In a spin: Spin outs and secondary portfolio transactions following Rockwood

A significant trend in Europe and the US over the last few years is the development of a market for secondary portfolio transactions, being the whole or part sale of a portfolio of fund investments rather than an exit on an asset by asset basis. Secondary portfolio transactions are therefore different from secondary buyouts where a private equity fund sells individual portfolio companies to another private equity fund, usually together with the existing management.

The benefit to the private equity investor for completing such a secondary portfolio transaction is that it can exit a number of assets, usually quicker and at less cost than a sale of each company individually, save for a discount to market value that is usually a feature but will depend on the quality of the underlying investments and the deal dynamics.

Secondary portfolio transactions are rare in Africa but the first significant example occurred in December 2013 when Barclays Africa Group (formerly ABSA of South Africa) disposed of its entire 73.37% interest in the Absa Capital Private Equity Fund I (the “Fund”) to a syndicate comprising funds managed by HarbourVest and Coller Capital, both leaders in the global secondary portfolio market.

As part of the deal, the investment adviser to the general partner of the Fund completed a spin-out from Barclays Africa Group to management to establish a new South African private equity fund manager named Rockwood Private Equity.

The Fund was fully invested at the time with a portfolio of assets that were sold comprising at least five diversified businesses with a reported carrying value of Barclays Africa Group’s interest valued at R2.3 billion (approximately US$135 million) as at 31 December 2013. The portfolio comprised Bravo Group (household furniture), EnviroServ (waste management), Kwikspace (prefabricated buildings in sub-Saharan Africa), Safripol (plastic manufacturer) and Tsebo (business services), all of which will now be managed by Rockwood through to eventual exit.

Emergence of a trend in South Africa?

The question is whether this is an emergence of a trend in South Africa or a one-off transaction. The answer lies in the perceived rationale for the deal and whether it can be applied to other similar institutions in South Africa.

The principal reason for the sale was the increased costs and challenges (for banking groups and insurers) of holding what has been deemed by the regulators as higher risk investments, which they argue, increases the systemic risk on the commercial banking system, and the increasing adverse regulation on banks and financial institutions holding such assets.

As a result of the banking crisis that followed the Lehman collapse and era defining losses as a result of holding exposure to sub-prime mortgages and complex products that banks did not price correctly (or manage the risks effectively), the Volcker Rule (enacted in the US pursuant to Dodd-Frank) and the Basel II/ III capital adequacy, liquidity and funding requirements have sought to restrict investments in hedge funds and private equity. Similarly the Solvency II Directive for European insurers and reinsurers and changes to the Pensions Directive (IORP II) for European pension funds have impacted such holdings.

The selling of non-core private assets by banks (such as private equity fund interests and direct investments) help a bank to improve its capital, liquidity and/or funding coverage ratios which under Basel III, increased on 1 January 2013 with various implementation dates for the different tests and buffers applying thereafter.

Therefore, when in mid-2013 Barclays Bank (UK) increased its stake in ABSA (South Africa) from 55.5% to 62.3% with the announcement of the merger of the bank’s African operations with those of ABSA and an increased strategic focus on developing Barclays Africa, the focus of the European and global regulations were brought to bear on the entire group’s compliance with the rules, including all private equity and hedge fund holdings and its significant interest in the Fund.

Equally, as South Africa was one of seven countries in the G20 to implement the first phases of Basel III (see below), ABSA itself would have also been under pressure to comply with the rules, such as a liquidity coverage ratio requiring banks to keep sufficient liquid assets to cover their deemed risky asset portfolios. As a result of these pressures, the Rockwood transaction was born.

The same applied to Barclays Bank in late 2011 when Barclays Private Equity in Europe spun-out its buyout fund to management, who formed Equistone Partners Europe. This was one of a host of similar transactions that occurred at that time (see information box on the next page for a selection of spin out and secondary portfolio transactions advised on by this firm).

