The rise of GP-led deals has blurred the line between secondaries and co-investments. Secondaries buyers are increasingly required to do bottom-up analysis of individual businesses and make high-conviction bets on their medium-term prospects – much like a co-investor.
The blurring has accelerated with the growing popularity of mid-life co-investments. Like secondaries, these investments are typically made a few years into an asset’s holding period, removing the early-stage risk associated with co-investing.
“Many GPs generally hold their investments at cost for the first year of ownership, which sometimes obfuscates the true performance of the investment,” says Marc Lohser, a managing director with HQ Capital in a paper published last year. “In a mid-life transaction, the GP has a current and recent mark-to-market.”
Unlike a secondaries deal, mid-life co-investments do not require a new vehicle or resetting fund economics.
Mid-life co-investments are not new. Large GPs have often called on LPs with direct investing capabilities to inject extra capital into portfolio companies in the middle of the holding period. However, secondaries buyers are increasingly interested in the strategy.
Patrick Knechtli, head of secondaries at Aberdeen Standard, said last year that some of his team spend half their time analysing mid-life co-investments and half on GP-led secondaries deals, as GPs become increasingly “agnostic” on where the capital comes from.
One firm is raising a fund dedicated to mid-life co-investments. DWS, formerly Deutsche Asset Management, is targeting $500 million for Private Equity Solutions SCSP. It received a $200 million anchor investment from the State of Wisconsin Investment Board in September 2019 and has closed several deals, taking minority positions in companies managed by Revelstoke Partners and Persistence Capital, among others.
Mark McDonald, managing partner of DWS’s private equity business, says the firm targets top-performing assets, typically two or three years into their holding period, that need capital to go on the offensive through acquisitions or expansion into new markets. Like preferred equity, the capital comes via a special purpose vehicle, but it is secured against one asset rather than a portfolio.
“We think of ourselves as a derivative of the secondaries market, not a co-investment fund. We combine a direct investing skillset with the structuring of secondaries – [for example] in things like liquidation preferences. The goal is to create significant alignment with the GP”
Mark McDonald, DWS
“We think of ourselves as a derivative of the secondaries market, not a co-investment fund,” McDonald says. “We combine a direct investing skillset with the structuring of secondaries – [for example] in things like liquidation preferences. The goal is to create significant alignment with the GP.”
LPs we spoke with were generally positive about the deals. The managing director at a US private pension says some proposed single-asset restructurings do not require reset economics and may be more suited to a mid-life co-investment structure. “There are less invasive ways of introducing new capital [than a secondaries process],” he says, adding it’s always preferable to avoid a double layer of fees.
Liquidity solutions are becoming increasingly diversified, with NAV-based lending and preferred equity growing into useful alternatives to GP-led secondaries. For buyers with direct investing skills and the willingness to take concentrated bets, mid-life co-investments are another useful tool.