This article covers:
- what a GP-led is;
- why elections matter;
- a summary of election notices;
- an overview of issues that can impact execution;
- other points to note;
- tax issues for rolling and selling investors; and
- how to be prepared for election processes.
1. What is a GP-led?
A GP-led transaction can take a variety of forms, but for the purposes of this article we have defined it as a transaction where a sponsor-advised fund initiates a sale of one or more of its portfolio companies to a newly formed continuation vehicle managed by the same sponsor (also referred to herein as the “GP”), but with a new set of LPs.
Practitioners often refer to a “sell or roll” election that existing LPs will have to make, i.e., either the LP elects to take its pro rata share of the proceeds generated by the GP-led transaction net of costs and carry (the “sell” option), or the existing LP elects to rollover such proceeds into the continuation vehicle. These transactions are typically structured so that existing LPs can elect either to (i) retain their investment in the target asset(s) (which may be on a tax-deferred basis through a “rollover investment” into the continuation fund); (ii) sell their investment in the target asset(s) through a cash-out process; or (iii) do a combination of both. It is also common for the GP-led transaction to provide that the failure to submit a proper election by the stated deadline will be treated as a sell (i.e. cash out) election.
2. Why do these elections matter?
Once election notices are delivered to LPs, the LPs’ investment will, absent an affirmative election to “roll”, be sold at a price set by the parties involved in the GP-led process, which will typically be established through an intermediated auction (and potentially supported by a third-party fairness opinion). Accordingly, LPs will need to review the materials provided to understand how the price was determined, the motivations for the transaction, whether it would like to retain its exposure to the investment (in full or in part), the economic and commercial consequences of electing to retain an investment, and the tax consequences of its election decision.
Existing LPs have to make a commercial decision, and often very quickly, about whether or not they are happy with the price offered, along with whether they want continued exposure to the asset or portfolio. In addition, if they want continued exposure that could be for a longer term than under the existing fund, they may have to provide a fresh additional commitment in order to elect to invest in the continuation vehicle.
3. Election notices
An election notice is effectively a disclosure document with an investment election form attached.
The election notices will vary in form from deal to deal, but generally they address the same substantive matters:
- description of the transaction;
- description of the process undertaken;
- risk factors;
- key disclosures, for example, conflicts of interest, consequences to the sponsor (such as crystallization of carry and management fees), financial statements and tax consequences to elections;
- summary of the key terms (for both rollover and cash-out), attaching the definitive documents; and
- election form – this may include an option to invest in the continuation vehicle, with or without a new commitment (if the option to choose has been provided) to the continuation vehicle, sell, or both.
4. Issues that impact execution of roll/sell elections
The election process
The default option (i.e., if no election is made within the stated timetable) will typically be to sell. Most GPs seek to comply with the U.S. tender offer rules, which require the election period to remain open for 20 business days. The election notice may be a substantial document to review and may arrive without any pre-warning.
The structure of the rollover vehicle
If complex new tax structuring underpins the new vehicle then this can make it much harder for existing LPs to assess the tax risk of rolling over, particularly where the existing LP has several underlying clients with very different tax concerns.
One point to consider is how the existing LP has invested. It should be considered whether the process can accommodate a feeder vehicle structure or changes to such structure, as the feeder vehicle structure of one or more existing LPs might not be appropriate for the rollover investment.
The terms of the new vehicle
The terms of the new vehicle and the terms of the rollover option may have a material impact on the “sell” or “roll” volume. A status quo option, which is intended to allow existing LPs to be able to rollover on largely the same terms as the existing fund, will minimize the changes the rollover LPs have to consider and may increase the “roll” volume. A requirement to invest on new terms in the continuation vehicle together with a requirement to increase the size of the existing LP’s investment (i.e. in order to rollover, the existing LP needs to take on unfunded commitments (further described below) to the continuation vehicle) may increase the “sell” volume.
Issues to consider when reviewing the terms of the new vehicle include those typical for any investment decision, plus some additional considerations unique to a rollover investment (for example, whether there is a new commitment; whether the economic terms of the investment (such as carried interest or management fee rates) have changed; whether there will be future valuation conflicts with investors providing new capital; and whether tax will be triggered despite retaining exposure).
The terms of the election notice will dictate the choices of the existing LP. Both the new fund terms and the sell volume may place control of the new fund in the hands of the new investor and the GP (for example, fund extensions). If the existing LPs can roll over on different terms to the new investor, or if there is no additional undrawn capital included within the structure, then this can create misalignment. When determining whether or not to rollover, it is important to review alignment and the thresholds for LP consent matters.
Mandate of the existing LP
It is important for an existing LP to assess whether it has the flexibility and mandate to elect to rollover, particularly if additional commitments are required.
In the event the mandate of the existing LP is expiring, it should be considered whether the election process allows affiliates of the existing LP to step in (i.e. for the existing LP to cash out and the affiliate LP to invest).
Where the existing LP is going through its own secondary sale process, it will need to confirm whether it has built in enough flexibility under its purchase and sale agreement (the “PSA”) for this separate sale to make an election to sell or roll.
Existing LPs may have older forms of side letter signed up when they made the initial investment. Such LPs may have developed new forms of side letter (with new “must-have” requests). If this is the case, questions to think about here include: Will the GP allow existing side letters to be carried across? Will the GP allow new side letter requests? Will the GP allow any comments on the new fund terms, such as side letter requests to deal with issues of alignment?
5. Other points to note
GP release
Some election forms may include broad releases in favor of the GP, which should be carefully reviewed.
LPAC waiver
GPs will typically obtain the Limited Partner Advisory Committee’s (the “LPAC”) waiver of any conflicts of interest, which is separate from any LPAC consent or approval. It is important that the LPAC’s role is understood. If an LP is on the LPAC and is asked to sign any waivers or consents, it should ensure it understands the duties (if any) owed to the Fund or LPs before taking action.
6. Tax issues for rolling or selling investors
The tax implications are often broadly the same for both rolling and selling LPs. Any rollover is unlikely to be structured to be tax neutral for all investors or potentially only for investors in one jurisdiction (we see this more frequently on transactions with a predominantly U.S.-focus and with U.S. investors that are structured to defer any gain arising to investors). If not tax-neutral, the rollover will likely be treated as a disposal (followed by an acquisition of a new asset) and will crystallize as a gain for both taxable rolling and selling investors.
As set out above, there is a need for rolling investors to understand the post-roll investment structure as this may not be identical due to any tax or other changes. Other tax considerations are broadly similar to a secondary transaction (for example, non-resident capital gains or withholding taxes such as ECI or FIRPTA and transfer taxes).
7. How to be prepared for the election process
Given the time pressures of the election process, LPs would be well-served to have a protocol in place for dealing with any roll/sell elections from receipt of election process up to the final decision.
Investors should ensure they review any election documentation promptly after receipt and communicate the timetable internally. It is important, as set out above, that investors assess GP’s motivation when considering the GP-led transaction. Be sure to commence internal assessment of the value of the relevant asset or portfolio as soon as possible. Consider engaging any professional advisers early on in the process.
During the process, LPs should review any existing side letter(s) for the relevant fund against any updated side letter template and identify “must haves” and any red flags.
Investors should ensure that any concerns with the process are communicated to the LPAC or the GP and that side letter requests (if relevant) are communicated to the GP at the earliest opportunity.