An African related spin out by two European regulated banks that also occurred at this time was the acquisition by Abraaj of Amundo’s North Africa private equity business from Société Générale and Crédit Agricole, including taking over the management of the US$161 million SGAM Al Kantara Fund (along with the team) and acquisition of the bank’s combined stake in the fund with five investments in Morocco and Tunisia.

There is little evidence of a trend yet as other examples are rare at this time. However, if the rationale holds true, with many of the South African financial institutions impacted by Basel III when in full effect, then they will indeed be looking closely at their holdings, particularly in private equity and hedge fund portfolios, to increase their capital and liquidity coverage, reduce their cost of capital or otherwise comply with other regulatory implications.

Who might be next?

The “Big Four” banks (other than Barclays Africa) and the other larger financial institutions in South Africa are not likely to be fully impacted by Basel III yet. Apart from the risk based capital requirements where final rules have been in force since 1 January 2013 (Level 4), the Globally Systemically Important Institutions Buffer (G-SIIB), Liquidity Coverage Ratio and Leverage Ratio elements of Basel III are only at Level 3 where the domestic legal or regulatory framework has been finalised and approved but it is still not applicable to banks.

Once fully implemented in South Africa, Basel III’s impact is expected to give rise to a significant increase in the minimum capital requirement from around 10% today to around 16% in 2019. This will for the most part be due to additional buffers imposed by the regulations to be adopted by the Reserve Bank to which South African financial institutions will need to adhere to.

As a result, those financial institutions that invest in private equity off their own balance sheets and/ or have in-house private equity teams and funds that they invest in (whether third party funds are raised or not) are more likely to explore spin-out options and secondary portfolio sales in advance of the full effect of Basel III and other regulations in South Africa. There are a considerable number of these teams that fall within this category.

Transactions could be driven from within the bank itself or by management within the private equity or hedge funds teams, who may find a sponsor to back them into a new vehicle (similar to the Rockwood transaction where the team worked closely with Coller Capital and HarbourVest). No doubt secondary funds looking for teams and assets are also knocking on doors.

In particular, with the growing number of independent private equity and hedge funds in Southern Africa, management within a bank or financial institution will need to be similarly incentivised to those managing independent funds in order to incentivise, retain and attract them and this may not be possible within a bank or financial institution. Even where the bank or financial institution wishes to retain the investments on its balance sheet, its main interest will increasingly be to have its assets managed effectively rather than to make money through asset management effectively in competition with its management who would expect to receive most of the profits.

Where the bank or financial institution has an independent or partly independent fund managed by a team employed by the bank or a subsidiary, external investors often show an increasing preference for the fund to be managed by an independent manager to remove any perceived conflicts of interest with the bank or financial institution, thus increasing the pressure for a spin-out. So there are both “push” and “pull” factors at play.

In Europe, there are few private equity teams left within banks or financial institutions – the spin-out transactions primarily occurred during 2011/12 in the immediate aftermath of the financial crisis.

Issues to consider for a “Rockwood” deal

For “Rockwood” transactions there are a number of key issues to be considered at an early stage and an overview of some of these are included below. In summary, these deals are complex to structure and negotiate, with competing interests and high stakes, but they can be done. Making use of the lessons learned from the European spin-outs post the financial crisis could be key.



Of course every situation will have its own particular issues and commercial drivers so a detailed understanding of these and terms of any proposal will be the essential requirement for a successful transaction.

