As the private equity (PE) market has matured, so too has its secondary market. The PE secondary market has gone through rapid growth, more than tripling from $20 billion in 2008 to $74 billion in 2018. This growth was initially driven by the need for liquidity among PE limited partners (LP) during the global financial crisis, but has now served more as a portfolio management tool, as many large institutions have looked to the secondary market to rationalize their private portfolios.
Simultaneously, the market evolved from LP-driven sales to more structured and complex general partner (GP)-led transactions. As illustrated above, these transactions made up just under one-third of the overall secondary market in 2018, and have been on a steady rise over the past five years. As the value of unrealized assets in older PE portfolios grows, so too will GP-led secondaries. Greenhill, an advisor in the secondary market, estimates that 2019 secondary volume will be $90 billion and 40% of that will be from GP-led deals. There can be benefits to these transactions – older funds can offer liquidity to LPs, while allowing the GP to avoid becoming a forced seller of assets before their value is maximized. Consequently, LPs can deploy this new capital into assets they feel are more attractive.
GP-led transactions generally take three forms: tender offers, fund recapitalizations or stapled secondaries.
- Tender offers are similar to traditional LP secondary sales, but the process is facilitated by the GP soliciting offers from secondary buyers and presenting them to existing LPs.
- Fund recapitalizations are more complex transactions, and generally involve the sale of the underlying fund assets into a special purpose vehicle (SPV). The GP typically will manage the SPV, often with reset fund economics (management fees and carry). The carry is often tiered, increasing as returns hit certain thresholds. This is to incentivize the GP to maximize value of the remaining assets that may have otherwise been sold prior to reaching their targeted potential. Often buyers will commit additional capital to allow the GP to make further investment into the underlying portfolio companies.
- Stapled secondaries are similar to the aforementioned transactions, but combine with a commitment from the secondary buyer to invest in the GP’s new fund offering.
These transactions, especially recapitalizations, are often complex and require approval from existing LPs, a secondary buyer and the GP. Particularly in a fund recapitalization, GPs often have to manage conflicts of interest driven by the fact that they are fiduciaries to the existing fund and will be participating in the new SPV that is typically established. In order to manage these issues, the transactions are often brokered and placed out for auction to ensure fair pricing and market terms. While they have the potential to provide solutions for all parties involved, the GP needs to be as transparent as possible or risk alienating its LP base, which is the lifeblood of any PE firm.
The buyers in many of these transactions are themselves private funds that specialize in secondary investing. These funds have raised significant capital over the last few years, with many of the largest fund managers raising their flagship funds in early 2019. For example, according to Greenhill, Ardian and Lexington are each currently fundraising for separate $12 billion secondary-focused vehicles.
GP-led secondaries will continue to grow in lockstep with the growth of unrealized PE portfolios. These transactions have the potential to simultaneously provide LPs with liquidity while allowing GPs to optimize outcomes for legacy portfolio assets. These benefits can only be achieved when transactions align interests between all counterparties.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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