Dennis Pereira and Ann Tadajweski Quoted on Considerations for PE Sponsor Before Launching a Private Credit Strategy

Akin Gump investment management partners Dennis Pereira and Ann Tadajweski have been quoted in the Private Equity Law Report article “What Must a PE Sponsor Consider Before Launching a Private Credit Strategy? (Part One of Two).” The first in a two-part series, the article looks at various factors for a private equity sponsor to consider before introducing a private credit strategy.

Among the considerations, according to the article, is whether the limited partnership agreements (LPAs) and other operative documents for its existing PE funds authorize the endeavor. Other outdated features of an existing PE fund’s LPA, however, may also need to be considered, noted Pereira. “Some of the affiliate transaction provisions and disclosures for the existing PE fund may not be as robust as they need to be,” he explained, “so a sponsor would need to evaluate those before its private credit fund could begin investing in one of its existing PE funds’ investments.”

A more common approach, Pereira said, is for a sponsor to engage the limited partner advisory committee (LPAC) of its existing PE fund on those matters. “Sponsors typically will initiate discussions with their LPs so they understand the intention behind launching a private credit fund and its potential impact – or lack thereof – on their existing PE investments, as well as to obtain LPAC approval where necessary,” he said.

Pereira added that it is important “for sponsors to update the technology in future PE fund launches to avoid these issues, including having certain natural conflicts between these strategies functionally preapproved or clearly addressed.”

While sponsors are used to structuring funds and investments around tax and liquidity issues in PE, the article reports there may be some surprises with how materially different those structuring considerations are in the private credit space. In PE, Pereira said, more structuring tends to happen at the portfolio-company level to account for tax issues introduced in the acquisition. Private credit funds, however, tend to require more upfront structuring because of tax issues associated with lending and to account for different types of lending, he noted.

For sponsors considering a private credit strategy because of its synergies with their existing PE expertise, the article says a closed-end fund structure can be more suitable because of the types of debt instruments they intend to pursue. Tadajweski said, “It’s very common – and, if anything, increasingly so – for those funds to be structured as closed-end vehicles, particularly as there is greater liquidity pressure with the type of products that they’re offering.”

When the fund is open-ended, Tadajweski said, sponsors often develop a strong valuation policy, appoint a valuation committee or, in some instances, obtain periodic valuations by an independent agent. She added that a sponsor may also discover a disparity in the actual liquidity of certain types of debt instruments held by a fund. An illiquid investment, she pointed out, “can be designated as a side pocket, which will table valuation issues until a realization event. Even then, a manager will sometimes treat distributions from the asset (e.g., interest or principal repayments) as partial realizations that are then moved into the main fund.”