This article is sponsored by Eaton Partners.
As GP-led transactions represent a growing segment of the secondaries market, the definition of secondaries continues to broaden and new actors, including independent sponsors and family offices, are taking advantage of them, explain Peter Martenson and Michael Pilson of Eaton Partners.
How did Eaton Partners begin working on GP-led secondaries?
Peter Martenson: It came out of our core business, which is raising capital for private equity funds. We typically focus on emerging managers, and funds two and three. About seven years ago, coming out of the financial crisis, we found that to raise first-time funds we needed to add something extra, potentially around preferred terms and also around co-investments.
As we continued to chat with LPs and GPs about what would get them excited, the conversation led to transactions with stapled secondaries and to assets that needed to be recapped from a GP’s last fund, which we facilitated.
Over the last five years or so we’ve been working with more outside clients on GP-led secondaries. A lot of times a fund manager will come in and we’ll tell them that they are not ready for commingled fundraising until they address a few issues, such as getting another realisation from their portfolio. So, we’ll do a single-asset recap or a multi-asset recap to provide them with a realisation while also stapling a commitment to their next fund. This better positions the fund manager for undertaking a successful commingled fundraise.
What kinds of GP-led secondaries do you typically work on?
PM: We focus on the mid-market. In the US, we’re still seeing a focus on continuation funds. More selectively, we’re starting to work on portfolio strip sales. GPs want to provide some liquidity and show they can get some DPI by selling down either all of their portfolio companies or a select portion of them to generate liquidity. And, of course, we still utilise the classic tender offer.
Michael Pilson: Independent sponsors who have a portfolio and are looking to transition into a classic commingled fund structure are presenting quite a few opportunities for secondaries buyers. Another source of transactions is family offices, which have portfolios of direct companies from which they want liquidity or that the team wants to spin out, or possibly there’s a dynamic where the family office can sell their portfolio to a syndicate or a single secondary buyer and create a traditional GP/LP structure.
What are independent sponsors usually trying to achieve?
MP: An independent sponsor may come to us and say they’re looking to raise their first classic commingled fund with committed capital. We take a comprehensive look at the situation and provide the most appropriate advice. Maybe the right transaction is to do a liquidity event with a current investor, package up their portfolio into a fund structure, and introduce them to the institutional world from that type of perspective. We try to be a value-add advisor and help achieve their ultimate goal by guiding the fund manager through the maze of what limited partners will find compelling.
As the secondaries market matures, what is your view on risk taking in GP-led transactions?
MP: In these transactions, the risk comes, when the fund manager is not equipped to optimise the structure. The fund manager may lack the necessary experience or the perspective on what the buyers want and/or what the sellers are looking for in a transaction. Certainly, you need to identify whether the GPs’ aspirations in the transaction are rational and reasonable. It’s risky to begin these transactions when you are not in touch with what the market will bear on valuation as well as risky to not have a good understanding of what the comparative asset owner’s valuation expectations are in relation to the price that the market is willing to offer for those assets.
PM: The risk in transactions is when there’s misalignment. That’s when someone doesn’t understand why the GP is doing something or why the LP is selling or why the buyer may want something. That’s when an advisor really helps out, bringing those areas of focus to the forefront and lowering the risk of the trade. Part of what we are working for is to help all parties get a transaction completed. That would be where we see the biggest risk – when the GP tries to do it on their own. They don’t have the benefit of an honest third party to help them navigate the current LPs, buyers, and sellers, and that’s when a transaction has a high probability of risk of failure.
How do you price GP-led secondaries compared with those led by LPs?
MP: With GP-led transactions, the pricing dynamic is drastically different than with the LP transactions. If an LP takes a typical fund portfolio to market, the buyers want to know the lowest price they can pay for these assets.
The dynamic in a GP-led transaction is quite the opposite in that if there is not a full, fair price, the LP is unlikely to exercise their option to sell and thus there is no trade. It becomes a market where a fair market price is a necessary ingredient to complete a transaction. If you take a transaction to market and it is valued at a very low price relative to NAV, I can assure you that no LP is going to trade.
That’s part of the advisor’s work as well, to figure out what the market price is going to be vis-a-vis the current NAV, because the higher the price closer to NAV or exceeding NAV, the larger the transaction. Buyers want to maximise the size of the transaction. If you’re an LP and a buyer is offering you NAV for an asset, you will consider the offer very seriously and most likely trade. One of the critical components to this marketplace is understanding the feasibility of a transaction and if there will be a significant bid – ask spread.
What advice would you give fund managers curious about GP-led secondaries?
PM: These transactions don’t just happen. We encourage GPs to take early and proactive action so as to get in front of the opportunity set. If they think ahead, they can put into place a good transaction around a strong asset that all parties are excited about. We find too often that GPs wait too long. They let the assets get too extenuated and then they have to rush and try to do something, which is not optimal to getting a transaction completed with LPs.
Be proactive, get in front of a process, hire an advisor, and let that advisor engage with you, your limited partners and the potential buyers to help solve what you’re trying to acheive. GPs are still trying to get their head around GP-led secondaries in particular. There’s still a little bit of trepidation by GPs. They wonder what LPs may think about it. In many cases, GPs don’t even know that GP-led secondaries are available to them. Given that, they tend to not take action, when in fact GP-led transactions are being embraced and welcomed by limited partners.