Park Hill on the swift evolution of the GP-led secondaries market

This part of the secondaries market is growing and changing at a rapid clip. Jon Costello, head of the Secondary Advisory Group at PJT Partners, explains the impact on the broader private equity industry.

Jon Costello of Park Hill
Jon Costello

The GP-led part of the secondaries market has undergone its own revolution in just the short space of time since the initial transactions were completed in the space in 2013. Jon Costello, head of the secondary advisory group at PJT Partners, walks us through these new-generation deals.

How would you describe the evolution of the GP-led secondaries market in recent years?

The GP-led secondaries market has evolved meaningfully since the initial transactions that were completed in 2013. Those early deals, which we refer to as Version 1.0, were mainly being pursued by small cap and mid-market sponsors that needed additional time and capital to reposition an underperforming fund before launching a subsequent fundraise.

A new trend that began about two years ago continues to be the main focus of GP-led transactions today. In this Version 2.0 world, we are seeing transactions being initiated by larger and higher quality sponsors, including globally branded platforms with multiple product offerings and investment teams. These transactions are utilising current deal technology, such as fund continuation vehicles and tender processes, to unlock value in some part of their platform.

We see many transactions where sponsors were looking for ways to accelerate liquidity to their LPs, attract capital to help grow existing portfolio companies, provide early momentum or a top off to a current fundraising effort, or to establish a new product offering. Investors interested in these transactions are looking for opportunities to enhance their relationships with their core sponsors and increase exposure to portfolio companies and funds that have performed well since inception, but could benefit from additional capital and/or time to maximise returns.

While we see the Version 2.0 phase of the GP-led market as having a lot of runway and broad investor appetite, we are now entering a new phase of GP-led transactions. The transactions are significantly larger in size, are being initiated by some of the most successful sponsors in the world, and include their most successful investments. We have begun to expand our focus and efforts toward the next phase of GP-led transactions.

And what would the next phase look like?

In these Version 3.0 transactions, top-tier sponsors of mid-market and globally branded multi-strategy firms are pursuing transactions to extend the hold period for their most successful “trophy” investments. We are currently working on multiple single-asset and multi-asset SPVs that will acquire highly successful investments from one or more funds managed by a sponsor. We see the pricing of these transactions as competitive with more traditional exit options available to sponsors and more attractive than a cross-over investment between funds or an equity recap with another sponsor.

We are now entering a new phase of GP-led transactions.  The transactions are significantly larger in size, are being initiated by some of the most successful sponsors in the world, and include their most successful investments

Given the strong alignment that will exist in these transactions between the current sponsor and the new and continuing investors, we see Version 3.0 transactions becoming regular exit options for successful investments. We are very bullish on this trend and see these opportunities as a major growth engine for secondaries market in the near to medium term.

Can you give an example of a Version 3.0 transaction?

We are currently working on multiple Version 3.0 transactions today. One example is a single-asset SPV transaction, whereby one of the largest and most successful investments from a mature fund is being moved into a new vehicle with an extended term of 8 years. The transaction will involve providing a liquidity option to existing fund LPs at a very attractive price and significant unfunded capital to pursue add-on acquisitions, fund organic growth initiatives, and a potentially buying out existing minority investors in the company. A second example is a multi-asset transaction with similar deal dynamics but involves providing a liquidity option to existing LPs of multiple funds and LP co-investors in the underlying companies around a specific industry play. The common features of these transactions are that they are larger and more concentrated than previous GP-led opportunities.

It is important for advisors in Version 3.0 transactions to have significant M&A and sector expertise, as these deals can involve dual or parallel track process. We are well-positioned in this regard and Version 3.0 has afforded us additional opportunities to work together with our PJT M&A colleagues to best position the businesses and our Park Hill distribution colleagues to bring these opportunities to the broadest set of potential investors.

How large are these GP-led transactions? How much of the secondaries market do they make up?

While these deals can be done at any size, we are seeing GP-led transactions increase in overall size and complexity, particularly as larger cap sponsors begin to utilise this technology. Historically, deal sizes for Version 2.0 transactions ranged from $200 million to $1 billion plus. Today, we are currently working on several multi-billion dollar transactions across the private equity, real estate and real assets spectrum and see the potential for a greater than $5 billion transaction to be completed in the next 12 months. As these transactions increase, it creates an interesting opportunity for LPs to invest at scale in the highest quality assets.

Last year, GP-led deals made up about 40 percent of the secondaries market. While historically LP trades represented the majority of secondaries market transactions, should the recent trends in the GP-led market continue, we could see 2019 be the year that GP-led transactions take over the majority share of the market.

How do these single-asset transactions impact the need for diversification in secondaries funds?

Single-asset and even multi-asset transactions within an industry concentration are inherently more concentrated and have more perceived investment risk versus the purchase of a highly diversified LP portfolio with hundreds of underlying companies. Clearly this perceived risk is mitigated to some extent when the investment opportunity is targeting a successful “trophy” asset with a top tier sponsor. Traditional secondaries investors are currently retooling their underwriting and allocation processes to address these perceived risks, so they can take full advantage of these attractive investment opportunities.

How is it changing the GP-LP relationship?

Both GPs and LPs have many more choices available to them over the life of a fund partnership. GPs in the Version 3.0 market can better optimise the exit of an asset to maximise returns to LPs that want to continue to hold exposure to the asset while providing liquidity to those that do not. We are also seeing GPs amending limited partnership agreements, or when they’re drafting new LPAs, looking to include liquidity provisions from the inception of the partnership. We’re also seeing LPs’ traditional advisors, such as consultants who have now developed more formal processes to help their clients evaluate their alternatives, become more active and influential in these transactions.

What is your outlook for the GP-led market?

This is an exciting time in the GP-led secondaries market. Secondaries buyers and LPs now have more liquidity options available to them, and through these transactions, they are able to maintain and increase their exposure to some of their most successful investments with their core sponsor relationships. We expect to see continued innovation and expansion of the market and significantly larger transactions. Whether GP-led transactions take over as the majority of the market in 2019 or 2020, we see the GP-led market continuing to play a major role in providing investors with attractive investment and liquidity options for the long term.