Impact on underlying investments

  • How does the change of ownership impact the funds’ portfolio investments? The severity of this issue will depend on the nature of the funds’ investments. Growth capital funds are less likely to be affected than typical mid-market buyout funds due to there being less debt and also a larger number of minority positions.
  • The existing equity documents for each underlying portfolio company will need to be checked for any rights of pre-emption, drag/tag rights, consent/veto rights or other approvals needed for a change of control. An over-arching strategy will need to be developed to navigate through these and the timing for each factored into the wider transaction.
  • Change of control clauses in banking documentation and key supply/customer contracts, as well as potential regulatory and competition law issues will still be especially relevant. Although these issues may in many cases be technical hurdles, they may become more substantive depending on the nature of any potential purchaser. If the purchaser has a large position in a competitor business which it is seeking to consolidate, this will likely be more of an issue.
Identification of assets and liabilities
  • Identification of the assets and liabilities actually being extracted from the wider business may not be immediately obvious unless they are already ring-fenced and identifiable. Detailed commercial and financial diligence will be needed together with the legal analysis on such commercial drivers in order to ascertain any associated risks or liabilities.
  • How the assets and liabilities are being valued is key. Of course the bank or financial institution will have carrying values for their assets and liabilities but these will need to be agreed as a starting point. Then, these transactions usually carry a discount to market value, but this will depend on the quality of the underlying investments and market conditions. Adjusting for the valuations over time will also be a feature.
Impact on team incentives
  • The impact on the team’s carried interest or bonus/ incentive arrangements and the operation of Good/Bad leaver provisions if applicable will have a key commercial implication. In addition, how the proposed transaction affects the vesting of existing interests will need to be agreed. Of course, the future arrangements for the team will also need to be agreed which is a separate work stream.
  • Perhaps the composition of the team will change and this is always sensitive, particularly if someone is cashing out. There are also sensitivities around the founding members and rising talent within the team which will need to be addressed.
  • The seller may not wish its team to speak to the buyer too early as there will be concerns about losing the team or keeping the team on side, possibly for another buyer waiting in the wings. Any unauthorised approach by management to a purchaser may be a breach of service agreements or fiduciary duties as directors.
Key man provisions
  • If there is an existing fund that is perhaps cornerstone invested by the bank but still holds third party money, the funds’ key man provisions and how one avoids them being triggered due to the adverse consequences, if at all, needs to be analysed and addressed. In the current environment, some limited partners may see this as an opportunity to recover previous commitments or escape obligations to comply with further capital calls which should be avoided.
Transitional Arrangements
  • onsideration should also be given to wider group support as part of any transitional arrangements post completion that might be required, unless the acquiring group is already fully set up to continue as before. Services such as IT, HR or rights to property, IP or other rights that are currently provided intra-group that will be needed by the business to own or use going forward, will need to be ascertained.
  • Similarly, to what extent will the new business need to use the wider group’s name and information on the funds’ previous activities? The team is likely to want to retain the use of the funds’ track record and previous success stories going forward and in the marketing of any future funds.
Regulation and authorisations
  • A regulated entity is usually required in order to continue to operate as the fund’s advisor. If one is not going to form part of the subject matter of the deal then a new entity will need to obtain regulatory authorisation in the relevant jurisdiction(s) as well as exchange control, tax and other clearances in South Africa. This could be a lengthy process to obtain and may need to be a condition to completing a deal, depending on the structure. There are also AIFMD considerations. Any regulatory capital compliance will also need to be built into the new business model.
Tax structuring
  • structure to suit the spin-out executives’ personal tax situations may not be reflected in the selling group’s historical structuring, which means a sale could be complex if all the considerations of the team are needed to be factored in. Any new structure can be much more bespoke, which will suit the spin-out team but requires access and detailed consultations during a busy period for all concerned. The team will likely need to hold significant discussions in order to agree how the internal equity arrangements will be dealt with going forward.
Funding of a transaction
  • How payment for the assets will be funded is a key consideration. If supported by a fundraising or leverage, this will have a significant impact on timing and conditionality for the transaction. The covenant strength of the purchaser is important to assess as well as track record in the market (ability to close). Guarantees, equity commitment letters or use of underwriting may be measures to employ but come with their own complexities and costs.


The above issues are complex and should be considered well in advance by those that intend to lead a spin-put and portfolio transaction similar to Rockwood. The parties will be best placed to address these matters up-front so that at least a road map for execution of a deal can be designed with all cards on the table. In our experience, solutions may always be available if there is a will from all parties to complete these exciting industry changing transactions. Seeking counsel from those closely involved in the European spin-outs post the financial crisis could be key.

Contributions from Gregg Beechey (Partner) and Eoin Hayden (Associate) in the Financial Markets Group of King & Wood Mallesons SJ Berwin, UK.