Welcome to the era of the secondaries operating partner

Secondaries capital that comes with deep sector expertise may define the next iteration of the GP-led market.

US private equity firm Clayton, Dubilier & Rice is widely credited for having pioneered the operating partner model – one in which value creation is driven through strategic operational developments within a portfolio company through the hiring of industry specialists.

Almost a half century since CD&R’s founding, this approach is beginning to appear in the GP-led secondaries industry. Just last week it emerged that Accel-KKR, one of the US’s better known tech-focused buyout and growth firms, is the lead investor in a continuation fund deal involving assets managed by Germany’s LEA Partners. Accel-KKR is using mainly balance sheet capital to back this deal as an LP in the continuation fund. A source familiar with the transaction tells us the firm may eventually aim to raise a dedicated fund to invest in such deals.

Leonard Green & Partners is also getting in on the action with the hire of David Fox from Strategic Partners and Garrett Hall from AlpInvest Partners, according to a source familiar with the firm. The pair will join in Los Angeles as partners and co-heads of a debut fund focusing on investing in continuation funds, and LGP sees an opportunity to be a value-add partner, Secondaries Investor understands. It is not launching a wider secondaries business, the source added.

European buyout firm Astorg has also launched a unit focusing on continuation funds and will focus on backing deals within its own sweet spots of healthcare, business services, industrials and technology.

It’s easy to see why traditional buyout firms are keen to get a slice of the continuation fund action. This is a market that accounted for 12 percent of global sponsor-backed exit volume last year, according to data from Jefferies, and one which many expect will grow.

On top of that, firms appear to be aiming to fill a white space in the continuation market: that of the sector specialist secondaries buyer. A GP running a continuation fund process could partner with a generalist secondaries firm and passive LP capital. Or, it could receive secondaries capital from a buyer with deep knowledge in a particular sector.

“If I’m a GP, do I want plain vanilla passive capital from a secondaries fund, or do I want slightly more active capital that comes with sector expertise and access to specialised networks?” a former big name LP told Secondaries Investor over lunch last week.

There are cases where more active specialist secondaries capital won’t be appealing. A large-cap software-focused GP might not want secondaries capital from another large-cap software-focused GP in its continuation fund for obvious reasons. Yet, a lower-mid-market European tech firm might find the idea of accepting secondaries capital from a mid-market West Coast-based tech and growth GP a particularly valuable opportunity.

Make no mistake: private equity firms will need to hire people with demonstrable track records executing on GP-led deals if their attempts at building secondaries units are to be successful. If they can do this, though, their firm’s expertise in a particular sector or industry may well give them an edge over their plain vanilla secondaries counterparts – and that’s something that should make most GP-led investors sit up and take notice.

Write to the author: adam.l@pei.group