Secondaries: Keep you holding on

The notion that GPs must let go of assets within a specific period of time has been turned on its head.

Simon Bachleda knows a thing or two about the value of holding on to good assets. The
co-founder of Denver-based buyout firm Revelstoke Capital Partners likes holding on to winners so much he and his firm have done so twice via the secondaries market.

“As an industry, private equity is generally conditioned to sell its best performers as early as possible, realise a gain and provide liquidity to its investors,” Bachleda told Private Equity International in February.

For some trophy assets, however, there is significant equity value creation beyond the initial hold period. “In these scenarios, a single-asset SPV can be a win for limited partners, management and the private equity sponsor,” he said.

Bachleda was referring to a deal type that has taken the PE industry by storm. So-called ‘continuation funds’, in which sponsors move assets into a special purpose vehicle, made up 55 percent of the secondaries market in the first half of this year, according to Campbell Lutyens’ H1 2021 Survey. A subset, ‘single-asset continuation funds’, which involve just one portfolio asset transfer, accounted for 24 percent of the entire market.

“The 10-plus-two construct is creaking at the seams,” said a panellist at PEI’s CFOs and COOs forum in June. The traditional structure does not work as well these days “in part because managers are more inclined to hold assets for longer periods, particularly the best-performing assets”.

Perpetuity

In addition to continuation vehicles, GPs now use a variety of other approaches to hold assets longer. Firms such as Blackstone and Carlyle Group have raised funds with terms longer than the typical 10-year period. Others, such as Vista Equity, have created “perpetual” vehicles that never close. Meanwhile, some GPs achieve longer holds through routine M&A by holding minority stakes in companies they sell. TA Associates and Sequoia Capital, for example, have raised funds that invest in their own portfolio companies.

“Longer holding periods for private equity investments are an important feature of the market of the future”
Dominique Senequier, Ardian

“Longer holding periods for private equity investments are an important feature of the market of the future,” Ardian president Dominique Senequier wrote in the firm’s 2020 Activity Report in June.

Continuation vehicles and other secondary technologies are putting downward pressure on the average fund duration, which is now longer than 16 years, according to a recent report from Upwelling Capital. This separates assets that are still attractive for investment from those that should be liquidated. Continuation vehicles also allow LPs to thoroughly analyse and stress test highly targeted single investments, which they cannot do with blind-pool PE funds, says Antoine Dréan, chair and founder of Triago.

One risk to continuation vehicles is the inherent conflict of interest posed by managers acting on both sides of the deal. Further, aside from some bespoke clauses in some LPAs indicating GPs may pursue such transactions at some point in a given fund’s life, “structurally, there’s nothing built into the documents to facilitate these trades”, says Gerald Cooper, head of secondaries North America, Campbell Lutyens.

While this lack of standardisation is “the biggest limitation to improving the efficiency in the secondary market”, the usefulness of these transactions should incentivise participants to straighten it out.