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Finding value in small buyout and VC secondaries

An increasing number of private equity secondaries transactions focused on small buyout and venture capital managers has helped Adveq find value in the market, explains Nico Taverna, head of the firm’s secondaries programme.

An increasing number of private equity secondaries transactions focused on small buyout and venture capital managers has helped Adveq find value in the market, explains Nico Taverna, head of the firm’s secondaries programme.

The private equity secondaries market has developed very successfully over recent years yielding record returns for investors. By virtue of the strong returns that have been achieved and a number of advantages over other private equity strategies, the segment has attracted a broad spectrum of investors including highly-specialised dedicated secondaries players as well as non-traditional secondaries participants such as corporate pension plans and endowments.

As with any growth segment, the private equity secondaries market has matured as evidenced by slowing market growth rates in terms of transaction volumes closed and a lack of meaningful innovation by investors. The maturing secondaries market has come with higher degrees of intermediation and more sophisticated market participants, which in turn has led to greater information transparency. Inevitably this has made it increasingly difficult for secondaries funds to generate strong returns by exploiting market and pricing inefficiencies. Against this backdrop, successful secondaries market players need to develop clearly differentiated strategies including geographic focus, deal size and targeted funds.

Adveq’s secondaries programme, focused on transactions in small buyout and venture capital managers, has allowed the firm and its clients to access an area less-pursued by larger market players. Due to lower deal volume and less information available, this segment is considered by some to be harder to tap into; however, Adveq has found success using this differentiated strategy. Overall, the volume of transactions has certainly increased in these segments of the secondaries market as it has matured. But, these particular sectors continue to operate as a sort of parallel market, which provides significant potential to find value.

What distinguishes the small buyout space from large buyouts is, perhaps too obviously, the size. Because it involves smaller funds and fewer investors looking at these niche markets, there is opportunity for investors who are willing and able to dig deeper and find the transaction opportunities. There is what you might call a “hidden potential” because it is not as widely known and as highly documented in the public domain.

Relationships, particularly geographically diverse relationships, are an integral part of access to these segments. An analysis conducted by Adveq shows there are currently more than 700 small buyout managers active in Europe alone. Similarly, in the United States, there are an estimated 800 active small buyout managers. Most of these managers are not known to the wider market, neither to buyers nor to intermediaries, which makes the sourcing of secondary transactions both challenging and resource-intensive. As fund managers increasingly use secondary opportunities to complement their limited partner base with long-term partners, a well-established primary practice in the small buyout space is key to securing the required market coverage and being positioned as preferred buyer of a secondary interest.

While deep knowledge of the fund manager universe is equally important to source secondaries transactions in venture capital managers, the proper assessment of assets in this space is often more challenging. Therefore, dedicated secondaries players with knowledge of certain niche industries have a distinct advantage due to asymmetry in information between buyers and sellers – one of the key features of inefficient markets. For example, Adveq has successfully closed a number of secondaries transactions in fund managers focusing purely on life sciences because of its investment professionals’ technical backgrounds and experiences in the sector.

Larger and pure secondaries players will face challenges trying to tap into the attractive niche markets mentioned above as intermediaries rarely provide access to the segment. Furthermore, many players lack the skills and confidence to price venture capital interests. Because the venture capital secondaries market is highly specialised and detail-driven, it requires not only overall skill in assessment of the secondaries market, but also a deep, experience-rooted knowledge of the particular industry segment in which the venture capital is focused. Investors must not only have a solid understanding of the industries, but also the ability to assess fund managers and conduct due diligence based on primary market offers.

To be clear, this does not mean that larger secondaries players will be unable to compete in the marketplace. Their competitive advantage lies in their ability to offer a “one-stop-shop solution” for sellers of large portfolios. However, as the secondaries market continues to mature, it will be the parties able to differentiate their strategies and leverage their established positions who are able to derive the most value from transactions.