Staples on LP stake sales in secondaries

This article covers:

• what a staple is;
• the reasons for a staple;
• whether this is a standard approach;
• staples from the buyer’s perspective;
• what the impact is on pricing of the secondary component; and
• the interplay with GPs’ control over the secondaries process.

What is a staple?

A staple is a term used to describe a scenario where a GP requires the buyer on a secondaries transaction for an LP interest in one of its existing funds to also simultaneously commit new primary capital to another vehicle sponsored by the GP – in essence, the GP “staples” a fresh commitment to a new fund that is being raised by the GP onto the purchase of an interest in an existing fund. A staple may also arise in the context of a tender offer, a co-invest or a GP-led transaction. Whilst this article focuses on a staple on an LP transfer, many of the same issues arise on a GP-led or co-investment.

Why a staple?

By seeking a staple, a GP obtains primary capital for future vintages whilst the existing LP is able to access optional liquidity through the secondaries transaction. This allows the GP to actively manage their investor base and to obtain new fund commitments. Where a fundraising process may be lacking momentum or where the fundraising market is difficult, the introduction of a staple alongside a secondaries transaction can be a useful tool for GPs to access fresh capital and provide a boost for a new fund.

Is this a standard approach?

Whilst the requirement of a staple on an LP trade is being sought by some GPs when approached by existing LPs, it has by no means become the standard approach on secondaries transactions and stapled secondaries still only make up a minority of transactions seen in the market. A GP’s relationships with its LPs is of paramount importance to GPs, and maintaining these relationships must be balanced against the GP’s desire or need for a staple.

From the buyer’s perspective

From the perspective of a potential buyer, a staple presents an opportunity to expand such buyer’s relationship with a specific GP, and also to increase its exposure to a particular investment strategy. This can be particularly attractive if the GP is one which the investor desires to build a stronger relationship, or if the fund otherwise aligns with the investor’s strategic priorities.

Conversely, as many secondaries buyers are looking to deploy capital quickly, the idea of an unfunded commitment to a new fund through a staple may make a transaction less compelling compared to the more straightforward opportunity of the purchase of the existing LP stake, particularly where the buyer’s investment strategy is focused on the secondaries market.

Impact on the secondary component

Pricing will be one of the most important considerations on a secondaries transaction, including where there is a staple. The pricing will be influenced by the ratio agreed between the GP and the prospective buyer, which will depend on many factors, including whether the staple is a commitment to a new fund without a portfolio of assets or if it has made some investments already.

Whilst a ratio that is less than ideal for buyers may frustrate the secondaries process if the GP continues to insist on such a ratio, a ratio more favorable to the buyer may lead to stronger pricing as well as more interest from other prospective buyers.

Interplay with GPs’ control over the secondaries process

A secondaries transaction is usually subject to GP consent to be granted at the discretion of the GP, as set out in the fund’s governing documents, without which the transfer cannot proceed. Typically, such consent is in the GP’s sole and exclusive discretion, without any limitations or qualifications. Accordingly, the GP is often within its rights to refuse consent for any reason or no reason. The buyer will need to ensure that any subscription to the new fund under the staple is conditional upon closing of the transfer of the secondary.

Conclusion

If a staple arises on an LP stake sale, the different parties will have different considerations to keep in mind. For the seller, it should consider how this may impact pricing and execution risk, particularly in the context of a portfolio sale. For the buyer, it will be whether the staple is an opportunity it wants to take up along with the ratio agreed with the GP and pricing. For the GP, it will be a case of striking a balance between executing the staple whilst keeping potential investors happy.

Authored by Ed Harris, Adam Brown, Leanne Moezi and Lily Wu.