Growth secondaries: When the price is not quite right

In the past, many secondaries investors viewed growth equity with wariness. While buyers were able to get comfortable with more mature assets, businesses with unproven models or no history of earnings were viewed as too tricky to price, and therefore too risky.

For a time during the pandemic, this situation went into reverse. Public market volatility made it difficult to price more traditional buyout assets. Backing companies based on a compelling narrative, as opposed to balance sheet strength, became easier in relative terms, especially in light of the compelling secular trends the pandemic helped to fuel.

“Demand for technology exposure and growth assets in general has risen, evidenced by public market valuations being up significantly relative to earnings over the last 12 to 18 months across most tech subsectors and indexes,” Joe Goldrick, a secondaries-focused partner with Adams Street Partners, said in June last year.

Average pricing for venture and growth funds jumped by 15 percent from the first half to the second half of 2020, according to Greenhill’s full-year report. Pricing was strongest for funds with exposure to late-stage tech, digital infrastructure and healthcare assets, the investment bank noted.

“If a sponsor is unwilling to acknowledge the changed environment in pricing a GP-led deal, there is a high chance it won’t get done”

Several sizeable GP-led deals got done in the growth equity space. In June last year, Canada Pension Plan Investment Board, StepStone Group and Northleaf Capital backed a $1.1 billion multi-asset process on a fund managed by Georgian Partners. The investments included IEX, a stock exchange designed to mitigate the advantages of high-frequency traders, as featured in the Michael Lewis book Flash Boys: A Wall Street Revolt.

General Atlantic’s $3 billion continuation fund, led by Ardian and HarbourVest Partners, included $1 billion of dry powder to develop the four growth equity assets. The deal closed in July and represented the “largest pool of new money secondary commitments” in a continuation fund to date, General Atlantic said. A strategy once viewed with caution was now breaking records.

Taking a hit

The secondaries market has not been immune to the decline of tech stocks, brought about by inflationary pressure and rising interest rates. While these conditions have not killed the appeal of growth secondaries, they have led to a pause and a rethink.

Growth-focused GP-led deals with public exposure executed during the pandemic have taken a direct hit from market declines. Affiliate title Private Equity International and Secondaries Investor are also aware of several processes – some with public exposure, some without – that were priced richly in the second half of last year and are now being repriced at the behest of buyers.

“A lot of buyers have had to step back and say, ‘What is the right valuation?’” says Derek Snyder, a partner with AltamarCAM Partners. “It becomes more and more difficult to comp to the right companies when you see markets down 15 percent, up 7.5 percent, down 3 percent week-on-week.”

Sponsors are not obliged to reflect declining public markets in their next set of valuations. First-quarter valuations were starting to be published at the time of PEI going to press; many were flat or just down slightly on a quarter-on-quarter basis, according to conversations with two funds of funds managers.

If a sponsor is unwilling to acknowledge the changed environment when pricing a GP-led deal, there is a high chance it won’t get done – particularly as many secondaries buyers have been loading up on GP-leds and are now close to their concentration limits. If sponsors are willing to accept a price that reflects the new market conditions, attractive deals are on the table for secondaries buyers.