that's one of the the issues but yeah if you buy something at at seven million dollars in the and the current nav is nine million dollars you and theory can mark it up by two million dollars on day one so yeah sorry how did the GPU react to this if they feel that you're kind of the bad there on the bad side of your portfolio you perceive that such they'll probably just try to sell you into retaining the investments and why it is stable well yeah exactly and those are all these sort of the minuses of working with the GP I mean essentially if you're telling a GP I don't really want to invest in you anymore their incentive to have an ongoing relationship with you is not that great and they're certainly not going to you know break their backs yeah I'm shooting at it not be in a situation it was one day off this was actually going to default so it's kind of a situation where it certainly was beneficial for us yeah that's a great point that's we and and we often deal with situations like that where GPS come to us we find in those situations the GP sometimes prefers to find an agent to sort of handle the process which basically facilitates everything they find we find a solution and they don't have to get too involved um so we've talked about the GP approach directly let's talk about the direct auction so basically you are here at Lago you decide to have an auction on your own and contact as many buyers of what what are some of the pluses and minuses of that one anybody use so much information exactly and everyone out there will know that you're selling and that could be one of the issues when we talked about confidentiality and reputational for for the the board of trustees at Lago that could be a something that they really wouldn't like so you do what you do get out there you get different prices from folks but at the same time everybody and then the market knows what you're doing the other option is to just go with one potential buyer but I think it's pretty obvious sure it's confidential so you solve that issue but the problem is how do you know that you're going to get the best pricing by just going to one secondary buyer out there in the market and so finally the last option as we alluded to is using an agent which to a certain extent can solve some some of the issues you're going to have a full auction process so you know that you're going to get more than one price by using an agent you can probably you can stay hidden from the market because the agent never discloses who the seller is so you resolve these two issues you get you get a more diverse pricing set so so those are the the the ways that sellers think about the sale process so let's um let's change sides now and let's take a look at the situation from the buyers perspective so now I want you guys to to place yourselves as a potential secondary buyer and let's look at the portfolio that that we see that we have I can dig it out well first of all who are the who's in the buyer world the secondary buyer world let's let's break that down who are the potential folks out there other okayso hundred bones okay so um so let's say funds of funds right so primary funds of funds so guys who typically invest in other funds on a primary basis why are those guys buying secondaries it's not their traditional business why would they be buying secondaries one reason like they if you have all the LPS or selling at distressed process because there's no net effect or if they want to get out of investment in your muck out of sort of some arbitrage something they can they can pick up a asset that they like at a discounted price yep before Vandermark you usually don't have the J curve because it's more mature fund and and it's probably only five to two seventy years beards on your beard yeah better liquidity so usually a lot of primary fund of funds um put aside a bucket of say 20% of their capital to invest in secondaries exactly for that reason so they can get a bit of a higher rate of return by investing in more mature assets so that that's so fund of funds let's put it as one group of secondary buyers who are some of the other secondary buyers well there's obviously the dedicated secondary funds right we're talking about the collars Lexington's landmarks those guys so those guys do nothing but by secondaries what kind of assets are they looking for typically anybody Daniel what kind of assets you know that typically secondary funds are looking for anyone else can help them out well the scribe well yeah this may be but if let's think about what a secondary fund is trying to do essentially they are giving their limited partners arm the the idea of a secondary fund is to buy more mature asset so if you're buying more mature assets you are essentially giving your limited partners quicker distributions so the types of assets that those guys are really focused on for focused on our older assets more mature fund so they're not looking to buy something that was just raised they're in a different game than the typical fund of funds yeah I have a question yeah I'm not so familiar with the secondary violence problem so given what you said about looking for mature assets so interested in funds that while having distributions coming due soon fire sales exactly so with that basically imply that I was essentially plant manager and the ability to find sort of helping buses within those ones who are having the clarity issues of estoppel is that the primary way they get into to to deals um no I mean they can get in through it through the deal in any way as what I think well the point that I wanted to make is that if you're a secondary fun you're going to let's say for example you want to buy a bane fund right Bane just raised fun ten a couple years ago now that fund has been only about 20 or 30 percent invested a lot of the capital is still sitting there that is not of great interest to a typical secondary fund they prefer to buy state Bane seven or Bayne eight or something where they know the distributions or they hope the distributions are going to come relatively soon so those are the types of assets that they're looking for now if they know some of the other LPS in those funds sure you can you can contact the guys who you think might be distressed and try to strike a deal there so okay yeah possible to map the certain terms of a country and why assets