The Challenged Fund: Toolkit for Dealing with Zombie Funds, Legacy Assets, GP Restructurings and Other Difficult Situations

Tom Bratkovich, Founder/Managing Director Longview Partners Introduction

This workshop will explore issues and solution paths for relationships that LPs no longer desire going forward, from the most simple to the most complex. The pros/cons and degree-of-difficulty of each solution path will be explored. Multiple real-life case studies will be presented (non- attributable summaries of which will be distributed in each session) to promote interactive discussion and determine whether the actual desired outcome was achieved. Participants will have a framework for recognizing, evaluating, and acting on these situations in the future

Learning Objectives: • Determine the root causes and evolution of challenged funds and how relationships can deteriorate over time • Provide a playbook of options for dealing with these situations and explore the nuances of pursuing various solution paths • Assess who initiates action in these situations, and why; assess whether and when an LP should initiate action and the potential benefits and consequences • Explore which of the following options might be a good fit for specific situations: pre-commitment legal terms, fee-reductions, suspension/commitment reductions, GP replacement, position secondary sale, fund restructuring, legacy asset management, and do nothing/business as usual

2 Description – Which Funds are “Challenged”?

• Anyone you have excluded from re-up, even if for non-controversial reasons: • Performance • Strategy drift • Team issues • LP allocation issues • More complicated – GPs stretching (or out-right breaking) the LPA • Waterfall manipulation • Cross-fund investing • Capital account manipulation • Conflicts of interest • Fee offsets • Didn’t read own LPA (!) • Early fundraising • Case Study #1 • More nuanced – LP belief that there is some way to improve likely outcome through “proactive management”

3 Case Study #1 – Situation 1.1

• Large, institutional RE GP with > $15 B of AUM, mostly in public REITs • You, the LP, are in one of the only commingled, funds that the GP manages • Capital calls as expected for 3 years; then the LP detects a small overage on the capital calls versus committed amount and stops funding capital calls for 6 months • A reach out to the GP for clarification yields assurances from the CFO and fund accountants that there is no discrepancy and the calls should be funded

4 Options 1.1 – Should you, the LP:

• 1.1A – Fund the capital calls – GP is large with decades in the industry, a great track record, and likely the LP’s fund accountants are in error, not the GP. The next fund is going to be raised soon, will likely be over- subscribed • 1.1B – Refuse to fund the capital calls, ask GP for full accounting –Buy some time, give the GP the benefit of the doubt and time to come back with a full accounting/explanation of the situation • 1.1C – Refuse to fund the capital calls, hire an outside advisor for a full accounting – Will take even more time, will cost additional expenses, but may get an independent assessment

5 Case Study #1 – Situation 1.2

• The LP decides to hire an outside advisor to assess the situation (Option 1.1C) . The advisor reviews the LPA, notices, capital accounts, and fund financial statements . The advisor engages in discussions with the GP’s CFO, fund accounting staff, and fund legal counsel • The GP failed to pay the LP for an early exit during fundraising; instead the proceeds were distributed to other LPs that committed before the final close • The difference is about $10 M on a $30 M commitment underpaid to the LP and overpaid to the other LPs . Still a high performance fund with 2.5x MOIC • The GP has been lending the fund capital to “make up” for the unfunded capital calls . Loans have first position over the LPs’ equity, have a high interest rate, and have not been properly disclosed to the LPAC to vet for conflicts of interest • The other LPs take a dim view of this line of inquiry, and hire their own advisors to make their own assessments

6 Options 1.2 – Should you, the LP:

• 1.2A. – Don’t believe the advisor, believe the GP and fund the capital calls – The advisor is new to the situation, doesn’t know the history of the relationship; the accounting really can’t be that “off”. • 1.2B. – Believe the advisor; ask the GP privately for a secondary exit for the LP from the fund – Will take even more time, may not get a fair bid/valuation, may be “stuck” with no resolution. • 1.2C. – Believe the advisor; ask the GP for a full repatriation of owed amounts, restatement of the capital accounts, and a suspension of further fund activities – Sure to anger the GP and other LPs, but may achieve the right solution over time, likely additional expenses incurred and even litigation

