Key Takeaways from Kroll’s Restructuring Conference

Deal Sourcing and Fund Restructuring in an Uncertain Economic Environment

Attention has been focused on the health, professional services and technology sectors, which receive the bulk of lending. Large parts of Europe are underserviced because of a focus on these primary industries.

There is a difference between the current economic climate and that of 2008. 2008 was more of a shock, whereas now, there is a build-up of variables and distress in the market. Debt maturities over the next two years has more than doubled and will result in an increase in distress in the marketplace but also present opportunities for private credit funds to step into special situations and debt restructurings.

The cost of managing a regulated fund and maintaining the infrastructure necessary in a regulated environment is no longer viable given a reduction in net asset value and by consequence fees. LPs and GPs are looking for more cost-effective structures to deal with tail-end issues. At times, the GP is facing regulator investigation or scrutiny and often a solution is to step aside and allow someone else to continue the fund. The investment thesis for underlying investments has failed, and the assets are distressed or require specialised skill sets to extract value. There is a concern regarding the management of the fund, lack of (or no) communication between the investment manager and LPs, including delays in audits and valuations.

We are seeing a much greater proliferation of “zombie funds” and, whilst coming to the end of lives, GPs and LPs interests diverge. The issue of moral hazard can arise, where sometimes GPs want a long run off to maximise management fees. Fund lives are now extending to around 17 years (as opposed to the standard 10-12 years) from opening to liquidation. There is no one solution to the issue of zombie funds, and there is also an increasing number of inquiries in this space. You can implement a structural solution (reducing cost base and lowering cost structures), or you can look for assets that haven’t matured to buy more time. In the U.S., there is a range of options and provisions that vary state-by-state. The use of Liquidating Trusts is common, which entails moving assets into a new vehicle, and decreasing the regulatory overhead. In the Cayman Islands, a fund can be rolled into a winddown, rationalising costs and providing runway to divest assets. Finding a structure that works for LPs and GPs is key.

Regarding LPs, the dissatisfaction with the Investment manager/GP is a concern. When this is the case, it is common for LPs to explore a replacement of the GP. The governing documents of a fund often provide LPs and GPs limited options. A change of the GP is possible, but often requires significant LP coordination. The key is to make sure the governing documents are as robust as possible and provide the tools necessary to effect change when needed. There are lot of ways in which funds can get involved, and lots of circumstances where GP and LP issues provide opportunities to buy good assets at distressed prices.

There have even been restructuring cases when interested buyers have gone cold on a purchase due to a lack of “future proofing” with its ageing workforce.