by Allen Greenberg, PEF Services

An orphan fund is difficult to define – as Supreme Court Justice Potter Stewart said regarding obscenity, “I know it when I see it.”  Well, the same is probably true of an orphan fund (also known as a zombie fund) – relatively small value remaining in the portfolio, probably too small for most secondaries to consider, let alone get anything close to fair value, little if any incentive for a fund manager, GP, and probably just burning expenses.

While difficult to define, the number of orphans is growing.  According to a Coller’s survey reported in its Capital’s Global Private Equity Barometer in August and September 2011, 57% of North American limited partners responding to the survey indicated they have zombie funds in their portfolios.

What to do? Well, if the fund can’t sell its assets via a secondary – maybe the fund can distribute assets in kind – not a great solution for institutional investors – who don’t want to own interests in several portfolio companies of modest value.  Plus, it involves convincing other LPs (who are equally reluctant to take on the task of managing companies of nominal value) in order to reach a contractual threshold to force the GPs to distribute the assets.  Many LPs consider the task of herding co-investors together to take an adverse stance against a GP to be nearly impossible.

The challenge is highlighted in a recent story told by Dan Primack of Fortune’s Term Sheet in March of 2012.  In this article, Dan describes a situation where the GP is asking the LP for an extension on a fund which will not return capital that would include additional management fees and waiving a claw back that the GPs owe the LP. With limited options, many LPs feel like they are being held hostage.

Solution
– consider outsourcing to a fund administrator who is not looking for any carry or backend and can monitor all key companies in the portfolio and provide LPs reporting for a reasonable fee relative to the asset value of the fund. PEF Services has acted in this capacity.

Result – substantial cost savings and enhanced reporting of information to LPs, including portfolio updates, financial reports and year-end tax information.

How do we know?  Because we have been there.  For one client that was not getting timely reporting, we brought the books up to date, provided timely quarterly reports and delivered K-1s by March 31, something the GPs had not done for several years.

For another fund, where after 2 years, only one modest asset remained, PEF negotiated, with the approval of the LPs, a sale of the fund’s interest back to the company.  We then made a final distribution and working with counsel dissolved the fund saving significant money by terminating the fund expeditiously.