PJT Partners: The GP-led market is just getting started

This article is sponsored by PJT Partners

Have there been any fundamental changes in single-asset continuation vehicles over the last year?

David Perdue: There have definitely been changes in the short term, however it’s hard to predict any long-term impact in an evolving market.

In 2022, we saw a sea change in what investors in single-asset products required in order to participate at scale. Coming out of the second half of 2021, it was common to have a minority stake sale to another private equity firm set the price, and then move the balance of the equity into a continuation fund. Those deals fell out of favour in 2022 and unfortunately, several deals in the marketplace got caught in the crosshairs of that and things got stuck a little bit, which caused a backup in the single-asset market. It made it harder to bring new product to market.

So far in 2023, more buyers are focused on multi-asset deals. There is still demand for single assets, but successful execution, whether utilising minority stake sales or not, is dependent on identifying differentiated demand in a crowded market.

What caused that sea change?

DP: The most common theme when you talk to people is LP feedback. A common question in the secondaries market is the double layer of fees, and how you generate enough alpha to justify that second layer of fees for a fund of funds investor. Ultimately, outsourcing the valuation is a key part of that underwrite for an investor. LPs came to their partners and said ‘that’s an activity we are expecting you to perform, and we would prefer to see you have a more active hand in steering the deals and setting the terms comprehensively, including valuation’. The main buyers in single-asset secondaries wanted to take a much more active role in that underwrite themselves and not be brought in afterwards once somebody else had done that valuation underwriting.

How do the different facets of PJT help to create a compelling story for buyers in a crowded marketplace?

Brian Levine: Taking a holistic approach, bringing the primary teams to the secondaries processes in terms of their relationships with investors, widens the top of the funnel for potential dollars that can go into a process like this. Making sure we’re attacking that in a well-coordinated effort just increases our chances of success.

Dayan Abeyaratne: There are many similarities with sell-side M&A deals, but there are also a lot of differences. The strategic advisory team has had to learn how to maximise that and work with the secondaries team and primary fundraising team. LPs who tend to lead these deals are in many ways as sophisticated as their private equity counterparts, so we have to meet them at that level, with that quality of work and with that kind of down-in-the-weeds knowledge of the asset and the ability to communicate that.

On the other hand, there are also a lot of investors, particularly in the syndicate, that tend to be generalists and might not understand all the nuances of a particular market. Together as a team, we’ve had to figure out how to take an investment thesis and present it to different classes of investors. Bringing the LP knowledge together with the industry knowledge is what we’ve seen get the best results.

How difficult is it to create true alignment between all parties in these deals?

DP: It can certainly be complicated. I expect we are going to see a continued increase in current fund co-investment in continuation vehicles. That’s viewed as positive alignment, and it also helps address capital constraints and gives people confidence on collapsing that syndication timeline and accelerating the close of the transaction. Having that investment and conviction alongside the new investor does help assuage some of the concerns people have about a sponsor being on both sides of these transactions.

Having said that, I do think there’s a role for liquidity, too, particularly for management teams. Almost all the alternatives to a single-asset continuation vehicle would count as a liquidity event for management teams, even if it was a sponsor-to-sponsor sale. So, treating it similarly is probably where things are going to head. Having the alignment drive from the sponsor themselves and relying on them to manage the relationship with the management team and make sure the incentive package is appropriate for the go-forward return profile they see is probably where we will end up.

What are the biggest challenges you foresee in the next 12-18 months?

BL: Available capital will remain a challenge. The exit markets have crawled to a halt, investors are forecasting a meaningful decrease in near-term distributions, deployment models are broken in terms of when GPs are coming back to market. For a period of time, GPs generally came back to market every three to four years. Then, investment paces increased and it became every one to two years. That’s going to slow again, which is healthy for the market. In the interim, investors and GPs will need to continue to work together to address their combined capital needs.

“Investors and GPs will need to continue to work together to address their combined capital needs”

Brian Levine

DP: There have been a lot of moving deck chairs on the advisory side in the secondaries market. We think that’s generally healthy in a market that’s growing. Having said that, we’re watching very carefully because it could be concerning if the quality of the transactions starts to get diluted as people try to build franchises and show progress and gain tombstones in a market that’s moving quickly.

A hallmark of this market has been the quality of the underlying risk exposure you can get, and how beneficial it is to both GPs and LPs. All private capital markets depend on LPs, so maintaining that relationship and the best interests of your LPs is something that’s really important to us. In 2022 we saw a concerning number of transactions hit turbulence in the marketplace, so we have redoubled our efforts on our underwriting, making sure we have the right alignment, manager quality, deal set-up and distribution strategy to raise the capital.

Are you having difficult conversations with managers that want to pursue a GP-led deal but you don’t think the asset is a good candidate?

DA: We spend a lot of time with GPs on the M&A side, and there have been many instances where we have had to tell them they can’t do a fundraise or a continuation fund. We’ve had the GPs come back and say, ‘yeah, you guys were right, thank you for that’. So, it does pay off for a franchise to give the right advice. That helps us, too, because we want to continue to have the relationship on the M&A side, so having taken them down a path they shouldn’t have been on is not good for anyone.

“In 2022, we saw a sea change in what investors in single-asset products required in order to participate at scale”

David Perdue

BL: At the end of the day, we want to give the right advice. Being upfront and transparent with your clients is paramount. It’s easy to look someone in the eye and just say ‘yes’ to them, but yes isn’t always the right answer. We are trying to give the appropriate counsel to our clients in every aspect, whether it’s primaries, secondaries or strategic advisory.

What are your predictions for the future development of the GP-led space?

DP: We are in the early stages of thinking about how continuation fund technology can be used in portfolio management. Does it start to play a role in the M&A markets? Potentially. Does it start to eat into the co-investment market and become a synthetic club transaction the way we saw private equity get deals done prior to 2008? Possibly. Are we going to continue to see larger transactions in the single-asset space and in the GP-led market generally? We hope so.

As we think about a $1 billion-$2 billion equity transaction today, for a single asset, that is still fairly small for the large-cap players that are raising $25 billion private equity funds. We need that market to grow for it to be relevant for the highest-quality assets that are in the marketplace today. My hope is we’ll continue to see even more creativity in the next couple of years, as more and more people start to participate in the market.

What are some of the common characteristics you look for to indicate a deal will be successful?

DP: There are a couple of different themes that are consistently present in the deals we take on and find success with. We spend a lot of time underwriting the demand side and making sure we can distribute in a punctual way with investors that are going to be excited about the opportunity. We focus a lot on the relationship. We want to be supportive of the GPs that have been good partners to us over the years, and so manager quality is always going to be a big focus. If you look at where PJT Park Hill has raised money historically, and where we focus as an institution in the M&A markets, there’s a lot of overlap. That’s consistent in the secondaries transactions we take on too.

Next, we want to have a real value-add to play, whether that is industry expertise, structuring expertise or something unique we can bring to market. We focus on onboarding the right transactions and vetting the underwriting before we take things out into the marketplace.

David Perdue is a partner and global head of the secondary advisory business within PJT Park Hill at PJT Partners, Brian Levine is a partner and global head of PJT Park Hill, and Dayan Abeyaratne is a partner within PJT’s strategic advisory group