Larger secondaries transactions may have garnered the headlines to date, but it seems that smaller deals are becoming the big story, particularly on the GP-led deal front.
“2023 is the year of the mid-market continuation vehicle,” says Matthew Sparks, a managing director at Northleaf Capital Partners. “Unlike previous years, we’re not seeing many of the larger, marquee deals getting done.”
The exception to this is, of course, Madison Dearborn’s $2.2 billion multi-asset continuation fund deal. At the time of completion, the transaction was the largest to get across the line on the GP-led side so far in 2023. Others have not been so lucky: in July, for example, Secondaries Investor reported that EQT had shelved plans for an approximately $2 billion GP-led deal.
“Over the past few years, around 80 percent of deals by dollar amount were in the $500 million-plus bracket,” says Mike Bego, managing partner at Kline Hill Partners. “But the music stopped in Q2 2022 – the markets tumbled, liquidity dried up and fund raising slowed down. Up to 60 percent of GP-led deals started earlier in the year didn’t get done, and the market went into freeze mode.”
The other block on larger deals has been portfolio management among secondaries players. “It is very difficult to raise continuation vehicles requiring greater than $500 million of equity,” says Sparks. “Buyers who were active in 2021 and 2022 are now having to manage company concentration levels and are being more selective.”
From super-size to downsize
The result is more activity in the mid-market space, such as North American mid-market-focused firm Centre Partners’ deal to retain medical and psychological evaluation services provider IMA Group and citrus product manufacturer Sun Orchard, and Texas-based lower mid-market PE firm Presidio Investors’ GP-led for Elevate Semiconductor, a San Diego-headquartered chip designer for semiconductor automated test equipment.
“Buyers are focusing on deals they can largely fund themselves because if they need to syndicate, that brings increased execution risk,” says Rodney Reid, a managing director and global head of the private funds advisory group at Moelis & Company. “That means they are looking to do smaller deals. There is more supply here, too, as many of the mid-market sponsors have already faced fundraising headwinds and LP pressure on liquidity.
“That means there is a greater opportunity for buyers to cherry-pick the best opportunities. Increasingly, secondary buyers that prefer to whale-hunt assets of larger sponsors are turning to the mid-market for deals.”
This point is also picked up by Bego: “The market reacted to last winter by downsizing, and we now see even the big funds doing $300 million to $400 million deals, while brokers are focused on deals that they can get across the line.”
A lack of capital is another reason for more mid-market GP-led deals. “The sell-side has been growing as all sponsors now understand the GP-led technology,” says Brian Sullivan, head of secondaries at GCM Grosvenor. “Yet the buy-side hasn’t grown with it. That imbalance is forcing everyone to move from larger deals into the smaller space. Bankers are reluctant today to take GP-led deals to market that will require $1 billion or more buy-side capital.”
“Increasingly, secondary buyers that prefer to whale-hunt assets of larger sponsors are turning to the mid-market for deals”
Moelis & Company
It is not just push factors that are leading more buyers to the mid-market; some suggest that these deals are intrinsically more attractive than the mega-deals. “The alignment of mid-market GPs tends to be better than for larger GPs,” says Bego.
“GP commitments and other forms of alignment are very strong in mid-market transactions: cross-fund investments, for example, are a theme in this segment. We’ve not seen very large GP-led deals with this level of alignment – large GPs have already been around for 20 to 30 years and they have massive pools of assets, and GP-leds are mostly done for portfolio management.
“Brand name GPs get more attention from the secondaries market, and many investors will only commit to a GP-led deal if they are a primary investor with the GP – these deals therefore tend to be very competitive. Smaller GPs that fly under the radar are more open to crafted, curated deals to get them done.”
More capital is entering the space as strategies evolve, however. “Lots of players are interested in the mid-market space – including larger players with LP-led and GP-led capability, alongside GPs and some smaller secondaries players raising capital specifically for GP-led deals,” says Jonathan Graham, a managing director at Asante Capital.
Recent fundraisings include Northleaf, which reached the $1.3 billion final close earlier this year on its third secondaries fund to invest in mid-market LP-led and GP-led transactions, and GCM Grosvenor, which attracted almost $1 billion for mid-market secondaries, also targeting both LP-led and GP-led deals.
Meanwhile, also earlier this year, Morgan Stanley Investment Management reached the $2.5 billion mark for a fund that exclusively targets single-asset GP-led deals in the mid-market. Churchill Asset Management is another player believed to be eyeing the space after hiring Nicholas Lawler from 50 South Capital to build a US mid-market GP-led arm.
Interest in the mid-market from all corners is leading to some competitive pressures on the best deals, despite the overall dearth of capital for the secondaries market. “When there’s an interesting mid-market deal, the whole market flocks to it and it can be challenging to get an allocation,” says Sullivan. “And the issue is that sponsors determine who gets allocations to GP-led deals, so you need to have an existing relationship with the GP and perhaps also be an investor in the fund if you want access to the best opportunities.”
Far from saturation point
Even so, many believe the amount of capital flowing towards secondaries in general, and towards mid-market GP-leds in particular, is still not sufficient to keep up with the supply of solid deals. “Most buyers are moving quickly through their capital,” says Graham. “We are years away from the market being saturated with capital or experience. Most principals we speak to say they can’t cover as much of the market as they would like.”
That situation may last for some time. Given that single-asset GP-led deals are a relatively new phenomenon, LPs may well wish to see more proof that these transactions can generate solid returns before they commit to new funds targeting the segment.
“The track record for GP-led deals is immature versus LP-led deals,” says Bego. “The earliest data point we have is from around 2015 and we will have to see more results come through before the market is adequately funded.”
For now, though, GPs are getting deals through where they can, with some in the mid-market embarking on second or even third GP-led deals. “GPs are starting to build a continuation vehicle track record,” says Yaron Zafir, a managing director and head of secondaries at Asante Capital. “They are building continuation vehicle portfolios and adding them to the marketing of their primary and co-investment track records as a mainstream offer to LPs.”
That is leading to firms creating new or additional roles, adds Graham: “Some GPs, even those in the mid-market, are now appointing someone to have responsibility for GP-leds and continuation funds. This movement is not going away.”