7 Case Study 1: Outcome

• The LP decides to confront the GP and the other LPs with the reality of the situation, threatens Option 1.2C, but ends up privately asking the CEO of the GP for Option 1.2B • The GP, Fund Counsel, and CFO had not read the LPA, did not understand the accounting rules for new fund entrants • The GP had been illicitly loaning the fund amounts from its own balance sheet without recognition of the implications • The GP admitted to not understanding how to manage private, commingled funds – not a large part of the overall business and fund accounting and conflict of interest controls lax • The auditor (Big Four!) failed to identify the discrepancies • The CEO of the firm gets involved, recognizes the risk to rest of the public platform if the news gets out, and agrees to buy the LP’s stake for the full value plus the discrepancy • The LP never re-ups with this GP again

8 Case Study 1: Lessons

• Even large, storied, high-performance investors can make mistakes and end up as a challenged fund relationship • Assessing probability-weighted cost-to-benefit of potential outcomes is important in decisions on whether to pursue a situation • Not all LPs will be on your side (or care) about your situation. Rarely are these situations “all of us” (LPs) versus “them” (GP)

9 Who seeks the change?

• LPs with large commitments, voting power, and/or long-term relationship with GP seeking actions . Rest of LPs may be “along for the ride” • May not be the relationship manager (PM, etc.) forcing the issue . CIO(s), allocation studies, risk/correlation managers, Boards, etc. • GPs (or factions) seeking something in return . Extensions of fund term (and fees), staple to next fund, release of concentration or cross-fund investment limits, etc. . Next gen team “fed up” or leaving • Advisors – acting for one LP client, pushing for others to support

10 Should you seek change?

• Do the probability-weighted benefits outweigh the likely costs?

Benefits Costs

Upside potential of action – increased NAV at exit, Your time – how long will it take? What other value minimize NAV degradation/downside creation in your portfolio could you be doing? Securing allocation to future funds with GP Hard costs - advisor cost (legal, accounting, consultants)

Your brand as a trusted advisor to GPs (if you care…) Reputational issues (GPs and LPs talk)

Your brand as an “active investor” (if you care…) Headline Risk – anonymous leaks to the press both while “in process” and after

• Assess the probability of each option coming to pass. Reality checks: • Do you have influence? • Do you have the $ to fund advisors to assist? • Do you have the votes? • Are the LPs/GP generally in agreement on the right path? • Do you have the time/patience to see it through? 11 Solutions - Overview

• Pre-emptive Measures – Pre-commitment • Fee reductions, etc. • Suspension/commitment reductions • Nuclear option: GP replacement/fund termination • Sell in secondary (GP may be buyer) • Restructuring transaction • Legacy asset management • Do nothing

12 Pre-emptive Measures – Pre-commitment (I)

• Knowledge gained during diligence can be instrumental to figuring out what to ask for and how to mitigate risk . These days, “How could I know?” replaced with “I should have asked” . LPs (and advisors) need to be as sophisticated as the GPs • Common important knowledge points: . Assessing gen succession plan, incentives/compensation, commitment of team, attribution, potential conflicts of interest . Assessing decision-making power (formal and informal) within the GP (IC, management company, overall firm, etc.) . Assessing culture of openness/transparency – reference checks with existing LPs and LPAC members, partners that may have left, etc. . Assessing commitment to governance – presence and power of Board (if any), LPAC, etc.

13 Pre-emptive Measures – Pre-Commitment (II)

• Ultimately the LPA (plus side letter(s)) will govern in any situation • Difficulty in starting relationship on a “down note” and pushing for “downside protection” terms . Balance is important, knowledge and support of advisors on “market” terms • Terms to pay attention to: • Key man • Waterfall • Suspension • Fee offsets • Voting/governance rights • Fund-level debt restrictions • LPAC/Board composition • Strategy definitions • GP removal • Cross-investing • Conflicts of interest • Investment restrictions/concentration limits

14 Fee reductions (I)

• Fairly common at extension periods (e.g., Y10+); rare at all other times • Forces GP to begin making portfolio and personnel decisions heading to wind down • Seek to avoid “blunt instrument” decisions; seek a thoughtful approach • Firesales generally are value killers • LPs should be proactive approaching this time period • GPs are happy to send out an extension consent for signature without discussion

