Paul Capital and Project U: Secondary Sales of Private Equity Stakes

Abstract

At a time of market turmoil, a university investment manager wants to unload the school's entire private equity portfolio; yet no public market exists, so the assistance of a partner at a PE firm is sought. This case provides an introduction to a range of secondary transactions and the valuation challenges that arise. Excerpt UVA-F-1626 Rev. Oct. 10, 2011 PAUL CAPITAL AND PROJECT U: SECONDARY SALES OF PRIVATE EQUITY STAKES Fall 2008 was a period of unprecedented market turmoil. Day after day, the headlines reported large declines in stock prices as waves of selling hit the market. Following the bankruptcy of Lehman Brothers in September, the S&P 500 had declined more than 50% from its 2007 high. Hedge funds were hit with redemption requests, causing them to liquidate securities. Even the hallowed halls of academia did not escape the carnage. Following the lead of Harvard and Yale over the previous decade, university endowments had aggressively increased their allocations to private equity (PE) and other so-called alternative investments. While these investments had often produced impressive returns, the previously favorable view of the sector quickly soured. As the value of the investments fell, they could not be easily sold because no public market existed for them. Further, investors in PE funds faced prospective capital calls that required them to put up additional capital. With cash in short supply, universities and other limited partners (LPs), facing budget pressures and investment losses, looked to unload their stakes in private equity. It was in this context that Patrick Derry, a partner at Paul Capital, had been contacted in November 2008 by an investment manager at Rhodes University seeking to sell its $ 162 million commitment to private equity. Derry had a good relationship with the investment manager and knew that the endowment was an LP with high-quality interests in PE funds. Because of his relationship and Paul Capital's reputation, this would be an exclusive deal to purchase the entirety of the endowment's holdings, if agreement could be reached on terms. In November, the investment committee at Paul Capital had authorized proceeding with “Project U” and had given the go-ahead for the first phase of due diligence. In February 2009, with the first and follow-up phases of due diligence completed, Paul Capital was nearing completion of a final offer to present to the endowment's investment committee. After investing nearly three solid months of work on the deal, Derry recalled, “It's often difficult to truly judge the seller's motivation. In this case, given what happened in the fall, we felt pretty good about the university's need to sell, but all that can change once a seller sees the size of the discount.” . . .