are being sold aside the fact that you'll be looking at here if there is a market there are centers still real and get any people I'm going to go there because mature is not enough fire crisis and I'm sorry so the basically the main question that monetary can Empire compared to they said well that's that's the issue that we face in the market today in the market today we have more buyers than we have well we have more people who want to buy than people who want to sell I should say so that's what's affecting pricing that is driving pricing up because there's a big demand for secondary capital with the large secondary funds that have been raised Goldman raised a five billion dollar fund Lexington is on its way to five billion there's been a whole number of new secondary funds I've raised big pools of capital and they're looking to invit but the mark the sellers have been relatively cautious in terms of selling their assets so that's that's creating a lot of the pricing imbalance so help going back to the previous topic you speak a little bit more about the dynamics of on called capital yes yes in fact we're going to go right to that when we talk about pricing so there's a whole little exercise that I'm going to go through and I'll address that point if I don't please remind me okay so the last group of that I wanted to talk about in terms of buyers are the opportunistic buyers so these are the other endowments and foundations so for example lago itself is a buyer of secondaries so that that's essentially our buyer world now we've talked about the motivations the secondary guys are looking for older more mature assets the fund of funds guys are looking to supplement their investing with something that's also older but now the endowments and foundations are pretty agnostic they're really looking for the types of GPS that they like they want to have continued exposure to if we look at the wish list that we have from Lago it's essentially a mix and match of different types of funds and different maturities and obviously what's driving it is really their interest in those GPS so in looking at this portfolio given what at what I've been talking about we can look at the portfolio in a number of ways we can sort of break it up and see how we would how we would classify this portfolio so now we looked at it at the point of being buyers now I'd like for us to think about if we were the agent on the deal and we're going to structure a transaction here so we've talked about we know what Lago wants to do we've talked about what the potential buyer world out there wants to accomplish so now as the agent we have to bring them together and we have to make sure that this is a successful transaction so how do we go about doing that the key is really to match assets with demand so in looking at this portfolio does anyone have any ideas as to how one would classify these funds what fits together what may not fit within this portfolio what looks like kind of an outlier if there are any or or how you would think about packaging something like this all right oh yeah good I guess at a very high level is kind of a soft scoop the glassy two categories one is kind of venture which seems to be much older vintages um you know maybe they're just taking a while to pay out or certainly to drag on any LP Saturn since they're like 99 mm yeah there's a category is generally more recent vintage buyout funds of varying reputations some of which it looks like you know I've been there Navy is just quite low compared to how much has been contributed yeah mm-hmm yeah I think that's that's great I that's sort of how I looked at it as well I think I would probably take some of these venture funds and package them together because they don't necessarily fit in with the other buyout funds so probably your Austin ventures your menlo ventures your oak and maybe the end the us venture partners you could put that together as one portfolio anything else how about the rest how does everyone feel about the rest of these funds yep go ahead I probably also being on the nice bio basically European and US alright that's another possibility depending on what buyers are looking for exactly any other ideas yeah I would also look into the division between how how much percentage of the fun is been unfunded versus funded exactly to target different yes that and that's an important point because remember unfunded and funded go to very different types of buyers so the unfunded in here would be your advent international your Silverlake 3 the Madison Dearborn and the t PG so you might want to strip those out and do something a little different so I mean that's just some ideas into how we would look at the portfolio obviously we'd have to dig into each of these assets and and and and do a little more work to figure out what the best solution is but as the agent the first thing that you're going to do is essentially get all the documents from the seller meaning and the documents that you need for the latest quarters are the lace quarters yep circuit as an agent I'm talking screw shame cool take a look at the funds and put it back to your clients saying no what I wouldn't a fencepost yeah yeah there's no admin strike record whatever in China has been truly amazing yeah and I hope you've included but this fund can potentially no finger lever you can hold well pitch your client not to sell yeah usually it may be the other way around I mean if something's a great performer then we might then the ideas you might get a great price for it so you might sell advant add a nice premium to nav and so therefore it still might be a good sale even even if it does have great prospects you might however tell them I win sell this one because there's two portfolio companies that are essentially public and whatever price you're going to take no one's going to pay you nav for it so you're going to take a discount on something that's already public so you should just hold on to that that that's the type of advice would give often yeah do you verify a navy so I was just going to talk about that what we do so we collect all the the latest quarters nav financial statements um capital account balance the we look at the GP reports annual reports we look at subsequent flows and distributions and we look at the LPA our job is not to we're not a valuation shop so we're not