15 Fee reductions (II)

• What is the right number/structure? . Usually, already baked into the LPA – fee basis is net invested capital . However, portfolio companies can have large NIC but low NAV – value based approached (now and at exit) usually better . Ask for the operating budget and a go-forward plan . Assess amount of accrued carry for GP (if any) – offers flexibility in negotiations . Reset of the carry basis/preferred return – can provide proper incentive to see portfolio through • LPs should assess any go-forward personnel plan based on status of portfolio . Remaining incentives should be concentrated in operating partners and portfolio company exit machinery – not necessarily in the founders . Assess the real GP capability to “move the needle” on the investment value – Do they have control? How many board seats? Part of a syndicate?

16 Suspension/Commitment Reductions

• Typically triggered by key man event, otherwise difficult to achieve votes

• The “time out” can give LPs time to consider other more complex solutions and to build consensus

• One of the “least common denominator” options. Can be a default as it delays harder decisions

• Not without costs

. Sends signal to investment professionals that they should start a job search – waiting for 6-12 months may not be in career interest

. May send signal to market that portfolio companies’ owner is in distress and “willing to move” assets at a discount

. Can highlight fissures within LP group and give the GP knowledge and time to exploit those differences

• Case Study #2

17 Case Study #2 – Situation

• Lower mid-market control firm on Fund II ($350 M, 3 made, Y2 of investment period); Fund I is $200 M, partially realized, -24% IRR, bottom quartile • LPs are quite sophisticated, many participating through emerging manager platforms; Fund II was diligenced when Fund I was at +12% IRR and goals largely met • The #2 senior investment professional leaves, triggering a key man event; the rest of the team (5 inv. profs) remains intact • Simultaneously, the GP begins to aggressively discuss two new investments with the LPs, and is eager to call capital to get the deals done

18 Options 2 – Should you, the LP:

• 2A – Vote to place the fund into suspension per the Key man terms (6 months), attempt to organize the LPs into a voting block to remove the GP and wind down the fund – The GP sand-bagged the Fund I true performance, and let’s face it, you are never going to re-up with this manager. It would be better to cut losses early; an advisor and counsel will need to be retained • 2B – Vote to place the fund into suspension and provide the GP time to put together a go-forward plan and find another investment professional to augment the team (i.e., cure the keyman) – The remaining deals in Fund I/II are early in their life, and could be interesting; it will take time/cost to truly diligence these portcos; an advisor and counsel will need to be retained • 2C – Vote to not place the fund into suspension, allow the GP to continue their investment program – The GP is a darling of your emerging program, has the strong support of your Board, and has reasonable portfolio companies that could be winners. This is an emerging manager, some hiccups are to be expected; the GP should be given more time, and advisors may be costly

19 Case Study 2: Outcome

• The LP decides to go for Option 2A and aggressively organize a block to remove the GP and wind down the fund • The first vote for suspension passes • The LPs split after this on the correct next steps and struggle to find a majority solution for 12 months: . 40% interests want to remove the GP and wind down the fund . 30% want to give the GP extended time to complete the investment period under a partial suspension . 30% want to remove the suspension immediately and allow the GP to continue on un-encumbered • Eventually, the LPs vote to permanently suspend Fund II (no more investments), to leave the GP in place, and to formally reduce Fund II commitments; advisor costs are high • Subsequently: . Most of the remaining investment professionals (other than the founder) leave the firm soon thereafter . Fund I remains bottom quartile . Fund II experiences a loss of 1/3 of the invested capital when the GP reports that one of the portfolio companies is being utilized by organized crime elements to launder money . Fund II never recovers, and the GP never raises another fund

20 Case Study 2: Lessons

• The solution that may seem infinitely correct to you may seem infinitely incorrect to the other LPs • Vote counting matters • There are thousands of GPs in the world; once you detect poor performance and decide to not re-up with a GP, the remaining capital might be better deployed elsewhere (if it can be recouped) • LPs have numerous structural constraints in implementing solutions such as this, including keeping legal separation as an LP from the business of the GP . Situations like this highlight why most of the market has moved to GP-led solutions for fund restructurings

