The market for secondhand fund interests hit as much as $39 billion in the first half of this year, accounting for around two-thirds of secondaries transaction volume, according to some estimates.
A confluence of events including public pension plans finding themselves overallocated to private markets; a slowdown in distributions; and funds returning to market faster than before, forcing LPs to seek liquidity options to free up cash, has made the opportunity to sell stakes in private markets funds all the more attractive.
Secondaries Investor recently caught up with Adrian Millan, a partner at PJT Partners, who leads the investment bank’s LP advisory practice. Here are his five top things that LPs should keep in mind when considering a stake sale:
- Portfolio construction is key
The best transactions occur where LP objectives and buyside interest intersect at the lowest opportunity cost to the LP. Providing too broad a menu of funds to the market can lead to unforeseen outcomes like certain asset types, vintages or geographies being selected away from an LP’s objectives of reducing others. Curation of a portfolio that optimises pricing against go-forward return, maximises buyer leverage and incorporates GP transfer restrictiveness have the highest potential for success. Said differently: selecting assets for an LP portfolio sale should look to capture the highest secondary prices relative to the LP’s foregone return from selling the assets, maximise the potential for the buyer to add leverage and recognise the transfer restrictiveness of several GPs. These attributes when optimised position transactions for success.
2. Understand the GP-led market
LPs contemplating portfolio sales must be advised on how best to consider current or upcoming GP-led liquidity options for specific funds or assets within their portfolio. These GP-sponsored liquidity events could be better standalone outcomes and fit well into an overall liquidity plan. Selling an LP portfolio without this context could lead to underpriced interests in a broader sale and the potential for not capturing the best demand for certain fund interests.
3. Explore all liquidity options
Many LPs view secondary sales as an all or nothing decision. In the current market, where risk and exit timing are more difficult to price, we are increasingly advising clients to explore partial liquidity options such as NAV financing and preferred equity, as an alternative to a traditional sale. Partial liquidity options are powerful tools when evaluating a discounted sale transaction relative to an opportunity to retain exposure to the assets and capture incremental upside. We have seen many LPs opting for partial liquidity where buyers have been unable to meet the LP’s price expectations for assets that have the potential for tangible upside, particularly in the last few quarters.
4. Anticipate competitive supply
Despite significant buyside capital formation over the last five years, LPs should factor in competitive supply in the secondary market as they make the decision with their adviser on what to sell and when. Buyers looking across similar deals will often seek out the one with the most pricing flexibility or the opportunity to select specific interests to form a preferred sub-portfolio. Being mindful of overall market supply and key selling windows, such as a GP’s fundraising kickoff, will allow for the best market receptivity.
5. Scale to the market
Especially today, a multistage process may be required to increase buyside engagement and pricing. Larger positions, such as those above $100 million, may need to be sold in tranches to increase the potential for broad market engagement and mitigate market appetite for certain GPs or sectors. For several LPs with oversized VC allocations, for example, smaller sales over a multi-quarter period have allowed those portfolios to be sold down entirely at higher prices. These outcomes were contrary to accepting a larger discount in uncertain markets on a full portfolio driven by a smaller universe of larger sector-focused buyers able to buy certain positions or portfolios of scale.