The anatomy of a fund restructuring

If GP-led fund restructuring becomes more commonplace in venture, pricing will be the key to its acceptance, along with a hundred other details that define these complex, difficult-to-do deals.

With exits harder to come by, restructuring an aging fund might provide an attractive path to return liquidity to limited partners.

But the negotiating table will have numerous sides, not just for existing LPs and a new group of investors willing to carry portfolio assets to fruition, but for firms themselves that have competing internal issues to balance.

Among them is setting a good-faith price that satisfies both an old fund and the newly created in-house entity to manage companies in the years ahead.

GP-led restructurings also will have to compete with simpler alternatives, such as direct secondary transactions. With directs, firms can sell off a fund’s final few portfolio companies in an M&A-styled or buyout deal, with LP approval typically not needed.

Still, the benefits of having a new path to liquidity may make the challenges worth enduring.

“I think all these liquidity elements are healthy,” said Kate Mitchell, a partner at Scale Venture Partners. “We want to take the friction out of the asset class. I think it is good for the industry.”

VCJ Venture
Kate Mitchell, co-founder, Scale Venture Partners. Photo courtesy of the firm.

In a perfect world, the deals offer a win-win-win by providing liquidity to LPs, opportunity to a new set of investors and time to devoted GPs to stick with their companies. They also typically allow LPs the choice to stay with a fund and chase a future gain.

The big question usually becomes upside: In other words, how much is there? Obviously, company quality is the key to this and to getting deals done with modest discounts.

Usually a third-party valuation becomes the starting point for discussions; then discounts range from small to as much as 25 percent or more. New investors are inclined to treat the deals as value-oriented plays, so they seek as much off as possible.

What follows are questions of carry and fees. Some criticize the deals as mechanisms for pulling forward carry. They argue that GPs shouldn’t be entitled to gains if a portfolio company technically hasn’t exited.

But the deals provide the opportunity to reset carry, as well, crafting incentives for firms without major gains and therefore little carry in an old fund to better manage assets moving forward.

Fees generally are small but can become a point of contention as parties weigh the financial needs of shepherding companies with the goal of minimizing costs.

The threshold for approving a fund restructuring can be a simple majority of LPs or a vote of as much as 85 percent.

One company with a successful deal is Canaan Partners. The firm restructured a pair of old funds in a $60 million deal that appeared to satisfy old and new investors, according to one participant.

All but one LP took the opportunity to get liquid and a portfolio of several mature, revenue-producing companies went to the new investors, who will have capital calls going forward, the insider said.

Canaan partners got to stay involved with the companies and also received carry from the old fund.

“I think the LPs got a very fair deal,” said the insider, who suggested the deal could help change the minds of hesitant GPs.

Canaan declined to discuss the transaction.

If it does, then more of these unusual transactions could occur.

“I think it will happen,” predicted Daniel Burstein, a managing partner at Millennium Technology Value Partners. “It will definitely take place because people are holding some high quality assets in their portfolios where the exits are still many years away and the private valuations are still high.”