On 19 March 2020, two days after several countries around the world went into lockdown as a novel respiratory virus began to spread from nation to nation, we wrote that it was time for GP-led processes to prove their worth. With uncertainty running rife – both in financial markets and on the streets –  portfolio companies would likely need extra cash from their private equity owners to pay staff, keep the lights on and prevent liquidations. GPs would require extra runway to manage assets, while LPs seeking to take cash out of private markets funds should have the chance to do so. All this could be facilitated by the GP-led market, we argued.

Three years on and the pandemic may seem like a thing of the past to many readers. And yet, a different set of market dynamics are converging to again thrust GP-leds – and continuation funds in particular – into the spotlight.

Here’s the problem: a lack of viable exit options are leading to private equity firms having to find other ways to sell companies, both so they can provide distributions to their LPs and to help generate their carried interest. IPOs are no longer seen as an attractive way to exit a business – a trend that has been growing for some time. Data from Morgan Stanley shows that the number of public companies in the US halved between 1996 and 2020, while in the UK, the number of listed companies has fallen to around 2,000 today from just over 3,200 in 2007, according to figures from the Quoted Companies Alliance.

Adding to this is the rising cost of debt, which has contributed to a slowdown in M&A activity. According to PwC, global M&A deal activity by both volume and value has been on a downward trend since 2021. The higher cost of leverage is making large buyout transactions trickier as buyers cannot finance their LBOs at the same levels as they have been over the past decade and a half, as affiliate title Private Equity International explored in its Private Markets and the End of Cheap Money podcast.

These challenges are causing some of private markets’ biggest firms to consider alternative ways to exit companies – and this includes using continuation funds. Describing the current exit market as “a little lumpy” in an earnings call this week, Christian Sinding – chief executive of EQT, Europe’s largest private equity firm by capital raising – said his firm was pondering alternative liquidity options.

”If we can create more value in the companies and for our clients by keeping the business a little bit longer and going out into a more robust market, we’d rather do that,” Sinding said, noting that partial sales and continuation funds were on the cards. EQT already appears to be using the latter; while there was no mention of specific continuation fund processes on the call, affiliate title Buyouts reported in February that the Stockholm-headquartered firm was working on exploring a continuation fund deal to further grow its portfolio company Waystar.

Lawyers who work on secondaries deals say they’re expecting a steady increase in continuation fund deals this year due to the above dynamics. Speaking at Morgan Lewis’s Private Investment Funds Summit in London this week, partner Joseph Zargari said the law firm was expecting to see another uptick in GP-leds this year as the M&A market slows.

“The traditional exit route for GPs is not really an option right now,” he said. “GP-leds are being looked at as a way for managers to monetise their carry.”

The fundamental question is, of course, where will the capital come from to finance this expected proliferation of continuation fund deals? According to research by Evercore, there was $131 billion’s worth of dedicated dry powder for secondaries as of the end of last year, excluding leverage. Based on last year’s volume breakdown, assuming 47 percent of that capital is to be used for GP-led deals, and roughly 80 percent of that will be for continuation fund processes (as opposed to tender offers, strip sales and preferred equity financings), that means there’s just $38.4 billion in available capital globally to help GPs hold onto their assets in this way.

To put that in perspective, that’s just enough capital for nine GP-leds the size of Clayton, Dubilier & Rice’s 2021 Belron deal and the money would be all used up. Food for thought.

Write to the author: adam.l@pei.group