21 Nuclear options: GP removal/fund termination

• Typically reserved for the worst-of-the-worst – fraud, willful misconduct, etc.; rarely used other than as a threat • Be careful what you wish for – remember the probability-weighted cost/benefit analysis of potential outcomes • Complicated legal issues (high cost) • Complicated relationship/reputational issues • Certain LPs will resist “on principle”, either actively or in the background • Certain advisors/firms specialize in running funds where the GP has been removed (e.g., Semaphore, Conway, Sherwood) • Setting incentives with new GP is important; protecting LP/GP separation (i.e., not piercing the veil) is also important • Case Study #3

22 Case Study #3 – Situation 3.1

• Lower mid-market buyout firm on Fund I, $100 M, in Y4 of inv period with only 1 investment completed and 1 other in diligence • You inherited this relationship from a past colleague; the GP appears to have been fairly silent over the last few years but is calling about the next investment • The single investment was made 4 years ago, is $50 M cost (and still held at cost), and is a convertible note in a foreign casino • The latest financials are late, quarterly reporting is scant, some team members may have left; however, the GP has a strong pedigree (Harvard Law School) and has experience operating in this emerging market • You are the sole in this fund (80% of voting interests)

23 Options 3.1 – Should you, the LP:

• 3.1A – Review the pending transaction, get to know the GP through in-person meetings, figure out/learn some details about the casino investment . This is a new situation for you - best to do some research with fresh eyes before making any decisions . In the meantime, fund the capital call(s) to ensure that your capital account is fully protected, as your predecessor has done

• 3.1B – Immediately put the fund into suspension with the view that you are going to push to remove the GP, and hire advisors to assist in building the removal case . Questions on the lack of an investment program (only one investment in 4 years), lack of a team, and not adhering to ASC 820 fair value principals, requests for additional full management fee . Plus this is not your relationship and you can probably save ~$40 M of undrawn commitments and put toward another pending, interesting fund relationship

24 Case Study #3 – Situation 3.2

• The LP decides to place the fund into suspension, hire an advisor to do a forensic drill, withhold capital calls, and build a case for GP removal (Option 3.2B) • You and advisor find a host of problems that could lead to GP removal for cause: • The team doesn’t exist • The management fees have been used to set up the founder in-country with a lavish lifestyle; the GP claims this has been instrumental to getting the one deal done and the other pending deal ready • The casino investment is legit (other PE firms also invested in same tranche of public convertible notes). The investment however was not proprietary and took little effort. The other PE firms have already exited; the GP could have exited 2 years ago but continues to hold even though liquidity is available • The GP has been charging the fund for GP-related expenses; management fees are not being used for stated uses • The reporting to LPs is not in compliance with the LPA • The fund auditor claims no knowledge of any of the above or need to mark-to-market. A legal case begins to be built against the GP and the fund auditor • The advisor finds and negotiates with two GP replacement orgs to take on the fund if the GP is removed; they are ready to go 25 Case Study #3 – Situation 3.2

• Your advisor digs into the convertible note, and finds a ratchet clause that could make the investment worth $500 M (10x!) • The GP is unaware of this, but once made aware, he displays some value by organizing a call with the CEO/CFO of the casino. They acknowledge the ratchet term but say that it is only worth $100 M (2x) • The GP hires high-powered securities litigation counsel and tells you that he is the best person to go after the $500 M (carry incentive, knows the parties, etc.) • They GP is willing to pay back the mis-allocated management fees

26 Options 3.2 – Should you, the LP:

• 3.2A – Remove the GP, hire a replacement GP, litigate for the $500 M – That’s a lot of money, better to have the outcome in the hands of someone competent! It might take $1 M+ in legal fees and 3+ years, but it is worth it • 3.2B – Remove the GP, hire a replacement GP, accept the $100 M from the casino operator and wind up the fund – Get someone competent involved, but don’t waste additional time/money to wrap this up. The legal case is uncertain • 3.2C – Keep the GP, litigate the $500 M – He seems to be willing/able to go after this, the incentives for him are clear ... plus he has made vague insinuations that if he is removed and the LP pursues the case that the LP will be piercing the LP veil and could be open to being sued by the GP for interference in the operation of the fund