saying that going to give you what the intrinsic value of this portfolio is our job is to tell you what the market what price you might obtain in the market so we use the information from the documents as well as transactions that we've done in order to give you sort of a range of where the portfolio might trade yep a bit more busy could you please clarify some Oh rose Tiger is because princess dpi or tbpi is not very cute oh sure no problem dpi is a distribution paid in so basically if you look at if you look at Austin the distributions are 0.4 X of what they've put in it so far and T V P I is total value to paid in total value is what is the nav plus the remaining commitment okay so we've done the analysis for Lago where the agent we've done the analysis for Lago we give them an idea of where the portfolio is going to be priced now basically we they have to figure out on their own what they're going to do so they decide to to go ahead with a sale now I've said to you that the market is extremely inefficient and so let me let me give you an example slide 23 I kept on stressing the fact that we really have to find the right buyer for these assets so these are some examples of funds that we've traded recently and kept the name somewhat somewhat out of it but you just look at the pricing differential of I can just this is a Bay 9 that we traded not not that long ago and the pricing that we obtained from a bio is a 33% discount to the March nav but what's interesting is look at where some of the other pricing was with as far as far down as a 70% discount to nav so we're dealing with a very inefficient market where pricing is really all over the board and in order to to transact at the right price you've got to find the outlier so again this is the idea of really being focused on specific assets and matching the right assets with the right buyers the price that we sold the Bay nine was to a family that was essentially interested in getting into Bane so they weren't a secondary buyer they had a they had a close relationship with the partners at Bane they wanted some exposure to them and therefore they were willing to pay a price that was a bit higher than the market now you might look at this and say well why would anyone pay a price that high they must be silly they why they doing that well essentially these guys are thinking that we we have a market clearing price because a lot of the guys offering the 60 70 percent discount they're offering the price but they're not transacting at anything so you've got to look at the motivation of the guys who really want to be in the fund and therefore are able to offer a market clearing price so we've talked about how the app assets fit together let's let's look at each of these portfolios separately let's say for example that we went along with Lisa's suggestion and we stripped out the the venture funds so we've got we've got a portfolio of about twenty-eight point five million if I did the calculations correctly about twenty-eight point five million of a few venture funds with not much of unfunded except for menlo ten so that's a portfolio that we could market to one group we talked about a possible European bucket arm we talked about the unfunded assets which we can market together as well so in the end we decide on three buckets let's say we just go with the venture funds the unfunded assets as well as what I'll call the rest of the main portfolio the reality is the way we typically do this is much more much more complex we have different sub portfolios that we offer to different buyers we do a lot of sort of mixing and matching in order to get the best price but I'll keep it a little relatively simple here now I'm in talking about pricing so pricing is reflected as a percent of nav we talked about premium and discount to pricing um and there's a lot of talk whether funds are trading at a premium or trading at a discount it's relatively misleading and can anyone sort of elaborate on why it's misleading to talk about the overall market trading at a ten percent discount or weather 20% discount is a good price or it's a bad price weather 10% premium is a good price or a bad price it's one of these things that's thrown out in the press quite a bit but it's very misleading to think about the market that way can anyone sort of give me an idea of why that is I can think of two reasons what is the fact that many transactions wouldn't necessarily be occurring at those prices right and the second is you're you're taking a snapshot view of a portfolio but what you're buying is it claimed a cash flow that's being realized in the future which doesn't necessarily correspond to the valuations do that exactly exactly yep got values for folders their own GB so did you get valid yeah that's another I've seen funds that smaller funds South American weather raising capital get that lp's reporting 425 to click the less fun so that write write it and the other thing is yep good now so you have a private home and it's not public traders are open for you to bond which is NAB if you're not doing every quarter from 11:00 they're using our book value or some value that does not follow what's actually today Frank so the enemy doesn't actually represent right exactly so let's say for example that you've got a position that's as of q400 nine was valued at five million dollars and you get a price of a 20 percent discount and then this quarter you get a price of a 10 percent premium well it doesn't really matter because you've got to look at how the na vi's moved so if the nav went from five million to two million then your 10% premium is really not a better price than the twenty percent discount you were going to get last quarter so people often fail to take that into account and throw out these premiums versus discounts as if they're sort of absolutes but you really have to pay very close attention just to how the nav is moving from quarter to quarter yeah this is possible and you actually do this to actually calculate the nav today based on the information that you have from previous quarters and public information we do we do an estimate of where we think the nav should be and also take a look at how soon some of the realizations are going to come come into being because that that's very important when you're going to get some distributions so those that's all part