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Private Equity 360: Zombie Apocalypse

Strap on your combat boots to learn about Zombie Funds, a little known problem facing fund administrators that can color your reputation and waste administrative fees.

Zombie Apocalypse Transcript

This transcript was assembled by hand and may contain some errors.

It has been edited for readability.

 

Bob: Hello, this is Bob Woosley, National Private Equity Practice Leader of Frazier & Deeter, and we’ve got a great topic today for our Private Equity 360 podcast. We’re going to talk about zombie funds: the Zombie Apocalypse, and our guest today is a partner of ours, Tom DiEgidio with FD Fund Administration. Tom, could you tell us a little bit about yourself?

Tom: Hey Bob. My name is Tom DiEgidio; I’m a partner at FD Fund Administration. We are headquartered in Philadelphia and have additional offices in New York and Atlanta. We have about 40 employees who focus on fund administration, and our main area of focus is real estate and private equity.

Bob: We’ve entitled this podcast the Zombie Apocalypse. You and I have been working with a lot of private equity firms that have spare funds with lingering investments, and they just end up being a real pain from an administrative standpoint. Can you talk a little bit about what is a zombie fund and why is it an issue?

Tom: Well, zombie funds, as you indicated, tend to linger in portfolios. Back in 2008, when the private equity market was at its peak, many investment managers overpaid for companies. So, these are assets that basically haven’t been marketable. A manager holds them in their portfolio, but there are a lot of downsides towards holding these assets in a portfolio from an investor’s standpoint. The cost associated with keeping these funds going really outweighs the returns to the investor.

Bob: And Tom, I would think that that if you’re a fund manager, it’s not great for your reputation, either if you’ve got a bunch of stragglers; I mean, that kind of  indicates that you may not have done the best job selecting or creating value and exiting those investments, correct?

Tom: That’s correct.

Bob: So you’ve been in this business a long time, and I know you’ve seen private equity firms come up with strategies that can help them manage these zombies. Can you talk a little bit about what some of those solutions might be?

Tom: For larger fund managers, they typically have the ability to package up these lingering assets and sell them at a secondary market. For some of the smaller fund managers that don’t have that outlet for selling these assets, there’s really only one other method for reducing the costs associated with holding on to the assets, and that’s a liquidating trust. A liquidating trust is usually a separate entity that’s created with the consent of the LPs, whereby the assets are transferred into a trust, and usually the costs associated with managing that trust are much less, more favorable for the investor when that transaction is completed.

Bob: So Tom, we’ve been involved with a lot of funds and firms where we’ve had to go in and help them get permission from their limited partners. Are you seeing more new limited partner agreements addressing the idea of liquidating trust when they’re forming their fund?

Tom: I think addressing the assets at the beginning of a partnership life is new. When most asset managers are creating partnership entities, the last thing they’re probably thinking of is methods for transferring assets that really aren’t marketable, but we are seeing managers creating a clause in their partnership agreements that addresses investments at the end of the partnership life. Taking it a step further, there are agreements that we’ve seen that have an automatic transfer of assets at the end of a partnership to a trust, so they try to stay ahead of the issue by incorporating that into their initial documents.

Bob: And of course, a liquidating trust, I think it’s important for the listeners to understand, is a new legal entity created with a limited partner’s consent, and it has to file tax returns. But how would you characterize the costs of maintaining that liquidating trust versus the administrative costs of keeping that fund alive and how it’s handled today?

Tom: The cost benefits, there are several. There’s the fund administration costs, which, in essence, 90% of that cost goes away. There’s also the cost of the managers’ fees associated with managing the asset and its traditional partnership type of entity, and then there’s also costs associated with the tax returns that are much less to prepare come year end.

Bob: So it sounds like it’s almost two buckets.  One bucket is if you have not addressed what happens to investments at the end of the term, and you have to go through the process of getting consent from the LPs which you’d like to avoid.  But I know it’s a process  you’ve been guiding people through. And then you have emerging managers or new funds that need to be writing this language into their limited partner agreements. Tom, I know you and your team regularly look at limited partner agreements.  I know you’re not an attorney, but you’re giving some best practices and language to attorneys, is that correct?

Tom: That’s right; we try and provide guidance as we review their initial fund documents.

Bob: That’s great. In a second I’m going to ask you for your email and contact information, but I do want the listeners to know that FD Fund Administration is one of the few private equity and real estate fund administration firms associated with a nationally ranked CPA firm, so a lot of these concepts, filing returns and the compliance, I know you lean sometimes on Frazier & Deeter, your parent company.

But Tom, could you  just give the listeners your contact information, which I know we’re going to have in some information we’re going to distribute, but how would somebody get in touch with you if they wanted to know more about zombie funds?

Tom: Feel free to give me a call, my number is 215.252.9510, and my email address is thomas.diegidio@fd-fa.com.

Bob: Tom, could you spell DiEgidio for everybody?

Tom: Sure, D-I-E-G-I-D-I-O.

Bob: Just like it sounds.

Tom: That’s right, just like it sounds.

Bob: Tom it’s been great, thank you, that’s the type of perspective I think is so helpful to our private equity firms to understand some best practices, ways to act save administrative cost and get rid of the Zombie Apocalypse. Thanks for your time, Tom, and thanks for everybody listening, and we’ll be sending out with this podcast some information as you register for the podcast, you’ll see some  links, so thanks so much, and we appreciate it, Tom.

Tom: Thanks for having me.

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