27 Case Study 3: Outcome

• The LP decides to pursue Option 3.2C, keeping the existing GP and funding the litigation for the full $500 M, paying a negotiated reduced management fee along the way in return for the GP repaying the fund the past owed amounts • The legal team researches and files the case in New York. The judge agrees that the case has merit and agrees to take it to trial • Trial commences and the case is pending final decision from the judge; it has been a 5-year journey …

28 Case Study 3: Lessons

• GPs are rarely completely out of their element managing a fund, but it does happen • Your time is valuable and experts are helpful, and probably worth the cost … . Without the support of the advisors in this case the true details would not have been uncovered given the relatively small size/importance of the relationship • Even when the case to remove a GP for cause is a slam dunk with blatant malfeasance . The GP is still likely the one that knows more about the portfolio than anyone else, and may be in a position to achieve best value from disposing the assets • Withholding capital calls is generally not recommended, but this tactic can provide leverage in negotiations with GPs; if the LP is a significant amount of the interests… with some risk to the LP’s capital account over time

29 Sell in secondary (GP may be buyer)

• Common place solution with attractive elements: . Relatively quick, low stigma, advisor fees minimized . Highly liquid and differentiated set of buyers, from large shops with complex transaction teams to boutiques that specialized in odd lots . Currently a sellers’ market – secondary funds flush with capital • Potential pitfalls: . Relationship with GP and GP approval rights, especially near the end of fund life, may not be conducive to sale . Secondary buyers may already know of dysfunction (and price accordingly – if at all) . Single rifle shot position sale can result in instant realization of low NAV outcome • Mixing within a larger block portfolio sale could “hide warts”, although buyers are sophisticated and may just give zero value for that particular LP position 30 Restructuring transaction

• These days, typically GP-led; convincing the GP to find a buyer and structure a deal may be easy (or hard) . GPs typically get extensions, reset economics, sometimes a staple . LPs typically get exit ability at a certain price • 50+ buyers actively looking for these deals given state of traditional secondary market (i.e., currently a sellers’ market, brokers/advisors are actively assisting) . Structure A: tender offer for LP positions, individual choice . Structure B: portfolio block sale with opt out . No-change roll options are more common now • Probability of execution still low – high degree of difficulty for various non-obvious reasons • Case Study #4 and Case Study #5

31 Case Study #4 – Situation

• Lower mid-market healthcare buyout firm with following fund profile:

Fund Size Age (yrs) DPI TVPI Net IRR Number of Remaining Remaining NAV Investments I $500 M 9 1.6x 1.8x 8% 2* $100 M II $600 M 6 0.4x 0.9x -4% 3 $300 M III $300 M 3 0.2x 1.8x 20% 4 $480 M * The two remaining investments in Fund I overlap with those of Fund II (i.e., they earlier positions in the same portfolio companies • The GP proposes a restructuring deal and wants to hire an advisor to execute such a deal, focused on Funds I/II • Fund III may be included if bids are good • GP wants to reset fee/carry and get a staple to Fund IV • View is that this will be tender offer for LP interests that want to sell; no-change “roll” options should be available for the LPs that don’t want to sell

32 Case Study #4 – Situation

• One investment is public and has been for 2 years (no restrictions). The company is struggling but cash flow positive, and has management issues • One investment is private, barely cash flow positive, and needs a strategic partner or otherwise it will also subside into “also-ran” status, also has management issues • Final portfolio company is a winner, a leader in its space, and has already been majority purchased by a strategic . Exit possible in two years at a pre-agreed-to multiple of EBITDA; EBITDA is increasing 18% per year • The team is intact and thinks that they can raise Fund IV and continue on, however the two founders are in their late 60s

33 Options – Should you, the LP:

• 4.A – Nip this in the bud – advocate to kill the process – The GP should focus on exiting the portfolio companies through normal means and investing Fund III • Potential conflicts are significant, what with the reset of the economics and the staple option • The advisor may be expensive and will be charged to the funds • 4.B – Stay silent, but in the background inform the GP that you would be interested in seeing this pursued and getting a bid – no one needs to know what you think, but privately you are done with this GP and would like an exit option, even if at reduced NAV • 4.C – Speak up! Strongly advocate in the LPAC meeting that this be pursued – The GP most likely has inflated the NAVs of all of these companies and Fund I/II look like they are headed for a train-wreck. This might be the best (and last hope) to recoup some value … which you can put to work in a better opportunity in a few quarters

