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Stapled Secondary Deals Drawing the Attention of the SEC

A new type of transaction that's becoming increasingly popular in the secondary private equity market is drawing scrutiny from the Securities and Exchange Commission (SEC).

These "stapled transactions" involve a private equity firm's general partner initiating a sale of portfolio companies from an older fund into a newer fund. The practice has recently become more widely employed. It's estimated that stapled transactions now comprise around 10 percent of the secondary private equity market.

There's a reason for this expanding popularity—stapled transactions offer a significant benefit. They allow general partners to seed new funds with existing assets or limited partner capital. Many times these deals require approval solely from the existing fund's advisory committee—a situation that may leave limited partners out of the loop before a deal closes.

Not everyone is convinced stapled transactions are entirely without cause for concern. Some observers have raised the possibility that stapled transactions may create a conflict of interest with regard to the fiduciary duties of private equity managers, as these managers are obligated to put the interests of investors over their own.

Stapled transactions may be especially tempting when general partners are having difficulties in putting together a new fund, as they allow existing assets to simply be rolled over into the new venture. In this way the general partner provides liquidity for investors while also providing investors for the new fund.

The potential for conflicts of interest to arise during a stapled transaction has drawn the attention of regulators. The SEC is on record saying such transactions are an area of concern and will be a focus of future compliance activity.

The popularity of stapled transactions has risen in recent years as fund managers seek a useful method of restructuring funds, or preventing them from becoming terminally unprofitable. These transactions provide managers with an exit for funds that are nearing their natural lifespan, while simultaneously offering capital for new funds.

Despite new scrutiny from regulators, the utility of stapled transactions means they will likely continue to grow in popularity—particularly if the U.S. economy encounters turbulence. During an economic downturn it's typically more difficult for general partners to raise new funds and to find an exit for existing portfolio companies.

Industry insiders and government regulators believe greater transparency is critical when dealing with stapled transactions. Officials with the SEC have said the disclosure of relevant information will be a key focus of compliance efforts. By providing limited partners with up front information about each transaction, conflicts of interest between general partners, limited partners and buyers can be avoided, or at least minimized.

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