The allure of GP-led secondaries

Muted M&A activity and liquidity demands are prompting more sponsors to consider moving assets into continuation funds, but successfully completing a GP-led deal is more easily said than done.

The pursuit among sponsors of GP-led secondaries deals has reached fever pitch, and it isn’t hard to see why. The success of future fundraising endeavours rests squarely on a firm’s ability to deliver liquidity to existing LPs. With M&A and IPO markets still dragging their heels, the opportunity for a private equity firm to sell an asset to themselves, obtain a cash injection to embark on a new chapter in the company’s growth story, all while delivering cash back to investors, thereby keeping the fundraising wheels in motion, is understandably a welcome option.

“For over a decade, LPs have generally been cashflow positive on their private equity books,” says HarbourVest managing director Rajesh Senapati. “More cash was coming in than was going out the door to service capital calls, even with investors running modest over-commitment strategies. But that has all changed in the past year and a half. LPs and GPs alike are now clamouring for liquidity.

“Continuation vehicles are therefore a great solution that allow GPs to provide optionality for LPs in need of liquidity, while at the same time achieving other objectives, such as raising incremental capital to support growth, getting more time in order to wait for a better exit environment, or realigning incentives for go-forward value creation.”

Palladium Equity Partners is one firm that has taken the plunge, announcing the close of a $450 million continuation vehicle earlier this year encompassing three businesses: entertainment destination Sky Zone, Hispanic cuisine specialist Del Real Foods and low-calorie flavourings provider Jordan’s Skinny Mixes, all companies acquired by Palladium’s fourth fund, which closed almost 10 years ago.

“The primary appeal for us was providing optionality to our limited partners to best meet their needs,” says Justin Green, a partner and co-head of flagship funds at Palladium. “A continuation vehicle provided our LPs with an option to take liquidity if they wanted to do that while allowing us to own the assets longer and create what we expect to be additional value for limited partners that preferred to stay in the deals.”

One Equity Partners, meanwhile, closed a substantial continuation fund last year, which centred around two European portfolio companies. Additional capital from the deal will be used to drive transformation acquisitions at aftermarket construction parts manufacturer and distributor USCO and laboratory glassware manufacturer DWK Life Sciences.

“One of the reasons these deals are so attractive in the current environment is [because] exits are down across the board and so LPs are starved of distributions,” says David Lippin, a partner and head of investor relations at One Equity Partners. “A continuation vehicle allows the GP to monetise the value created over years of ownership, generating liquidity for those LPs that want it. At the same time, it gives the sponsor the opportunity to continue to grow and develop those businesses, allowing the growth trajectory of assets they really like to continue.”

Indeed, in many cases today, GP-led secondaries are not just the most attractive exit option available, they may well be the only exit option on the table. “In 2019 and 2020, when the M&A market was hot, sponsors were using continuation vehicles to retain ownership of assets where they had long-term conviction, while generating liquidity and de-risking existing LPs,” says John Rife, a partner at law firm Debevoise & Plimpton. “Now that other forms of exit have dried up, however, the focus is less on de-risking existing funds, and more about realising assets in a market where there are few other credible exit routes. In fact, a continuation vehicle may well be the most likely exit route to succeed today, whereas in 2020, it was just one option among many.”

The problem, of course, is that this has exacerbated the supply/demand imbalance in the GP-led market. “Given the meaningful opportunity set today, secondaries buyers have the ability to be highly selective in the deals they choose to pursue,” says Senapati. “This includes the ability to potentially shape a portfolio that is high quality but that will also price well for LPs receiving the liquidity option. Taking a mixed-quality portfolio to market today as part of an end-of-life solution may not get the level of interest that GPs would like, or the type of pricing LPs may be looking for.”

“There seems to be a lot of supply in the market right now relative to demand,” adds Palladium’s Green. “As a result, some capital providers are focusing on existing relationships, looking for deals that meet very specific criteria, or looking for significant pricing discounts. While it is possible to get deals done, I do think the market is challenging.”

Amyn Hassanally, a partner and global head of private equity secondaries at Pantheon, agrees. “It is clearly a buyer’s market and so only the most compelling opportunities will complete. There needs to be realistic valuation expectations, high-quality assets and managers, strong alignment and sound transaction rationale if a deal is going to get across the finishing line.”

David Perdue, a partner and global head of the secondaries advisory business within PJT Park Hill, says: “Given the current supply/demand dynamics, it is important to understand the demand for your transaction, as well as market awareness of what other deals are in competition with your deal, to inform an optimal marketing and execution strategy.”

As a growing number of GPs try their luck in an intensely competitive continuation vehicle market, affiliate title Private Equity International has gathered some top tips for sponsors hoping to run a successful and more seamless process.