GP-leds are now an established tool
On the face of it, conditions were ripe for an increase in GP-led secondaries activity last year. The rise in interest rates, geopolitical and economic concerns, public market volatility and falling valuations hampered M&A and IPO activity. GPs with high-quality assets that were reluctant to exit through these routes in such a market instead looked to continuation fund structures to hold on to their best performing companies and extend value-creation runways.
As Joseph Marks, a senior managing director and head of secondaries at Capital Dynamics, tells Private Equity International: “In times like these, when M&A activity levels are materially down and the IPO market is largely shut, GP-leds are becoming the third leg of the liquidity triad.”
GP-led transactions – and in particular the option to cash out – also provided an attractive proposition to LPs, many of which were grappling with the denominator effect and seeking solutions that could provide them with liquidity. Indeed, Raymond James’s 2023 Secondaries Outlook Survey noted that LPs’ decision to sell in continuation fund deals has been above historical levels and predicts that, given LPs’ ongoing liquidity needs, it is expected to stay that way over the year ahead.
While the market remained resilient – total volume reached $52 billion in 2022, per Jefferies’ latest Global Secondary Market Review – it was not impervious to wider macroeconomic uncertainty. GP-led volume contracted by 24 percent year-on-year and, given the more challenging valuation environment and lag between public and private markets, more GP-led transactions priced at a discount.
Market participants also reported a general increase in secondaries buyer selectivity, and a higher bar for concentrated deals. Continuation funds represented around three-quarters of GP-led transaction volume last year, according to Lazard data. The advisory firm estimates that single-asset continuation funds accounted for approximately 40 percent of GP-led volume in 2022, down from 52 percent in 2021, while multi-asset deals accounted for 34 percent of volume last year, up 3 percentage points.
In H2 2022, “it was quite difficult to get anything done that wasn’t either pretty modestly sized in the single-asset market or was diversified”, Holcombe Green, global head of private capital advisory at Lazard, told affiliate title Secondaries Investor. “When there is economic uncertainty, secondary investors retreat to what they view as safety, and what secondary investors typically view as their own version of safety is diversification. They do more LP deals, and they prefer diversification in their GP deals where they can have more than one way to win.”
Despite shifting sentiment and wider macro turbulence, it’s worth noting that GP-led volume was still the second highest on record last year. Meanwhile, GP-led transactions accounted for almost half of all secondaries volume, indicating that the market has become an accepted portfolio management tool and one that GPs are increasingly comfortable turning to during times of market distress.
Alignment is becoming ever more crucial
Given the challenges posed over the past 12 months, it is perhaps not surprising that many of the secondaries professionals PEI spoke to for its 2023 GP-led Secondaries special were keen to stress the importance of alignment in successfully getting these transactions over the line. In a 2022 survey by Capstone Partners, over a quarter of LPs cited misalignment as the biggest red flag in a GP-led transaction, second only to no carry rollover. When asked what their three main priorities are in a GP-led transaction, reinvestment of carry by the GP came out on top among LP respondents (64 percent), surpassing the quality of the asset (61 percent).
“GPs assume that the first thing that LPs are going to worry about is valuation, and this concept of conflict that they’re trying to pull the wool over their eyes,” Capstone managing partner Steve Standbridge told Secondaries Investor last year. However, while getting the highest valuation is important from a fiduciary perspective, LPs get “comfort if they know that the GP is all in, that they’re rolling their carry, that they may be rolling their investment”.
This greater onus on alignment was also prevalent among the more selective buyside, and adviser figures suggest sponsors ramped up their efforts accordingly to demonstrate they had ‘skin in the game’. Around 90 percent of the continuation fund transactions that closed last year featured key principals at GPs reinvesting 100 percent or more of their realised economics, according to the Jefferies report. Meanwhile, the report noted, around a quarter of single-asset deals featured cross-fund investments from sponsors’ current flagship funds.
Capital constraints should start to ease
Just as LP capacity constraints and macro uncertainty dampened private equity fundraising last year, the more challenging environment also took its toll on secondaries fundraising. The amount of capital raised by secondaries funds dropped by $23 billion year-on-year to almost $49 billion, per Secondaries Investor data.
However, funds are seeking to raise some $95 billion of secondaries capital in 2023, according to Lazard. The advisory firm reported that three-quarters of respondents to its latest survey are currently fundraising for new flagship vehicles, with half of respondents anticipating that they will wrap up their fundraising efforts in the first half of this year.
Given that a growing number of managers have launched, or are in the process of launching, dedicated GP-led strategies, this uptick in fundraising would be welcome news for the capital-constrained GP-led market, which has so far been characterised by a mismatch in supply and demand.
In January 2023, Blackstone announced that it had raised $2.7 billion for its debut GP-led continuation fund strategy, Strategic Partners GP Solutions, as well as $22.2 billion for its flagship secondaries fund, Strategic Partners IX. This is just one example of a trend that is expected to pick up steam moving forward: buyers separating out their secondaries strategies.
Such specialisation can help secondaries managers stand out from the crowd, sidestep concentration limits and cater to the needs of an increasingly diverse and sophisticated investor base.
As is the case in other asset classes, the move towards specialisation could be seen as a sign of the market’s maturation. Indeed, Yann Robard, founder and managing partner at Whitehorse Liquidity Partners, recently told Secondaries Investor that the secondaries market is ripe for disaggregation. “You’ve got preferred [equity], you’ve got diversified LP, then leveraged diversified LP, then multi-fund continuation funds, then single-asset continuation funds,” he said. “What you have is a risk-return spectrum that’s starting to get created in the secondary market and that’s just a natural evolution of the maturity of this industry.”