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Big private equity backers have raised concerns that some of their peers may be waving through controversial deals where buyout firms sell companies to themselves, adding a fresh twist to worries about conflicts of interest inherent in the transactions.
Investors, including one big sovereign wealth fund and one of the biggest US public pension plans, told the FT they were worried about whether some institutions rubber-stamp asset sales to continuation vehicles when such a deal could benefit their other business lines.
Some large private capital firms invest in traditional buyout funds and also have secondaries businesses that back continuation vehicles — the dedicated entities set up by buyout firms to purchase assets from their older funds.
The head of investor relations at a large international buyout group said that certain US pension plans were now objecting to procedures whereby just a small committee of a fund’s backers tend to vote through the sale of one or more portfolio companies to a continuation vehicle.
There have long been worries about whether private equity firms themselves could be conflicted when a continuation vehicle buys an asset from one of the manager’s older funds. But investors in the selling funds are now questioning whether their peers have potential conflicts in deciding whether assets should be put into continuation vehicles.
The rise of continuation vehicles, which accounted for roughly a fifth of all private equity exits last year, and the growing pool of money dedicated to supporting such transactions have underlined concerns about occasions where private equity fund investors could find themselves on both sides of a transaction.
Some institutional investors are demanding that a wider group of fund backers be required to approve selling assets to continuation vehicles, the private equity executive said. Backers of buyout funds “don’t love [continuation vehicles] as a way of exit”, the person said, adding that “they want greater consultation”.
The US pension plan told the FT that “limited partner advisory committees are becoming increasingly conflicted”, referring to the industry term for backers of buyout funds. They added that when committee members’ employers also had strategies dedicated to backing continuation vehicles, “it’s hard to know which interest they’re serving”.
Private equity groups have turned to continuation vehicles in recent years, either to avoid selling companies at lower valuations in a difficult economic environment or to stay exposed to their best-performing assets.
Last year there were more than $100bn of sales into continuation vehicles globally, up from about $70bn the year before. This compares with $7bn or less in 2015, according to Jefferies.
One investor described a recent incident where multiple members of the limited partner advisory committee on the fund selling assets to a continuation vehicle were employed by institutions whose other business lines would be investing in the same continuation vehicle. “They were quasi-insiders,” the investor said.
Another private equity executive said they had seen two recent instances of multi-strategy firms using potential commitments to a private equity firm’s future buyout fund to help secure preferential access to the same firm’s continuation vehicle.
Investors in a fund selling assets to a continuation vehicle are typically invited to cash out their stakes or reinvest in the new vehicle, usually after the buyout firm has completed a bidding process with third parties to set the price.
The US pension plan executive suggested that bidders could offer to pay higher management or performance fees in a new fund “in exchange for a cheaper price” on the continuation vehicle.
Firms such as Hamilton Lane, HarbourVest and Partners Group run both business lines. The firms, which declined to comment, have not been accused of any wrongdoing.
One person from a multi-strategy group said that, where two business lines were involved in the same transaction, the buy side was represented by a separate investment team, avoiding the potential conflicts described to the FT.
Another multi-strategy firm said that it recused itself from the selling fund’s committee where its other arm was on the buy side. It added that it was not market practice to offer commitments to future buyout funds in negotiations over continuation vehicles.
The Institutional Limited Partners Association recently released guidance on information that buyout groups should share with a selling fund’s investors about any side incentives received with each continuation vehicle bid.
“Describe any factors that excluded or favoured certain acquirers,” the guidance said. “Are there benefits that [you, the buyout firm] is receiving as part of the deal?”
Mustafa Siddiqui, founder of dedicated secondaries firm SQ Capital, said “multi-strategy platforms inevitably come with conflicts of interest because they have to manage the competing interests of different businesses with different investors”. He added that walling off confidential information within each business line was “easier said than done”.
