In a harsh fundraising environment, PE firms are once again turning to the secondaries market with a view to offering a tender process on existing funds while securing a staple of capital for their new fundraises.
In these transactions, existing LPs are offered the chance to sell out of their interests in a fund at a pre-set price to a secondaries buyer or buyers. Those buyers agree to make a fresh commitment of capital to the new fund, known as a staple. The size of that staple is worked out via a ratio.
Tender offers made up 7 percent of the approximately $43 billion of GP-led transaction volume last year, according to Campbell Lutyens’s 2023 Secondary Market Overview. The average staple ratio for GP-led transactions in 2022, which predominantly applies to tender offers, held steady on 2021: for every $2.60 of secondaries capital deployed in these transactions, $1 of primary capital was committed.
What is driving tenders currently is LP overallocation. The GP is raising a new fund, but LPs are constrained because of their overallocation to private equity and so cannot commit, Nigel Dawn, senior managing director and head of Evercore’s private capital advisory group, tells Private Equity International. If an LP received a good offer for their investments, they will consider selling it with the hope that part of those proceeds will be recycled into a new commitment with the GP.
A number of managers have rolled out tender offer deals plus staples in recent months. The likes of Carlyle, Harvest Partners, Sun Capital Partners and Providence Equity have launched or closed processes, affiliate title Buyouts has reported.
However, some recent transactions have been met with a lukewarm reception by LPs in terms of take-up. The biggest problem has been around pricing.
“We had a few situations… where indicative pricing came in it just did not make sense for the GP to pursue the liquidity offering further,” says Immanuel Rubin, head of EMEA secondaries at Campbell Lutyens. He adds that offering discounted pricing can give the impression that you’re challenging your own valuation marks.
“The second half of 2022 and particularly Q4 will be regarded as a bit of an aberration in terms of price” for these transactions, says a secondaries adviser who wished to remain anonymous. Traditionally, these transactions have been priced at par or above, they explain. However, buyers weren’t motivated to deploy capital last year, which created a bid-ask spread in the market. “The pricing they offered was probably less attractive than would typically be the case.”
What buyers are looking for
Market participants feel there will be more stapled tender transactions launched in the coming year, with pricing already improving. However, buyers tend to look at these transactions opportunistically when weighted with other opportunities.
Ross Hamilton, a managing director in Partners Group’s private equity partnership investments division, which invests in secondaries opportunities, has seen an uptick in conversations with managers around these processes. Some of the transactions it has seen are structured as full processes offered to all LPs run by advisers, while some are smaller matchmaking exercises, Hamilton says. In the latter case, GPs are helping to facilitate a sale for some investors looking to cash out and hope to see a staple if a transaction happens.
Still, market participants shouldn’t expect the secondaries market to become awash with buyers willing to jump on every opportunity. While their firms have participated in these transactions in the past, two large buyers who wished to remain anonymous pointed to the fact that they seek to buy assets rather than unfunded commitments like a staple.
“We’re all about trying to get money to work right on day one. That’s our job,” one of the buyers notes. The other adds: “I don’t love it, but I can get comfortable with it as long as it’s with a high-quality GP that I really like.”
Similarly, it can be difficult to judge how many investors will take up the offer. Unlike continuation funds, tender offers are discretionary. “You could do a lot of work and even succeed in being the top bidder, and then nobody sells,” Rubin explains.
Regardless, buyers do look at these transactions closely. Buyers are looking for a quality manager – typically one that they know well – with a quality portfolio.
A ratio also has to be agreed upon. There is a wide range of variables that have to be thought through, such as whether the staple is a commitment to a new fund without a portfolio of assets, or whether it has made some investments, Hamilton says.
One of the anonymous buyers says a 2:1 ratio is less than ideal for a buyer, and this will be factored into pricing. They would be willing to offer stronger pricing to a 4:1 ratio, for example, which would lead to stronger take-up from LPs.
The market cycle also plays into buyers’ thinking on tender offers plus staples. “Are we late stage, like toppy frothy? Or are there great buying opportunities?” one of the buyers asks. If it’s the latter, they add, it will give them more comfort that a blind secondaries commitment will be invested into a strong market.
For the right transactions in the right market environment, tender offers plus staples can offer some strong positives for managers and their LPs.
“Almost every GP should run a tender. That’s always been my view,” Dawn says. Tenders are typically launched towards the end of the fundraise, close to final close. At that point, the GP has visibility on who in their investor base will commit to the new fund and who won’t. “It is a service that the GP provides to their LPs to say, ‘I’ll hire a banker, I’ll run an competitive auction process’.”
Because GPs are engaged, buyers are able to perform deeper due diligence compared with an LP stake sale. “Often, there may be a 5 percent improvement in price, if not more. This is why it makes sense all around,” Dawn says.
For a tender to be really successful, however, pricing needs to be around 100 cents on the dollar, “or certainly in the 90s”, the secondaries adviser adds.
Tender offers plus staples can be powerful tools if pricing is at par or above, Rubin explains. Having that pricing builds momentum and validates marks, signalling the end of a fundraise and therefore creating scarcity. “But in an environment where you offer liquidity at 80 cents on the dollar, that creates exactly the opposite.”