In the summer of 2014, a Texas-based private equity firm quietly made plans to drain all assets from two of its mezzanine debt funds.
The firm, Capital Point Management, had agreed to sell the assets to an affiliated company, Princeton Capital Corp., in exchange for shares of the latter’s publicly traded stock.
Such a transaction required the approval of both a board of advisers and a majority of investors in the funds. But, court documents show, Capital Point’s investors claimed they didn’t learn about the deal until they saw a news article about it on April 14, 2015 — a month after the sale had closed.
After some deliberation, a private vote was held among the limited partners invested in the first of the two Capital Point funds. The decision at stake: whether to get rid of their general partner.
On September 8, 2015, the investors delivered their verdict to Capital Point’s Houston offices. Addressed to firm president Alfred Jackson, it was a notice of removal, effective immediately.
In Capital Point’s place, the LPs had installed a new GP, a little-known company by the name of Semaphore.
Founded in 2001, Semaphore is an advisory firm specializing in what CEO Mark DiSalvo describes as “troubled” private equity, venture capital, and hedge funds. When investors lose faith in their asset manager — because it has committed fraud or otherwise misbehaved — Semaphore is there to step in. As of early May, Semaphore was actively managing 11 funds that it had taken over from the original GPs.
“They’re special forces,” says Andre Rice, president at fund-of-funds firm Muller & Monroe Asset Management. “They roll in like the Marines and take control.”
Rice’s firm was among the LPs that voted to get rid of Jackson and his firm that summer in 2015; Muller & Monroe had inherited a 6 percent stake in the Capital Point fund when it was hired by the state of Connecticut to run a portfolio of private market assets.
“Capital Point — that was a mess,” Rice recalls. “But DiSalvo did a very good job with it.”
When, a year later, another of Muller & Monroe’s GPs, a firm called Mansa Capital, began exhibiting what Rice describes only as “disturbing behavior,” Semaphore was the company he turned to. With enough LP support to make the swap, Mansa was out and Semaphore was in.
For his part, Mansa Capital founder Ruben King-Shaw claims the separation was mutual. While he says it is true that the relationship had become “tense” due to capital constraints, he adds that he had wanted to withdraw from the partnership to deal with a “personal health crisis,” but could not do so without the approval of his investors.
(DiSalvo declined to comment on the circumstances surrounding the Mansa Capital takeover, or any of the other funds that Semaphore has engaged with.)
Typically, the removal of a GP requires the support of investors representing somewhere between 70 and 80 percent of the assets in the fund, although it can vary depending on the LP agreement. Emily Mendell, a spokesperson for the Institutional Limited Partners Association, says a clause outlining the causes and process for GP removal is included in almost every LP agreement, granting investors the power to replace their GP should circumstances require.
This power is rarely exercised — a state sovereign fund employee could think of only two instances in his 15 years of employment where a GP’s behavior was bad enough to merit action, and more than half a dozen other industry participants interviewed for this article gave similar responses.
“There’s never a partnership that goes perfectly,” explains Joncarlo Mark, founder of advisory and investment management firm Upwelling Capital Group. “But for a group of limited partners to say, ‘We are going to replace the general partner,’ it really takes a lot. A lot of times they would prefer to try to work out a solution — or, candidly speaking, ignore the problem altogether.”
Like Semaphore, Upwelling Capital offers GP replacement services, but Mark says his company focuses more on problems that could be solved through fund restructurings — realigning the interests of GPs and investors by eliminating management fees, for example, or finding a way to maximize the value of a stake before it’s sold on the secondary market.
“It’s not binary,” he says. “It’s not, ‘I can do nothing or I have to go to nuclear war with the GP.’”
Another company LPs might turn to is Kirchner Group, founded in 1985 by CEO W.B. (Bud) Kirchner to help turn around individual companies. Around 2004, Kirchner says, he came up with the idea to begin applying his company’s expertise at the portfolio level. His firm has now stepped in as a replacement GP or co-GP at about ten different funds, which Kirchner Group manages on behalf of clients including secondaries firms and insurance funds.
“We had one that was an SEC poster child for GP issues,” Kirchner recalls. “But typically it’s situations where the GP’s team needs additional skills.” For instance, he explains, some of the managers may have moved on, or the existing team’s skill set may no longer be as relevant at that stage in the fund’s life cycle.
At Semaphore, DiSalvo says, fund takeovers occur when the firm’s LP clients — typically pension funds, but sometimes endowments or family offices — believe that their manager has committed “fraud or significant malfeasance.”
Or, as Mark puts it, “When shit hits the fan.”
It could be a situation like Capital Point, where a manager acts without the permission or knowledge of the LPs. It could be a governance problem, where some minor issue isn’t immediately disclosed and it evolves into a major coverup. It could even be flat-out theft, where a GP made up investments, wrote them down to zero, and pocketed the cash.
“We don’t take over funds that are just orphan funds in wind-down mode,” DiSalvo says, referring to funds where there’s very little value left in the portfolio and the GP has moved on to something else. “We only appeal for the takeover of funds that are in dynamic and challenging circumstances.”
Often, he adds, these extreme problems will surface within the first few years of a fund’s life cycle. “Most of the funds that we’ve stepped into are younger funds,” DiSalvo says. “In many circumstances the fund continues to have available capital, and we will continue to invest that available capital as the GP.”
Depending on the situation, the fund’s lockup period might be cut short or extended, but typically when Semaphore gets involved, the goal is to manage the portfolio to fruition — not just wind it down.
Other firms do specialize in wind-down services. Global advisory firm FTI Consulting recently launched a unit, FTI Capital Management, tasked with stepping in as the GP when a distressed fund needs to be restructured or wound down.
“Our focus is on wind-down and on exit, but that’s not to say we wouldn’t consider asking investors to provide new capital in order to provide the optimal exit position,” says Andrew Morrison, a senior managing director at FTI.
Although FTI Capital Management is new, Morrison and his partner, David Griffin, have several years of experience working in the distressed fund space as consultants. Typically, Morrison says, clients come to FTI when assets are underperforming or illiquid. Those clients could be investors in the fund, but they could also be the GPs themselves.
“They have a sense of responsibility to make sure their investors are looked after and the fund is properly wound down,” Griffin says.
In those cases, GP replacement could be a fairly cordial process. If anything, Griffin explains, the original GPs are “anxious to move on to the next fund and get back to doing what they do best.”
Under other circumstances, however, removing a GP can be “very intense,” according to Rice of Muller & Monroe. As Semaphore’s DiSalvo explains, once his firm has been hired to take over as the GP, the original GP has to be informed that its fund was taken away — a conversation that can often be unpleasant.
“I’ve had my fair share of people screaming at me and demanding that I leave their offices, telling me that I have no authority to do what I’m doing,” DiSalvo says.
Even if the GP is quick to give in, there’s a long and difficult process of audits and getting to know the individual portfolio companies that make up the portfolio. The process, as Rice describes it, is “onerous” and can entail costly legal fees. But if the job’s done right, an investment that would have otherwise been written off as a loss could break even or, in the best-case scenario, become profitable.
“When these kind of problems happen, typically you don’t expect to get your money back,” Rice says. “In both of these cases” — the Capital Point and Mansa Capital funds — “we expect to get our money back.”