of what goes into play but you do have to take until you do have to depend quite a bit on the GPS valuations because we can't pretend to know more than the GP but they follow up very basic what nav is let's say you have a private company how does the GP value that is that based on cost or is that based on in DC RP different GPS do it different ways some you know some day using DCF some are using comparables so GP is always in their financial statements they'll have a full explanation of how they value those companies usually looking at comparables yeah what about when you have a deals it's a club deal and you have multiple GP value at different marks that happens it happens and so yeah that I mean and that's in a case where basically you know you you find the GP who's got to value the highest and you think maybe I should sell that one and it's it happens once in a while yeah is the volatility the nav mineral sponsors and it was fun yeah I find in in general if I look at what happened over the last year I find that GP said tended to have been quite aggressive and marking their portfolios down so what we notice let me see if I can find a slide that tracks DNA they did you remember what page that was on what we notice was that slide 18 if you take a look at here this is the nav evolution in the last in oh wait a no.9 so you saw in queue 408 a pretty aggressive mark down in the na vi's on especially in a large buyout sector and then there's been and then those guys have tended to to start writing things back up we don't have q 409 but it was probably up another 5% in q 409 so yeah I think it does mirror yes just a quick question so on large buyout Q one of o nine down five percent what happens when you have a situation where the sponsors are telling you we're down five percent and the debt markets suggest that they're down 35% or even 100% yeah well we dealt with a lot of cases like that where we saw a lot of funds that you know we knew the numbers they were publishing were just you know didn't make any sense you know they were essentially relying on comps to prod to price their assets but the equity in their deals was worthless so we saw that quite a bit and and that's why at that time in in q4o aq 109 you if you tried to sell a large buyout fund you were barely getting anything and try selling Blackstone five at that time and your price was probably around zero yeah how much information do the Bears in the secondary market have to be able to what can be the big price yeah the bidders come in really in two groups some of them are in the funds already so they have the information they are able to talk to the the GPS they're able to have the conversation the dialogue and and sort of have a walk through portfolio company by portfolio company the others are taking a look at the docks and trying to organize calls with the GPS GPS come from you know all shapes and sizes some guys are very open to having a dialogue with a potential buyer others are not that interested so essentially these guys have to make a call at the end of the day as to how much information they have yeah what percentage of your clients relay there's not they'll pee themselves but yeah that's actually good question uh last year we saw a big jump up in terms of gatekeepers and actually I think we've got to chart on that too the reason being that a number of pension funds and started to be more active in buying assets but they can't they don't really have the wherewithal to price these things themselves so they have to be hired they're their agents and gatekeepers to do that so some of the groups that are relatively I mean really you name it you know Cambridge Associates and all those guys have been very active in pricing assets for the clients 6% yeah now that makes up 64 that it was it was negligible but now they make up 6% about 6% of buyers okay so continuing with our sales scenario and by the way I had before I go on so we talked about the pricing being done at a reference point the quarter ended all subsequent calls and distributions are netted against the price is that that pretty clear to everyone if it's not so let's say your fund q4 that's in q4 o 8 your nav is 5 million dollars if there was a call of a million dollars after the after that that reference date then that is actually netted against what the the buyer pays calls and distributions are netted so so what I want to do is give you an example and talk about sort of the pricing that that and and also the unfunded so let's say for example that this and this is where we'll get into the unfunded and how pricing pricing effects so let's say there's a fund XYZ that's a 50 million dollar commitment at December 31st 10 million of capital had been called and the nav on that date was 8 million all right so 10 millions would call the nav is 8 million um and this is all at December 31st 2009 then on February 1st another 2 million dollars is called so we're trying to sell this for a limited partner the highest price that we get out in the market is 4 million dollars okay can can everyone tell me the different how we would talk about the price here so what would be the base price how would what what do we quote as a base price let me just repeat this 50 million dollar commitment to fund 10 million of capital has been called the nav is 8 million at December 31 On February 1 there's another call for 2 million we go out there to market this everyone's looking at the December 31st date and the highest price we get is 4 million so what's the base price well as a percentage of nav how would we say that what's the base part what's this good fifty exactly the price is 50% so the price that it's being offered out there in the market is 50% but let's think about the adjusted price and let's see if you guys can figure out what I'm what I mean so granted the base price is is four million dollars but how much is the seller actually going to receive when the deal closes let's say the deal closes on March 25th okay ha exactly so the cell is going to get six million everyone get that because of the two million dollar call so therefore what is the adjusted price well let's think about it so the sellers going to get six million and their nav or their value is the 8 million nav plus the 2 million so 40 50 60 % so 40% discount is going to be the adjusted price okay so that's how we