Article

Creative exit strategies drive higher returns for sponsors

Published Date
Oct 5, 2023
Related people
With dual-tracks largely off the menu for the time being, we explore the risks and opportunities inherent in alternative exit strategies, including synthetic IPOs and sales with ‘stapled’ debt. 

Issue

The same macro headwinds facing sponsors pursuing acquisitions (stubborn inflation, high interest rates, Ukraine and volatile equity markets) apply to those looking to exit their investments. Here we are seeing an equivalent degree of creativity being applied sell-side.

Solutions

Some features we are seeing include the following.

  • Sponsors targeting assets that come with portable debt financing (these are mainly in the infra space although can be found elsewhere). Here, acquisitions don’t trigger a change of control that requires the original lender(s) to be repaid. Negotiations in these transactions often focus on how the portability is formulated.
  • Is there an approved list of equity sponsors or an “acceptable investor” test?
  • How does the latter apply where an equity consortium is bidding for the asset?
  • What happens where there is no change of control protection (as is often the case with investment-grade deals)? Is there a post-change of control ratings trigger and consequential repayment obligation?
  • On fully portable deals, (i.e. where the change of control doesn’t trigger repayment or there is no change of control-linked provision), is there a “know your customer”-type condition that applies?
  • The use of “stapled” debt, whereby sellers arrange acquisition financing and “staple” it to the asset so that the deal can progress quickly once a buyer is found. Sellers are increasingly considering stapled deals even where the target’s funding is portable, with sponsors either looking to plug anticipated gaps in the bidder’s equity universe or exploring ways to optimise their returns. This generally occurs where the exiting investor is more risk-averse than the buyer, so from the latter’s perspective the debt structure may be under-levered.

Rise in continuation fund deals

  • Sales to continuation funds (which are typically set up and managed by the general partner (GP) selling the asset). The U.S. Securities and Exchange Commission – wary of conflicts of interest – has mandated GPs to obtain fairness opinions around asset prices in continuation fund deals where investors are offered no choice but to sell. GPs also need to be wary of the deal being subject to either FDI or (particularly in the case of the U.S.) antitrust screening if new investors come in, even if the ultimate fund manager doesn’t change. We explore the challenges of continuation funds and how to navigate them here. 

Synthetic IPOs, which are bespoke transactions in which GPs sell interests in the portfolio asset to groups of limited partners, who can then trade those stakes between one another. In most investment funds, GPs have no right to distribute in specie non-listed stock – i.e. any distribution to LPs must either be in the form of cash where the asset is sold, or cash/cash equivalent where the exit is via a public listing. In most synthetic IPOs, the fund documentation will therefore need to be amended to achieve this outcome via the consent of the LPs and/or the investment committee and limited partner advisory committee. 

Content Disclaimer
This content was originally published by Allen & Overy before the A&O Shearman merger