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| Willis Stein & Partners | |
| Size | Recapitalization of private equity fund Willis Stein & Partners III and its associated general partner (fund manager) Willis Stein |
| Date | August 2012 |
| Financial adviser | Moelis & Company |
| return to the Global Deals of the Year index | |
Many of the perceived shadowy corners of the global financial system have had a spotlight cast on them in the wake of the 2008 credit crisis, highlighting some acute problems that might have otherwise remained in the shadows.
For the private equity world, the emergence of so-called zombie funds and companies, with the latter often owned and controlled by the former, is a particularly worrying problem, which could be expected to get a lot worse.
Zombie funds are private equity funds that have reached or passed their expected wind-up date without returning capital to their investors.
They are unlikely to make a profit – or even, in many cases, return investors their capital – yet there has been little prospect of many of them being wound down or restructured successfully, at least until now.
In a groundbreaking deal last year, Moelis & Company solely advised and engineered a recapitalization of US private equity fund Willis Stein & Partners III and its general partner or manager, Willis Stein.
On completion in August, it was the first ever successful, comprehensive and contemporaneous restructuring of an independent private equity investment vehicle and its manager, and as such could provide a blueprint for similar transactions to follow.
“The Willis Stein transaction establishes a new framework for thinking about these types of situations,” says Stan Lai, managing director, Moelis & Company in New York. “We believe over the next three to five years we will see several vintages of funds that will face similar challenges.”
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| Stan Lai, managing director, Moelis & Company in New York |
Indeed, of the roughly 10,000 private equity funds raised over the past decade, at least 200 now qualify as zombie funds, accounting for as much as $100 billion of the $1.5 trillion currently invested in these vehicles, according to consultants TorreyCove Capital Partners LLC.
Furthermore, Coller Capital, one of the biggest global investors in private equity’s secondary market, estimates that 57% of private equity institutional investors in north America have a stake in at least one zombie fund, compared with 41% of European and 50% of Asia Pacific investors.
Troublingly, this figure might well rise, with the maturing of funds raised in the boom-time years of 2005 and 2008 largely failing to deliver good overall returns.
So how do general partners and limited partners deal with this problem?
Historically, there haven’t been too many options other than trying to sell the fund’s assets at a steep discount on the secondary market, or simply winding up the fund itself.
However, a fund’s assets can usually be sold only one by one at fire-sale prices, if at all, while there is little incentive for the fund manager or general partner to wind down a fund, because it continues to be a source of fee income.
In the Willis Stein restructuring, however, a new option has emerged.
The transaction was structured as a merger with a newly capitalized entity and included a consent solicitation process requiring majority approval, which was attained, from existing limited partners. A merger subsidiary was then established and capitalized by a consortium of new investors, which included funds affiliated with Landmark Partners, Vision Capital, PineBridge, other co-investors and existing rollover investors.
Concurrent with the merger transaction, assets that could be liquidated were spun off into a liquidating vehicle in which each existing limited partner received its pro-rata interest. The merger further provided each existing limited partner with the ability to obtain full cash liquidity for the remaining interests and/or roll its interests on an ‘advantaged economic basis’ and continue as a limited partner in the merged partnership.Two other interesting aspects of the transaction centred on value and financing strategy.
On the valuation front, limited partners that elected for the cash liquidity option received aggregate value for their interests near net asset value.
A majority of the limited partners saw better value in this approach compared with the potential value that could be derived from either a forced sale of assets (within the remainder of the extension period) or through a sale of an existing limited partner interest in the secondary market.
On the financing front, one of the challenges was navigating the balance of participation among new equity capital and potential rollover equity capital.
As such, the subscription amount of rollover equity would not be determined until the consent process was complete and, as such, a parallel debt-financing process was conducted to provide ‘standby flex capital’ to fund any capital gap in the transaction once the level of appetite for rollover equity capital was known.
This was obviously a highly complex transaction, but its structure and success could prove to be a valuable guide for future restructurings.
Ultimately, the capitalized vehicle effectively realigned the interests of the general partners and limited partners, providing an exit alternative to existing LPs electing liquidity, and an extended fund life with general partner economics calibrated to the interests of new and rollover LPs.
“Every situation will be unique because the dynamics surrounding each fund and fund manager are, of course, pretty specific,” says Lai.
However, he adds: “As you consider the elements of this deal, there are strands that you can draw from and apply to other situations that may benefit from an alternative solution or path forward that historically may not have been available or apparent to these groups, both on the investor and fund manager side.”
