Why you should know about preferred equity

The alternative to debt or a secondaries sale is gaining traction, with Vision Capital the latest player to enter the fray.

On Monday we broke the news that 17Capital was back in market with its fourth fund. For anyone not aware of the preferred equity specialist, 17Capital has more than doubled its funds with each fundraise and is seeking more than €500 million for its latest vehicle.

Preferred equity is gaining traction in the secondaries market and it’s easy to see why. Limited partners can take on preferred equity – a tranche that sits between debt and equity in the capital structure – instead of selling stakes in their portfolios, thus keeping exposure to any potential upside while benefiting from liquidity.

It can also be more cost-efficient and flexible than debt financing, which usually requires a diversified portfolio. Preferred equity can be issued against even concentrated portfolios.

So why should secondaries participants care about this niche part of the market? For starters, it’s a strategy that seasoned players are moving into, with European direct secondaries pioneers Vision Capital the latest to join the sector. In July, the London-based firm announced the launch of its principal finance platform with a focus on providing preferred equity to general partners.

Vision, for its part, believes its track record of working with portfolio companies gives it a competitive edge when it comes to its financing strategy. “Our equity skillset means that we are able to evaluate concentrated portfolios efficiently,” Julian Mash, Vision’s founder and chief executive, tells me. “We think about how companies are valued, their individual prospects, how they are financed, who else might buy them one day.”

It’s also a market that’s evolving, and evolving fast. When 17Capital pioneered the strategy in 2008, its main use was as a problem-solving tool for players in need of liquidity. Today, a wider range of industry participants are starting to see its benefits, including funds of funds, evergreen managers and listed private equity firms to either solve problems or fund growth.

For Yann Robard, who left his position as head of secondaries and co-investments at the Canada Pension Plan Investment Board last year to launch preferred equity house Whitehorse Liquidity Partners, which focuses on the strategy, it’s the next big thing.

“If you look at the secondaries market back in the late 1990s, people would have told you it shouldn’t exist. Now it’s commonplace,” Robard tells me. “Then you go to 2005 and ask players, are you ever going to use leverage to do secondaries? Buyers would have said absolutely not.”

While preferred equity financing is still in its infancy today, it has significant growth potential and is the next evolution in the secondaries market, according to Robard, who tells me: “I think in 10 years from now it will be fairly commonplace.”

Robard’s sentiment certainly rings true: the secondaries market is known for its innovation and forward thinking and when it comes to new developments – preferred equity to boot – participants should be asking themselves if they want to get in early on the next evolution.

How big is the potential market for preferred equity? Let me know: adam.l@peimedia.com