look at these different issues of pricing now another way to think about things that are relatively unfunded because when you're looking at a position like this where 40 million of the capital still hasn't been called what's the goal of the seller a seller here is really trying to get rid of all this capital commitment that's sort of lying around that there for some one reason or another they want to get rid of so we often want to talk about discount to total exposure and I think this is the point that you were making earlier so we want to talk about discount to total exposure so let's think about total exposure total exposure is your nav plus your unfunded liability so what would the discount to total exposure look like on something like this answer basically what does it take for me on this 40 million well the way I would worded is what penalty do you have to pay what price do you have to pay as the seller to get out of this 50 million dollar commitment that you made in looking at total exposure and looking at nav plus unfunded because the typical way we look at the pricing of the secondary market is just to look at the nav but now in a position that's so unfunded we want to look at the total exposure because a lot of the exercise here is to get rid of that future commitment liability so what with these numbers that I've thrown out I'd like to see if anyone can figure out like what would the discount the total exposure God media and you are getting off 46% is it it 46 or 44 or okay close but all right so it's so it's 8% discount right did everyone understand how that was done that pretty clear sorry guy Oh yes but you wanted to yeah that's a different situation in a lot of those funds frankly the GP lowered the font size another example of that is a Sun five where the GP cut the fun size by 20% because essentially all the LPS felt that they had given too much capital and they wouldn't find the opportunity to invest in that so it depends on what you know what the overall the feeling in the market is out there but it's essentially kind of the same exercise yeah when you come down the pub side what happens to the management fees that you're abused on daughter - um that's a good question that's a good question I don't think they're returned I don't know what they did on Sun five do you know - I don't know I don't know so we so we've looked at selling funded and unfunded to get the idea of of a discount to total exposure versus the base price - nav so those are those are all the way that that we look at transactions in in our business the last part I want to really go through is sort of the closing and the transfer process and then I'd open up to questions if anyone has anything they want to they want to cover the closing process once you find once you have a buyer that that you can agree with on price we move to usually the purchase and sale agreement signed between buyer and seller which outlines the terms of the closing the price all the schedules that that define the position at the specific point in time the one of the funds on here I believe has a right of first refusal it might be Silverlake - how would you get around a right of first refusal if you're a buyer is that something can be done do you just or how would you feel about a right of first refusal if you're a buyer let's let's start with that actually this work yeah yeah and yeah usually breakup fees hard to do but yeah you'd want to get compensated by that you guys ain't no information ass so I think I know that yellow piece of the photo like Harper Dalton yeah you know people who were actually selling yeah you could yeah right the depends yeah depends yeah I want that fingers to card I feel pretty badly for the winners curse so in this case you if you bid for this and you set the prices on can match yeah and then the other all these in the fun to have more information if they know the price is worth it they can just close at that yeah and if they let you pass with is because you gave a person was too hot yeah yeah exactly so right so you essentially are setting the market price and then allowing everyone to come and take it away from you after you've done all your work so it's not a nice thing to have so how do you get how can you potentially get beyond that one of the things folks often do is if you're bidding for a portfolio and you have there's multiple assets and one of them has a right of first refusal you basically assign prices to each fun and the fun that has a right of first refusal you bid at a 60% premium and you're pretty sure nobody's going to buy it at the 60% premium right so you essentially allocate your pricing amongst the portfolio did everyone I see some blank stares so you basically yeah so it's not the the fund that has the right of first refusal refusal to write a first refusal you bid at a much higher price way above the market price and then you take away from the pricing of the funds I don't have a rover because it doesn't matter you can you get as long as the seller just wants their overall price so they don't care how you allocate the different prices among the different funds but for the fund that has the rover you have to alert the GP the seller has to alert the GP to say that I'm selling this fun at this specific price so then when you allocate the pricing among the different funds the seller can say to the GP I'm selling your fun at a 50% premium who's going to do better than that in what sense Oh multiple chains yeah for Jase five finds and it's a package so remaining oil remain for that that only roads obviously if the sellers bundling portfolio but then it's a salad or probably want to break down before you try to maximize funds and then well there's trade off whether in the circus yeah it depends I mean you probably you're gonna want to break up funds but that doesn't mean that you're going to want to sell funds individually you might package say four or five funds together and find a buyer that's really looking for that package and when you have that package then you can you can diversify the prices pigs up weathering everything or selling exactly exactly are there teen liability issues associated with that if you're sort of allocating value disingenuously um I mean to be honest with you not sure that it's real I don't know point never and we have a lawyer you know I mean you're