06 May 2020
The challenge of divesting in uncertain times
During a time where divesting is extremely challenging, managers need to assess the remaining term of their tail-end funds and gauge their investors’ liquidity expectations. The extreme market volatility makes any ambitions to go public highly uncertain, the cash-flow constraints will put the majority of trade sales on hold and many secondary buy-outs will be withheld by the lack of available financing and disparate price expectations. The deceleration of private markets fundraising, will further compress multiples in the short- to medium-term. As a result, managers need to explore exit alternatives for their tail-end funds.
Managing the needs and expectations of LPs
Before the market dislocation, funds nearing their maturity were a reliable source of distributions for LPs. While distributions are generally expected to be deferred for the next 12-18 months, GPs are issuing capital calls to support their existing portfolio or repay bridge loans. This combination has a material impact on the LPs’ overall liquidity, and may lead to constraints to fund capital calls and make primary fund commitments.
The power of GP-led secondaries
Over the past five years, GP-led secondaries have become a standard liquidity option for managers. While the majority of transactions are motivated by maximizing the value of already strong assets, GP-led secondaries have also been used to carve-out special situation assets. GP-led secondaries can truly be a win-win for both GPs and LPs. On the one hand, managers can stay invested to maximize the value of their asset(s), and potentially raise additional capital for add-on investments or value creation initiatives. On the other hand, LPs have the choice between liquidity or roll-over depending on their individual needs. Some investors seek to de-risk their investment and use the proceeds to reinvest in younger, more diversified funds. Others have appetite for a more granular and extended exposure to managers who have a proven track record with the asset(s). When LPs chose liquidity over reinvestment, secondary investors come into play to purchase such LP interests at a set price.
Appetite from traditional secondary investors has substantially increased over the past years, and GP-led secondaries make up an important part of total secondary transactions:
The decade-long bull market has catalyzed the trend and we expect GP-led secondaries to remain a powerful tool in the current environment, once market uncertainty has eased. Many GP-led secondaries will come to market over the second half of 2020, with several GPs already preparing their transactions.
Alternative liquidity solutions
While producing different outcomes, preferred equity solutions are currently a popular liquidity source. Fund and portfolio level credit facilities (NAV- and hybrid facilities) remain the most reliable liquidity source, but new lender relationships are difficult to establish. Dividend recapitalizations or direct minority sales might gain more traction again, once markets have stabilized.
Different times, different needs
Under normal circumstances, secondary buy-outs, trade sales or IPOs are default exit routes for any asset that is ready for monetization. Beyond the traditional purposes of carving-out those assets that have substantial value to further unlock, GP-led secondary solutions can also fill the traditional exit void:
Attractivity of GP-led secondaries in turbulent times
IRR protection and liquidity option
Carving-out certain assets that will benefit from a longer holding period, additional management and potentially unfunded capital, allows GPs to prevent unnecessary IRR dilution of its existing fund(s). Further, it provides LPs with a currently rare liquidity option, which LPs will particularly value.
Experience / Blind-pool mitigation
Especially during uncertain times, existing and new investors will appreciate the manager’s credentials with the asset(s). The increased risk adversity will also scrutinize the blind-pool risk of primary fund investments and attract non-traditional investors to GP-led secondary transactions.
Investor sentiment, travel constraints and less capital at hand will slow-down the fundraising of successor funds. Offering stapled secondary transactions to important anchor investors will catalyze the fundraising process.
Attractive entry valuations
Once the current uncertainty has eased, lower entry multiples will be an opportunity to make attractive add-on acquisitions. Managers who already have an information and experience advantage with a specific asset and market are better placed to make accretive add-on acquisitions and put more capital to work. In parallel, the GP may also restructure the financing package during the process.
To further maximize the asset(s) value, a credit facility can be structured within the transaction fund.
Deferred payment options have become a default feature offered to secondary investors. By using a credit facility, managers can offer a deferred payment option while generating liquidity for their existing LPs.
As an alternative to traditional financing and debt, Hybrid or NAV credit facilities are an efficient source of financing for add-on acquisitions or other value creation initiatives.
Credit facilities can be used to optimize cash management, for example by bridging capital calls, collateralizing FX-hedges or pre-financing investor distributions.
GP-led secondaries are a complex structuring and operational undertaking. The manager’s entire fund platform – its existing and new fund terms, regulatory environment, LP-base, operational set-up and various stakeholders need to be carefully assessed to define the most efficient transaction structure and mechanism. To minimize costs, the set-up process and stakeholder management should be streamlined.
When defining the new fund terms, managers need to balance between the fees and duration, considering both existing and new investors. Existing LPs need transparent information and sufficient time to consider the new terms and conditions, the transaction’s mechanism and the dilutive effect of the potential additional capital being raised. The valuation is sensitive, it is usually reviewed by an independent valuer and signed-off by the fund’s advisory board.
Ganryu Capital Partners provides tailored and turn-key structuring solutions to swiftly implement or optimize your private market funds and global credit facilities at the best execution price.