At a time when GPs are likely fighting fires on various fronts, the private equity secondaries market believes it has the right tools to help.
This was the topic of a webinar moderated by Private Equity International last week hosted by advisory firm and placement agent Cebile Capital. Over 75 minutes, experts from secondaries giant Coller Capital, preferred equity specialist Whitehorse Liquidity Partners and law firm Weil, Gotshal & Manges discussed the ins and outs of GP-led secondaries processes versus preferred equity financings.
GPs may need capital to keep portfolio companies afloat during the crisis but not have it in their funds. Or they may want cash to go on a buying spree, gobbling up their portfolio companies’ competitors. Or there may be liquidity issues within their LP base they need to address, such as LPs who need to see an increase in distributed-to-paid-in multiple before reupping.
“What you thought might be a 2020-21 exit window for certain portfolio companies is simply not viable anymore,” said Sunaina Sinha, managing partner at Cebile. “You may need more time and/or more capital to continue to manage the portfolio [and] give your shareholders the return you initially anticipated.”
Enter what’s known as a “continuation fund” in secondaries parlance, in which assets are moved from an existing fund into a new vehicle. The fund is backed by replacement capital from secondaries buyers as well as existing capital from LPs who wish to remain exposed to the assets. LPs who want to cash out can do so – often at a premium to the assets’ net asset value – and there is often fresh capital for new investments as well.
Holding periods for assets were already lengthening prior to this year’s crisis, said one of the panellists, and when the covid-19 dust settles, many GPs may find that holding onto assets via a continuation fund makes sense.
“People compare the current crisis to the GFC and it makes sense, because what else are you going to compare this to… but it may turn out very different,” said Remco Haaxman, a partner at Coller. “It may not be followed by a 10-year bull run that makes everybody look good. People need to think about how this is similar and how this is different.”
Continuation funds are, of course, not always the panacea – it can take six months or more from first floating the idea with LPs to closing the process and they almost always require LPAC approval to mitigate potential conflicts of interest. The panel’s consensus was that such deals are likely to restart in the medium-term when valuations become clearer.
In the meantime, panellists agreed there was a lot of buzz around preferred equity options for GPs wanting to be defensive, go on the offensive, or even to finance their GP commitments.
Pref’s positives have been accentuated by the crisis. Financings can be executed in weeks and can be simultaneously signed and closed. Unlike setting up a continuation fund, a pref deal typically doesn’t require LPAC approval as there is no potential conflict situation – though it may require LP approval if it’s structured as an amendment to the fund’s waterfall. It also doesn’t require the issuer to price equity in a deal: a plus given today’s uncertainty.
Speed is king when GPs want to take advantage of a downturn, said Yann Robard, managing partner at Whitehorse.
“You’ve got to think about how much capital you actually deploy during the eye of the storm, because if you’ve seen the trough, then you’re in the recovery and you’ve missed the crisis,” Robard said.
Ultimately, which secondaries tools GPs feel are best suited to their situation – if one is at all – will depend on what they are trying to achieve. As many as one-third of GPs have delayed fundraising plans due to the crisis, said Sinha, citing a Cebile survey, and for sponsors facing portfolio or fundraising issues, the secondaries and pref markets may be able to help.
Asked what they were most looking forward to doing when the lockdown ends, panellists said: dining on steak at a restaurant, giving friends and family hugs, and knowing one’s children are running amok within the safety of their school walls and not stuck at home. On these points, GPs, LPs and secondaries market participants alike will surely be in agreement.