Big private equity backers call for greater scrutiny of sweetheart deals
Concern that investors are insufficiently prepared to challenge buyout firms on deals involving potential conflicts
Big backers of private equity funds have called on their peers to avoid waving through sweetheart deals by buyout firms without properly engaging with or challenging fund managers.
An influential body of some of the world’s biggest private equity investors has set out detailed expectations of investors sitting on fund governance committees when managers propose to sell the vehicle’s holdings to themselves.
Committee members should be “fully prepared for meetings with the requisite experience to engage, and where appropriate, challenge the [buyout firm]”, the Institutional Limited Partners Association said in new guidance on continuation vehicles.
Buyout managers have increasingly turned to continuation vehicles — new funds that they raise to buy companies from their older funds — in a difficult market where they have struggled to sell companies to third parties.
The call by ILPA comes after the FT reported that buyout backers had raised concerns about the effectiveness of small committees of fund investors that traditionally approve or veto actions by managers, after an explosion in popularity of the conflicted deals.
Continuation vehicles, which allow private equity firms to hold on to companies in the hope of selling them for more later, carry inherent conflicts of interest because the same buyout group sits on both sides of the deal. Investors in selling funds worry the manager could influence the price.
A committee was most effective at assessing a buyout firm’s “management and mitigation of its conflicts inherent in a continuation vehicle” when the committee did “not simply ‘rubber stamp’” conflict disclosures, ILPA wrote.
The body spelled out how committee members could have their own conflicts. “Members may also sit on both sides of a continuation vehicle transaction and have a financial interest in the CV acquiring the asset(s) at a low price,” ILPA wrote.
Some large private capital firms invest in traditional buyout funds and have separate strategies that back continuation vehicles. Firms such as Hamilton Lane, HarbourVest and Partners Group run both business lines, but have not been accused of any wrongdoing.
“A [committee] member may be rolling its interests into the CV but it may also be invested in a . . . fund that is investing in the CV”, said ILPA, or “another part of its firm might be acting as lead investor” in the CV.
In April, two of the largest global private equity investors told the FT they were worried about whether some firms rubber-stamped asset sales to CVs when such a deal could benefit their other business lines. Continuation vehicles accounted for about a fifth of buyout exits last year.
One fund investor said there had been concerns for years about fund investors attending committee meetings unprepared or sending only junior analysts, but that continuation vehicles were “shining a spotlight” on the problem.