really just allocating assets it's not like it's not like you're saying this is it's not like the market always says that this is worth that let's say for example you sell let's say these guys had sold Bain 10 at a 50% discount does that mean that Bain 10 is worth 50% of the nav does that mean that Bain 10 has to write down there an AV because that's the price at which it's selling out not necessarily it's really just it's just a market of buyers and sellers so it's not really setting any it's it's not really sort of setting a market price or selling a valuation which is what I what I'm trying to say yep this raises a question of like the secondary market has developed for private equity for LP interests has caused changes torpedo makes some terms and funds less favorable than they used to be are there any others other than the one you mentioned that have come under scrutiny or have changed since it's my personal that's what you mean that the GP is actual terms like you said the right of first refusal oh god foreclosure yeah to the second arrow is the only tremor yeah yes yeah we're actually seeing fewer rights of first refusal because the right of first refusal is a bit of a pain for the GP the the reason they started it or a lot of them had it was because some of this big secondary firms basically started saying to a lot of help the GPS will invest in your fund but we want to make sure that when there's a secondary I mean that they would say we'll invest in your fund on a primary basis but we want to make sure that when there's a secondary we have access to it so the GPS wrote it in the LPA that oh let's put this right of first refusal to make sure that these guys have a first look whenever there's a secondary the problem now is all those guys who have rights of first refusal it's a huge administrative nightmare I mean - - because so many people are trading these funds right now can you imagine being in sun five we traded over a 150 million of of commitment in some five last quarter or two quarters ago it's if they had had a row four it would have just been a huge administrative nightmare for them so a lot of we're seeing a lot of GP is actually moving away from these types of things the only issue we come across where GPS may be a little bit sensitive to the secondary market is if they're actually currently fundraising one of their another the subsequent font because obviously if you can go into fund X minus one you may not go into if you can buy fund X minus one you may not go and invest on a primary basis and fund X so so a lot of times they might say while we're fundraising we're not allowing any transfers that that's one of the things that we've come across it's probably the most important one to answer your question yeah so this is a how the GPS get around the trick that I just mentioned if there's a right of first refusal and if a secondary buyer is putting a premium on these would probably get upset that is no no not really GPS don't really care I mean because remember the GP ultimately always has the final say in terms of whether they want to allow the the lp or not right no matter what the price that the GP allows the transfer so if it's an LP they definitely don't want then even if you weigh over bid on the pricing you're still not getting it so the GPS don't really care about what pricing you get like I said if they had been trying to please you know a secondary buyer who wanted to have access to the funds well if it didn't work out didn't work out it's not the GPS fault and like some people have already alluded to sometimes just being able to facilitate the exit of an LP that couldn't couldn't commit or was a facing default GPS prefer to just find a solution to the problem that that's generally what we find more and more um well I should see more and more but some GPS are starting to work with qualified matching service the reason they do that is to not exceed the amount of any fund that can be traded in a given year certain funds there's actually I don't know the details of the law but there's a threshold that a fund can't be traded at more in a given calendar year and after you exceed that threshold there is a possibility that the fund may lose its exempt status so obviously that would be the worst situation imaginable for a general partner so in order to manage the transfer of funds they set up a qualified matching service which oftentimes means that only a specific amount can be traded per quarter and usually it's every quarter end sometimes every half year and the GPS monitored the volume very carefully so for some funds that have been heavily traded you can have a backlog of things that are waiting to be transferred at a specific date there's a number of funds that we traded in March or April of oh nine that closed Jan 1 2010 because we had to wait for the for the the the window to open up for the buyer and the seller it makes no difference it doesn't matter because the moment you sell the moment you sign the purchase and sale agreement all the cash flows get Trude up so you just have to wait a little bit longer to actually get your money but it the city the the sale happens at that date anyway yeah in fact way in some cases let's say you're training the backbone of company X if you want to sell this or else the company in sugar process if they know what's this then the you mustn't banks usually write some kind of David contracts where you just pass through those and in return you get something yeah so you don't care about yeah yes it is it is there there have been issues where an LP wants to sell and the GP will not allow transfer so you do a swap essentially a swap agreement it happens quite a bit there are some legal things you have to think about they there are laws that say that essentially if you are getting the cash flows then you're the owner and you have to declare yourself as the owner even if you're not officially the owner so those are all things that you that have to be taken into account sometimes especially if it's a international investor there are other laws that that come into play so it adds a degree of complexity to it but it does happen quite a bit and we'd call this you know something we call a structure transaction yeah from these tax issues see the process is made you have your very specific kind of corporation to conduct private entities