This article is sponsored by Credit Suisse and appears in affiliate title Private Equity International’s GP-led Secondaries Special Report.
What continuation fund trends did you see in 2021, and what were the drivers of market activity?
Jeremy Duksin: Last year we saw an extension of the trends that started to emerge in 2020, namely a material uptick in engagement by sponsors around continuation vehicle solutions.
Prior to 2020, continuation vehicles primarily involved whole fund recapitalisations. In recent years, and in particular in 2021, managers have rapidly adopted continuation vehicles as a standard exit route for individual high performing assets.
That trend materialised in conjunction with secondary funds growing large enough to tolerate larger exposures to single assets. The trend took off in 2020, as engaging with GPs around high-performing assets helped secondary firms mitigate pandemic-related risk in their portfolios.
Now, deal sizes are becoming ever larger, with an increasing number of continuation vehicle transactions including third-party co-sponsors to help digest multi-billion-dollar assets. We are also seeing broad entry into this market of non-secondary investors, with traditional co-investors and primary investors participating in syndication processes and occasionally leading these transactions.
Jonathan Abecassis: In 2020, there was a high volume of transactions where, as a direct result of covid lockdowns, processes were held up or pricing was not in line with expectations and that triggered the desire for assets to be moved over to continuation funds.
By 2021, it was business as usual in financial markets and therefore business as usual in secondaries, with managers being proactive and looking at portfolios to decide which assets to sell in this form. That created a doubling of the volume of GP-led transactions year-on-year and more very well-established managers tapping into the market, in turn causing others to follow suit.
What developments did you observe in the context of single versus multi-asset transactions?
JA: Single-asset deals have become a majority of the GP-led market, at least by transaction volume. There are several reasons why single-asset transactions have been the main growth area – on the supply side, we have tended to see examples of large sponsors bringing large assets to market, so if it’s a $2 billion asset, that is more than enough for one deal.
In addition, there is an easier conversation to be had with LPs on the sell side if they are being asked to look at a specific situation and say, ‘This asset is ready for sale and this is a fair price,’ rather than assess a more complex portfolio deal.
On the demand side, buyers have adapted their strategy to take advantage of single-asset opportunities, developing policies on single-asset exposures and raising sidecar vehicles to upsize commitments to single-asset deals.
However, a desire for diversity remains and therefore multi-asset deals are still an important part of the market, particularly in the mid-market, where there is more interest on the buy side for deals offering diversification and a larger overall transaction size.
JD: These multi-asset deals no longer exclusively involve pools of unsold assets in older funds, but now increasingly involve multiple high-performing assets in recently invested funds, where the sponsor utilises a continuation vehicle to create an alternative exit route for multiple companies. That is in part to provide an attractive diversification effect for the buy side, and it is driving positive demand momentum.
What challenges have you encountered around pricing of continuation funds, and how can they be addressed?
JA: In general, pricing wasn’t the primary challenge last year. We found that most transactions fell into one of two categories.
Either the NAV was sensibly priced and there was nothing transformative happening to the assets in conjunction with the continuation fund, which generally resulted in the deal pricing at NAV or a small premium to NAV. Or there were continuation vehicles that had a more transformative event identified in one or more companies, which could result in a meaningful premium to NAV paid in the continuation vehicle as buyers were willing to pass on expected future uplifts to sellers. In those situations, there was more of a conversation being had with buyers to say, ‘If you can hit this price then we can justify selling it from the current vehicle, but we would rather be a buyer than a seller at this level.’
JD: There is now an understanding that a transfer price meaningfully below NAV is rarely tolerated by the underlying investor base or the LP advisory committee, in particular if the selling fund has time remaining in its harvest period to pursue other alternatives. If there is any challenge generally in pricing, it is in ensuring that transfer value provides for adequate upside to justify the vehicle’s economic terms for new entrants.
JA: The market has been growing so rapidly that bandwidth among buyers is something everyone needs to be cognisant of. Instead of looking at all opportunities, most buyers are now focusing on a small number of deals that they have conviction on, which means sellers have to focus on a smaller number of buyers in the advanced stages of a process.
The level of diligence has also increased, along with the scale and consolidation of assets, with processes now more akin to full M&A processes.
JD: As the win-win aspects of these transactions have become better understood by GPs, dealflow has continued to increase, and for the moment demand is somewhat constrained.
This may have an impact on pricing in 2022, but so far we’ve not see that materialise to a great extent.
Where do you expect to see the most activity and demand for continuation funds this year?
JA: Deployment has been overweight in healthcare and technology assets over the last two years as people sought defensive strategies through the pandemic. Market participants will look to a broader spread of sector exposure for new deals, partly to diversify away from those heavy commitments.
JD: While I expect single-asset continuation vehicles to remain a powerful theme, increasing buyer interest in multi-asset transactions will lead advisers like us to unearth more diverse opportunities in that part of the market.
What market developments might we anticipate in terms of deal dynamics?
JD: Longer term, we hope to see more standardisation of rep and warranty, and other legal terms, greater transaction efficiencies and shorter deal cycles.
Also, third-party co-sponsor involvement in these transactions is increasing, and we are seeing sponsors putting capital from their active funds alongside continuation vehicles to help demonstrate conviction and underpin valuations. We expect to see these trends continue.
JA: While we have seen differing outcomes on take-up by LPs of the option to roll over into continuation funds, we expect provision of a reinvestment option to remain a market standard best practice. As a result of the growing number of transactions and higher frequency of sell/roll decision requirements, I anticipate LPs to become more sophisticated in addressing these investment decisions going forward.
Jeremy Duksin is global head of Capital Solutions and Jonathan Abecassis is EMEA and APAC head of Capital Solutions in the Credit Suisse Private Fund Group