The pandemic accelerated a change that had been in motion for years: the GP-led process becoming a tool for upper quartile managers.
From the third quarter of last year, pent up buy-side demand and the unwillingness of buyers to take on riskier, diversified exposure allowed many sponsors to recapitalise their best assets on highly favourable terms.
This trend has continued into 2021. This week Secondaries Investor reported on a process involving long-hold manager Castik Capital and its portfolio company Waterlogic, which has increased sales fivefold since 2015. Leonard Green & Partners, General Atlantic and Waterland Private Equity have all completed or are set to complete $1 billion-plus processes at par-plus pricing, Secondaries Investor and our colleagues at Buyouts have reported in recent months.
This move up market raises a question. Is there still room in the GP-led market for assets that have struggled – perhaps due to the pandemic – and which could come good with more time and capital?
At the smaller end, the answer appears to be yes. Buyers such as GP-led-focused Hayfin Capital Management, which writes cheques of between €10 million and €50 million, are seeing an “enormous” opportunity to enter pandemic-impacted businesses at a lower price point. It employs many structuring features more commonly associated with LP portfolio sales to bring buyers, sellers and LPs to agreement.
“Whether it’s earnouts, some form of arrangement around the priority of cashflows or preferred equity, we can have these conversations because GPs seeking capital for a continuation solution understand we need to have a way to address the downside risk,” says director Vladimir Balchev.
Outside the smaller end of the market, it is difficult to imagine challenged dealflow turning from a trickle into a flood. A handful of more challenged deals have entered the pipeline, according to one managing director with a top 10 buyer. With so much high-quality dealflow out there, these challenged deals are easy to ignore, she adds.
Advisors, often under-resourced, have little incentive to take up mandates with higher execution risk. The success of the market in presenting itself as a tool for high-quality assets also makes it difficult to propose structured processes.
“[GP-leds] are seen as a clean process. Going to the LPs and saying you can either roll or get 50 percent now and 50 percent in two years’ time…it’s off-message,” says one buy-side partner.
Still, there are ways for buyers who do want to bank on the recovery of assets or industries to get downside protection in a way that does not makes LPs’ lives more difficult. Renegotiating the waterfall in a way that rewards the GP for real outperformance is one way – particularly with a status quo option that delivers the same economic terms for LPs, says Alex Green, a partner with law firm Macfarlanes.
What are some other ways that buyers can seek downside protection when looking at pandemic-affected assets? Write to the author: firstname.lastname@example.org