34 Case Study 4: Outcome

• The GP receives majority vocal and private support, but also some dissent; the GP launches the process • The advisor hits the market – two bids are obtained for ~0.65x NAV on Funds I/II (no bid received for Fund III) . Both are structured as a tender offer for LP interests, both extend Fund I and offer the GP management fee and carry resets; one includes a staple for IV . The advisor believes the bids can be pushed up into the 0.70x-0.75x NAV range • The advisor learns during the process that the two founders have gravely divergent views and do not have a good relationship; the LPs do not appear to be wholly aware of this dynamic but one of the bidders is . One of the founders and the majority of the next gen wants to submit the bids to the LPs and negotiate to a final solution . The other is “embarrassed” by the bid valuations, doesn’t want to lose face, and so decides to kill the process before the LPs are fully aware of the bids; certain dissenting LPs are privately lobbying for “no deal” • Subsequently, the GP holds onto the positions for too long . The public company share price tanks, the other struggling private company is sold for a deep discount, and the winner exits at about current NAV; Funds I/II return 0.4x of the NAV at process launch . During the following two years, the GP team splits into three groups; fund III achieves 1.0x DPI before this happens, but the LPs are left with a dilemma on who should manage out the fund 35 Case Study 4: Lessons

• Whatever your position, advocate for it! . In group situations, the “silent majority” is often not enough to drive a GP to the right solution . GPs need to know what you think early and often in situations like this • The cost for getting a bid on tail-end fund assets or a restructuring deal is not significant (~$100K to pay an advisor) relative to the potential savings . There is no obligation typically to take a bid - might as well learn what the market thinks about the portfolio • What if a bid is received? Should you take it? . Often, the GP’s advisor can give you insight on the valuation (the good ones will have done an independent valuation), but note that the advisor’s incentives are to both push the bidders to a higher price while encouraging LPs to take that price . Hiring your own advisor to work through the alternatives, structure, and valuation can be quite useful; try sharing the cost and work product with several friendly LPs 36 Case Study #5 – Situation

• Mid-market control buyout firm on Fund IV of $800 M, on Y8; two portcos remain, both of which the GP has attempted to sell through standard M&A processes with IBanks in the last two years • Company 1: Healthcare services firm in a fairly positive situation – growing, proven platform build model, busy acquiring smaller competitors to construct a regional winner . First sale attempt 2 years ago – multiple bids received, but they were not compelling to the GP; the LPAC was informed of the bids and the LPs tended to agree . Second sale attempt last year – once again, both the GP and LPs believed that the bids were not compelling • Company 2: Waste management firm in a more difficult situation -- barely cash flow breakeven, business areas that are not complementary, asset heavy, management turnover . The GP bought this firm out of receivership 5 years ago – the prior owners had ties to organized crime and the original investment thesis was a turn-around at a rock-bottom price; while there have been no inklings of further malfeasance, the turn-around has taken longer than expected . The GP took this firm to market in hopes of achieving liquidity with an M&A broker, and received no bids 37 Case Study #5 – Situation

• The GP has hired a fund restructuring advisor . Proposes to sell the companies as a package to a secondary buyer . Set up a Newco with the GP and paid a small fee until ultimate liquidity for the positions can be found • The GP has informed the LPs that they will not raise another fund, i.e., that they are retiring. The GP’s prior funds have all been 1st or 2nd quartile • The GP’s management fees have decreased substantially, and a skeleton crew remains • Fund IV has cleared hurdle so carry available if the companies are sold for something near NAV • Privately, the GP has told the larger LPs that if a tail-end fund solution/buyer can be found, perhaps the LPs can get liquidity and the buyer can provide some follow-on capital for the healthcare company to continue the rollup . The GP would be willing to stick around to manage that investment with the option for the GP and LPs to participate

38 Options 5 – Should you, the LP:

A) – Nip this in the bud – advocate to kill the process – The GP should focus building the companies until they can be sold . If it takes more than 18 months, the LPs can just extend the fund until ultimate liquidity is achieved

B) – Stay silent, but in the background inform the GP that you would be interested in seeing this pursued and getting a bid – no one needs to know what you think, but the GP has already held these investments for 5+ years and any liquidity offer would be at least considered

