The market for GP (general partner)-led secondaries is buoyant. Such transactions accounted for almost two-thirds of secondary deals last year, according to McKinsey’s 2022 Global Private Markets Review. That appetite shows no sign of slowing. More than a third of institutional investors (36%) are planning to allocate more than $100 million to such deals in the first half of this year, according to a survey published in May by Eaton Partners. An additional 7% of investors are planning to pump more than $500 million into GP-led secondaries before the end of June, the survey found.
In the past, secondaries transactions were typically a way for GPs to restructure poorly performing assets into so-called ‘zombie funds’. Now, however, when funds reach their maturity, GPs are realising their gains while also holding on to the best-performing portfolio companies and restructuring them into a new fund. Increasingly, these GP-led secondaries (or continuation funds, as they are sometimes called) may contain just one portfolio company. Half of all GP-led secondaries deals in 2021 involved a single asset, according to McKinsey. In theory, any private equity-owned asset could potentially wind up in a secondaries deal, effectively taking the ceiling off the market, McKinsey said. In some cases, GPs are even transferring ‘trophy’ assets out of relatively younger funds and putting them into continuation vehicles, according to Jefferies.
This rapid increase in GP-led secondaries activity over the past two years has, however, created some friction. Often, this happens because the mechanics of the transactions are not as widely understood among limited partners (LPs) compared to when they invest in a traditional private equity fund.
“The onus is on companies like us and the sponsor community to help with education around the risks and opportunities available in this market,” Bozoglou told Private Equity Wire.
The Institutional Limited Partners Association (ILPA) in the US, for instance, is planning to issue guidance in the second half of this year in a bid to improve transparency around GP-led secondaries and ensuring adequate protections for LPs, particularly regarding fees and the amount of time given for due diligence. The US Securities & Exchange Commission (SEC) is also proposing to tighten regulatory guidelines for GP-led secondaries, with the new rules expected to be finalised before the year is out. Those are likely to include specific provisions on valuations to ensure fair value for LPs.
“It’s absolutely important that the industry takes stewardship of these issues and enforces some policies and procedures,” said Titanbay’s Chief Commercial Officer Adam Harrison, speaking in the same interview. “I think the regulator is stepping up to that. The number of complaints that have come from LPs has shone a light on it, and that now needs to be resolved, and I’ve got faith that it will be. Ultimately, the GPs have to be aligned with the LPs.”
One issue that has been raised is that some LPs have been given fewer than 10 business days to participate in a secondaries transaction. That is a challenge for any LP, but potentially impractical for those whose board only convenes once a month. On other occasions, terms and fees have made secondaries transactions unpalatable.
The ILPA says that such deals require an LP’s full attention, but because the timings of the process are unpredictable, it can be very disruptive for LPs—particularly if there are multiple GP-led secondaries transactions landing at the same time. Continuation fund structures are also typically bespoke, meaning it is not easy to evaluate the impact of participating in any given deal.
Added to that, few LP agreements will have been drafted to take into account what happens in these situations, meaning there might be limited LP engagement or a lack of transparency.
However, the appetite to participate in such deals has been growing, in large part because of the potential returns on offer. More than a third of investors (34%) expect such deals to yield a gross internal rate of return (IRR) of 15%, according to the Eaton Partners survey, while almost half (46%) are expecting to pocket a gross IRR of 20%.
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