so jeweled is synthetic you will not be given via legal folding it for the tax reliefs maybe should be that's a very good point and I missed that that was another thing that we faced is is it and again especially on the international side where there would be tax issues involved so all these things have to be taken into account which is why the majority of the market functions as straight sales there's a lot of talk about structured transactions but oftentimes the the legal fees associated with these with these transactions are just prohibitive and so most of the market is straight sales yeah if you project forward say 10 15 20 years how do you see this market do you see it becoming an efficient market by liquid very low spreads a lot of regulation or do you see it remaining as this just the one on one negotiated transaction test 10 20 years that's I don't know I I don't even know like next year what this markets going to look like but um I think my feeling is as long as the general partners have the keys to the information and the final say in terms of the transfers that this market will tend to continue to be highly negotiated there have been some there have been some efforts to set up things that are close to exchanges try to transact these uh you know on broker screens or online or things like that to a certain extent I think that stuff is still relatively a very minor part part of the market and and most of it is really more of this type of highly negotiated one-on-one type transactions and again I think that's because the GPS have the final say and and the the information out there is quite a symmetric you know yeah point you know selling secondaries and helping Nelson's response yeah probably have a pretty market otherwise also program a framework yeah uh-huh the question is where the fire was ever thought to company yeah I mean we have to fundamentally change our business but we have like the knowledge of the network if you ever decided just storage yeah what is your mind yeah well the difficult part for us would be that half of our business has been relationships with general partners so we've raised capital for them we've given them strategic advice things like that how to raise their fun how to structure their funds one of the things I don't talk about but we work a lot with new funds we worked with a very large family that was that had a public business and they wanted to start they wanted to create a private equity fund so we work with them for over a year in terms of the issues they would have to think about so because we're very we're an advisor to the GP community as well it'd be difficult for us to become you know a paid advisor on the LP community also in terms of them investing in funds you know and being a gatekeeper but you know our business is always evolving but that's not that's not an area that we've really kind of done much work on oh yes go ahead you know some of the just curious as to whether they're any lasting fallout yeah no that's that's a very good point um lasting fallout I would have to say no I think for a while we were being cautious in terms of who we were calling and and you know who we were calling on and and getting in front of but one of the things that I think's been rather positive about what's happened with with New York is that it's tighten the standards of what a placement agent should look like it's the the goal was really for all agents to be licensed with FINRA all things that we've had for a very long time so it's essentially kind of weeded out the folks that were just you know relying on on relationships and kickbacks and so on to to get further in the business so for us it's been a pretty good thing and and the markets seems every reacted the same way yeah sharing information about what these are like for a secondary business yeah sure yeah that's probably most important thing yeah generally the fees are a percentage of the price of the price or the value that the seller receives so for example if you sell a 10 million nav fund at 8 million dollars and you receive cash of say eight and a half million because there were some subsequent calls our fee is a percentage of that eight and a half million and the fees usually between two and three percent that that's the the general range fundraises yeah for fundraising it's similar well we do all types of different different arrangements but typically it's 2% on new money no no working process oh yeah yeah sure we have so we have partners in all three of our offices whose job is really to monitor the market and find the GPS that we want to work with on a given year we'll probably work with eight to ten general partners and we try to diversify it in terms of strategy geography and size so we want a buyout fund a venture maybe a venture fund these days maybe not let's see energy mezzanine we want to work with some guys in Europe we want to work with guys in the Middle East so if you if you want to only do 10 funds there's only so many that you can look at so our partners are constantly on the road meeting with GPS we we find the ones that we really like we sort of run through the numbers look at the story we discuss internally whether we think this is a group that's going to work we have our folks who deal with the limited partners figure out whether this is something that's going to have demand and then and then we'll basically pick a GP so that's the typical process so you had a question whether you participate in the other side selling and probably that has never unity of ten you sell that for twenty just yeah yeah definitely oh yeah yeah definitely no we've had many many agreements where if we can sell a portfolio at at a ten percent premium for every percentage point higher than that our feed doubles or I mean you know incrementally doubles or something like that so yeah obviously yeah different I mean we tried the most important thing is to be aligned with our client which is why we won't always take a percentage of the actual amounts of capital that they that they receive yeah what's the normal duration start to finish on one of these transactions I love when people ask questions where I have a slide there so typical I would say anywhere from 10 to 14 weeks and that is you know I can go through the stead of preparation is really collecting all the documents outlining a price