It’s an oft-touted fact that leverage can turn from friend to foe if a deal goes sour. But there’s another tool in the secondaries market toolbox that has exploded in use over recent years and has the potential to wreak havoc on deals: syndication.
It’s hard to think of any sizeable deal completed over the last few years that was backed by a sole buyer. Syndicated deals – whether a group bidding together, or a buyer selling down exposure post-closing – have become the norm in recent years.
Syndication has allowed buyers to spread risk and to take down deals that would otherwise be too big for any one secondaries investor. A €1 billion-plus bet on, say, an ice cream maker, is a lot easier to swallow when you can cap your exposure at €300 million, for example.
Private equity sponsors are going to have to make tough decisions about their portfolio companies amid the covid-19 crisis. If follow-on capital is required to rescue an asset, then the task is much more straightforward if you can be sure the capital is there to deploy.
Recounts a veteran secondaries investor: “If we were doing a $600 million deal, then we would capitalise that deal with $750 million, so we had $150 million contractually available to help that company if it ever needed it.” The same investor notes that he would only allow co-investment if the co-investors had committed capital to a vehicle they controlled. “If there was ever a problem, we didn’t need to convince 12 other people to put up their share of $100 million.”
This situation feels even more acute in the case of single-asset restructurings, which rose to account for 17 percent of the GP-led market last year, per UBS data. A restructuring involving a company in a particular industry or market disproportionately hit by the coronavirus pandemic could leave secondaries investors wondering whether the others around the table will be ready and willing to participate.
“It’s a different risk that people have never thought about,” says the same veteran. “You’ve reduced your dollar risk to that deal, which in one sense is good, but if you did 10 of them, and you’ve got 10 situations like that where you’re dependent on nine other people to finance the solution, that’s not a great spot to be in.”
How big a problem this ultimately turns out to be is anyone’s guess, but here’s some sobering statistics: according to Lazard, one third of all GP-led deals last year were larger than $500 million and as such required syndication. Secondaries investors participated in a greater number of transactions last year, with smaller capital investments on average, the advisor notes.
With as much as $88 billion of equity spread thinly across a higher number of deals last year, many buyers will find themselves at the whim of their fellow syndicatees’ views on how and whether to save an asset.