This article is sponsored by Duff & Phelps and appears in affiliate title Private Equity International’s September secondaries special.
What is the most noteworthy change you’ve seen in the secondaries market over the last year?
Kevin Nowaskey: Since the onset of the pandemic, we have witnessed a historic year in the secondary market, with a huge change in both its levels of resiliency and creativity. Despite the initial shock of shutdowns leading to a temporary pause in nearly all activity in the secondary universe, the subsequent rebound in the second half of 2020 speaks volumes for the critical role of secondaries in private markets.
In a year of many changes, the rise of GP-led transactions to become a standard part of GPs’ playbooks has been among the most significant. Whereas before these transactions were viewed as a sign of portfolio distress or fundraising difficulties, LPs now view them through a different lens and can better appreciate GPs’ motivations. Historically, private equity managers had only two main exit options for portfolio companies: selling to a strategic or financial buyer, or an IPO. GP-leds now offer an attractive third alternative and will continue to be a key focus of fund sponsors who no longer feel constrained by the traditional 10-year fund life.
Given the emergence of GP-led transactions as a norm, limited partners are generally more comfortable with GP-led processes as long as there is alignment across all parties. We expect the trend of sponsors taking an active approach to portfolio management and liquidity to continue through 2021 and beyond.
How can the secondaries market support, from a demand perspective, the expected dealflow associated with the explosive growth of GP-led opportunities, combined with the anticipated flood of traditional LP portfolios coming to market?
KN: Coming into 2020, there was some concern that the secondary market was growing so fast it would reach a point where secondary capital and dry powder would be insufficient to absorb dealflow. Market participants have responded quickly to the level of GP-led opportunities in the market and raised dedicated secondary capital at unprecedented levels. In just the last nine months, many of the world’s largest private equity managers have pivoted to build out or acquire teams in the secondary space.
Dexter Blake: In addition to the large secondary funds being raised, we are seeing smaller niche secondary players entering the market, focusing on credit opportunities, real estate or infrastructure, for example. We believe the growing number of niche secondary investors who have emerged with strategy, size and/or geographic-focused mandates will create more demand for non-traditional dealflow.
In our view, there will be no shortage of capital for secondary transactions of all shapes and sizes given the constantly evolving and expanding buyer universe.
You mention change as a theme you’ve witnessed in the last year. In terms of innovations in the secondaries space, what comes to mind?
KN: The first one is the entrance of new strategies into the secondaries market. Previously buyers were pursuing private equity, growth and to a lesser extent venture; now, the increased interest from general partners means investors are expanding into new areas with exclusive vehicles dedicated to those new areas.
The second innovation is around the deal types within the historically popular private equity and growth strategies, where we are seeing more and more innovative transaction structures tailored to specific tax regimes or LP mandates. Those deals are about minimising complexity in the transactions via a more efficient structure, and people are really starting to understand that you can structure around almost anything, not just to overcome roadblocks but also to make things more efficient.
Separate from that is the growing market share of GP-leds over LP portfolios. This year is going to see more GP-led transactions than LP portfolio deals, which will be the first time that has happened in the history of the market.
DB: Years ago, the secondary market was generally limited to basic LP interest transfers. Now, there are all these sophisticated innovations leading to different types of transactions, it’s not one size fits all. GPs and LPs can set out their objectives and the market can come up with solutions to accomplish them.
Preferred equity, NAV-based lending, LP tender offers, stapled transactions, continuation funds for both single- and multi-asset portfolios and the use of third-party leverage are just a few of the innovations that have emerged.
More recently, the continuation vehicle on a continuation vehicle, which represents a creative solution not historically seen in the market, has arisen, and we only expect such innovations to continue.
Sorting through all the solutions that could work for a particular buyer and seller in a secondary transaction has become significantly more complicated and increasingly regulated, underscoring the need for an experienced and reputable adviser to successfully navigate the market. Last year, more than 30 percent of GP-led transactions involved some form of third-party valuation, which is obviously something Duff & Phelps, A Kroll Business, is well known for.
We also have a transaction opinions team that is one of the leaders in providing fairness opinions on these types of deals. Kroll’s numerous business lines complement our secondaries advisory group to enable us to address the challenges presented by this continuously evolving market.
The secondaries advisory space has seen a whirlwind of turnover and growth in the past few years. What do you think has driven this change, and why do you feel sellers can benefit from engaging a secondaries adviser?
KN: In response to the growth of dry powder in the secondary market and extraordinarily high deal volumes, the advisory side has struggled to keep up from a staffing perspective given that this is a specialised skill set and a relatively small (but growing) talent pool. The complexity of the deals really requires a new mindset on an ad hoc basis to look at each transaction and, given how young the market is, the issue for advisers is identifying talent with the full suite of tools to meet client needs.
The demand for professionals has really been tough to keep up with. We are seeing that right now, especially on the M&A side where there have been teams moving and even entire firms being acquired. That’s a testament to the growth of the secondary market and the increasing attention being paid to it.
There is, of course, a benefit for sellers from this rapidly growing advisory space, who can now tap into far greater expertise for secondary transactions. The biggest value proposition that we offer sellers is that we can help them navigate any of their valuation-related queries and we can provide a transaction opinion, so we can give them that extra layer of assurance that they are covered from a regulatory point of view. We can navigate those complexities for them in a way that helps them understand all the options.
DB: Years ago, the secondaries market wasn’t meaningful enough for the larger firms to pay attention to it. It is now significant enough that everybody is starting to see the opportunity and putting together teams with a secondary focus.
If you dive into these transactions as a manager without adviser support, there’s really no back-up down the line if a regulator starts asking questions. If there are any questions or potential regulatory issues, we can turn to our regulatory and compliance group for guidance to make sure the transaction is where it needs to be from a compliance and regulatory standpoint.
Many sellers have often tried to sell on their own over the years, some have been successful while others have not. With all the different innovations in the market today, the environment is much more complex and harder for sellers to navigate. Aligning with an adviser that is well-versed in all the different transaction types that can guide sellers through whatever path they choose to take can play a key role in helping to achieve the best possible outcome.
Has the composition of Duff & Phelps’ secondaries group followed suit with the market and evolved over the past year?
KN: Absolutely – we’ve added several senior team members over the past year, which enables us to handle the growing needs of the seller universe and our clients. In our minds, the importance of being able to cover every potential transaction of any size is reflected in our team growth.
We plan to continue building out our global team over the next 12 months to maintain our high-touch approach to secondary market advisory. We expect to continue adding at the senior and junior levels, as secondaries remain a high-priority segment for the firm.