C) – Speak up! Strongly advocate in the LPAC meeting that this be pursued – What are the chances that traditional sales processes can be run again and again and achieve a different result? . Time to seek a buyer with potentially a lower cost of capital (i.e., the secondary funds) and if the bid is good, remove the burden of continuing to pay fees to the GP 39 Case Study 5: Outcome

• The GP presents the case to an LPAC consisting of 5 of the largest LPs: . Four of the five LPs are enthusiastic about running a process (approximately 70% of the voting interests) . The fifth and largest is adamantly against running a process (30% of the voting interests) – wants individual M&A processes (i.e., try again) and argues it is not fair for the GP to attempt to find follow-on capital and continue to manage the assets for a fee • The large LP makes vague threats that it will try to replace the GP if he does not agree with this course of action, noting that they are retiring anyway so they shouldn’t care . The LP has a secondary practice and introduces his secondary team to the GP with the thought that maybe they can bid on/buy the assets outside of a competitive process . The GP considers whether this LP is acting inappropriately and whether to discuss this with the other LPs. The GP also wonders if this LP has pierced the GP/LP veil and could be legally liable for interfering with the operation of the fund • Ultimately, the GP decides to kill the process and try again to sell the companies through traditional means: . The healthcare company goes to market, and after 9 months, a buyer is found for a moderate gain above the carrying NAV . The waste management company cannot be sold once again. The fund has to be extended, and two years later the company receives an offer at 0.7x the carrying NAV, the GP accepts the offer • Mixed result -- on one hand, a small improvement over the carrying NAV is obtained; on the other hand, small management fees and fund expenses are paid for an extended period, advisory fees are still paid to the M&A bankers, and some potentially liquid capital remains locked into the waste management company for an extended time 40 Case Study 5: Lessons

• LPs have a diverse set of opinions when presented with the same facts. No opinion is right/wrong, but it does complicate solutions for funds at the end of life • Collegial working relationships developed over the years among the LPs themselves and with the GP can be quite helpful in working through issues such as this • Remember who manages the fund by LPA – the GP. Decisions should be made by the GP; GPs (if they value their reputation and customers) should solicit input but ultimately they have to make the call • GPs generally want to do the right thing but sometimes the situation can be ambiguous and fraught with issues for them as well • Incentives can become unhinged near the end of a fund’s life, and the best path to maximizing value is not always clear; focusing on incentives can often get to a good solution, if not the best solution

41 Legacy Asset Management

• Outsourced management of relationship (or multiple relationships) to a third party advisor (e.g., Upwelling, Longview) . Exposure/LP position in fund remains intact, GP remains intact . Advisor will employ previous solution set on a case-by-case basis to optimize legacy fund outcomes • Protects LPs precious time resource, may improve outcomes, partially shifts headline/PR risk • Typically entails annual fees and/or some performance based fee component • Degree of discretion/decision-making for advisor is negotiable

42 Do Nothing

• Naturally let a fund wind down over time with little further interaction from LP • NAV is typically low portion of overall portfolio near end of fund life; ability to move the $ needle is low • LP staff time is a valuable resource; opportunity cost of continued interaction may dictate time better spent elsewhere • Zero additional cost from advisors; spared further conflicts with GP and other LPs in many situations • Retain headline/PR risk

43 Summary of Options (not mutually exclusive)

Pre-Emptive Fee Suspension/ GP Replace- Secondary Restructur- Legacy Do Nothing Measures Reductions Comm ment Sell ing Asset Mgmt Reductions Tailored Solution        

NAV Outcome        

Advisor Cost        

Headline/ Litigation         Risk Time to Complete        

Success Chance         44 Conclusion

• The Challenged Fund can take many forms, some of them not intuitively obvious • Once identified, change can be driven by one or more constituencies (e.g., GP, LP(s), advisor(s)), each with a different approach and view of the correct end game • Probability-weighted cost/benefit options should be carefully assessed before embarking on any solution path • Various solution paths were explored with an assessment of benefits, costs, and issues which may arise • Case studies have been presented to sharpen thinking about the nuances of these situations

45 Questions?

46 THANK YOU

Tom Bratkovich Managing Director Longview Investment Partners [email protected]

47