for the potential for the seller giving them an idea of what issues how the portfolio should be structured the documentation is giving access to all the potential buyers the information that's out there the contacts were very focused on limited auctions we want to make sure that we invite the right people to the process not folks that are going to make the process dilutive interim discussions is when the the potential bidders analyze the portfolios we usually give them about three weeks to do that and then the first-round offer all auctions are done in a two round process first round we weed out the guys that are not going to make it to the second usually second round is anywhere from two to three folks again they get to do some due diligence with the GP gets it speak to the GP talk about the portfolio companies fine-tune their pricing and at the end of the final offer is in the form of a binding letter of intent review that with the seller any last-minute fine-tuning and and we have a signed LOI then usually you probably want to allow two to three weeks for the purchase and sale agreement that's when you get the lawyers involved those guys take a long time you get your purchase agreement then you've probably have to allow another three to four weeks for the GP consent so you have to send the seller has to send a letter to the GP saying I have found a buyer I'm interested in selling my fun I found a buyer at this price maybe doesn't have to disclose the price to pay that depends on the terms and then has to wait for the formal okay from the GP once all those things are done you have the transfer and the closing and wiring and like I said 10 to 14 weeks it's typical yeah just a quick question how surgical is that yeah it depends so if it's if it's a buyer that's already knows the GP and has followed them very well it can be pretty pretty light but if it's a GP that they don't know and the fun documents are not all that clear then you're gonna have some guys we really want to gonna going to want to dig in and do sort of a top-down analysis of every portfolio company so it really depends on on the GP yeah yeah and that's a good question um we had a situation recently actually where there was a fund that we were raising and we had one client that had their prior final portfolio and they were looking to sell it our advice given that we knew the GP quite well our advice of the client was now might not be a good time to do this because as this fund is raising currently they're going to be very demanding about the transfer and some one of the things that a lot of funds who are raising guys we're raising funds do they do they request staple transactions in the sense that they say ok let's say you want to buy my fun - or you want to buy fun - from this seller I'm going to say you can I'm only going to approve the transfer if you also commit to my fund 3 it's called a staple transaction very unpopular with buyers unpopular with with everybody and the market is really moving away from that but GPS um GPS are still rather adamant about that yes given your position is a placement agent you probably you see a lot about what is happening with the countries situation we've heard quite a bit about the effect of the crisis on fundraising in card equity yeah I mean fundraising has been quite tough David do we have any stats on the latest fundraising environment I'm I'm not sure but it's been it's been a tough environment for sure um I would say the areas of the fundraising environment that have been probably more robust are distressed GPS raising for distressed investing secondaries investing has been rather robust mezzanine has picked up a little bit as well but on the traditional buy outside it's been it's been pretty rough going and like I said earlier we try to have a pretty diverse offering in terms of the types of funds that were offering to our clients so we were working with a group in the UK raising a distress fund and they had a stellar reputation and we were able to raise that in three months and it was oversubscribed and this was in 2009 in the depths of the the bad market so so they're 50% less so the overall overall fundraising environment was 50% lower in 2009 so obviously it suffered and especially I would say on the the middle the buyout market in general certainly big buy yeah we we probably saw people being a little more flexible about management fees we heard about groups getting rid of the 2% and essentially defining a management fee number that they allocated between LP so that was something that was talked about you know probably I think we're done with the 30 percent carry that that that doesn't seem to be happening much anymore those are some of the the things that that we saw your prediction on how many buyout forms will go out of business I you know it's hard to say I sometimes I looking back in in the oath o 1 o 2 O 3 I thought there were a lot of groups that wouldn't have survived and somehow they managed to so I don't know some some guys make it and others don't but not sure the size that's your the size of Montana has decreased quite a bit that's for sure yeah there was a lot of talk about the denominator respect hovering down Federation because of how out of whack it was relative technique there's been a return of equities right see the valuations come back up do you still think that that is going to be a cause of concern or foil piece or do you think that that's not a reason anymore for them that to continue investing in the private entry point I I think a lot of LPS have resolved more or less some of the denominator effect issues that this many of them still are slightly overexposed but not as much as they were obviously I think it's still going to play a role though a lot of these guys are looking at the situation rather carefully they don't necessarily want to do anything radical so they're sort of going to wait for the denominator effect to solve itself over time so that's definitely that's going to slow down fundraising in my opinion one last question okay thank you okay thank you

Channel: Wharton School

Views: 98,363

Rating: 4.9223299 out of 5

Keywords: private, equity, class, finance, lecture, Triago, business, documentary, private equity, deal structuring, school, Wharton

Id: C51On8YmGCw

Length: 80min 11sec (4811 seconds)

Published: Thu Feb 10 2011