The changing face of GP-leds

How would you describe appetite for GP-led secondaries transactions among both GPs and LPs today?

Current appetite for GP-led transactions is generally quite strong. GPs are increasingly considering this kind of transaction as a viable option for managing their portfolios, providing liquidity to investors and maintaining exposure to successful assets.

LPs are also showing more interest in these deals given the potential for early liquidity that they offer.

Global private equity exits reached a decade low in 2023, and private equity firms started this year with record unrealised transactions. According to survey findings from our Private Equity Trends 2024 report, a growing number of firms will have to come back to the market with new fundraisings in the near term.

This lack of exits is the primary obstacle to successful fundraising as LPs wait for distributions before allocating to new funds.

The GP-led market is therefore expected to play a crucial role for both LPs and GPs in 2024 and we anticipate another busy year.

What is driving GPs towards continuation vehicles as an alternative exit route?

GPs are turning towards continuation vehicles as an established fourth exit route, and there are several drivers behind this. These vehicles allow GPs to hold investments for longer while at the same time offering existing LPs the flexibility to choose between cashing out or maintaining their exposure to the asset.

Further, alongside the challenges in the fundraising market, IPO markets are mostly closed and the M&A environment is still challenging, so more managers are considering continuation vehicles as an option to provide liquidity to investors. That is particularly relevant when the GP has a strong asset that they are reluctant to sell in the current low valuation environment. These transactions offer an elegant solution to generate money back to LPs.

As a rule of thumb, it used to be that if there were 10 investments in a portfolio, it was likely that one or two of those would exit via IPO. Now it is also likely that one or two assets would be part of a GP-led transaction. Where these were considered an exception in the past, they are now becoming more broadly accepted and, for the right candidate at the right time with the right reasons, they are a good option.

How can increased scrutiny on valuations in GP-led processes be dealt with?

There is currently a sentiment in the market that, while valuations are generally coming down, there is a clear distinction between a select group of high-quality assets and the rest. The so-called trophy assets that typically go into continuation vehicles are best suited to achieve high prices in general, so there is increased scrutiny of valuations in GP-led secondaries and that has to be dealt with.

It is important that GPs are totally transparent in sharing the details of the valuation methodology that has been employed. Equally, in these processes it is quite common to have a third-party independent valuation to validate the transaction.

We have also seen minority equity sales used as a benchmark for GP-led transactions, which involves selling a minority stake in the asset through a traditional M&A process in order to set a price for the continuation vehicle to acquire the remaining stakes.

This approach is quite appealing, particularly when the sponsor believes a conservative third-party valuation does not accurately reflect the true value of the asset. Our team can help on these types of processes, given our integrated M&A setup and sector expertise, and we are having discussions about these with numerous counterparties at the moment.
 

How can GP alignment be achieved on deals in a way that satisfies LP demands?

This requires careful consideration. GPs align their interests with LPs by rolling their crystallised carried interest into the continuation vehicle, which demonstrates a commitment and willingness to share the risk. Many secondaries buyers require a sizeable rollover on most occasions, and we also see incremental commitments becoming more common. In a challenging environment like the one we are currently experiencing, secondaries buyers seek strong alignment, but securing that capital is becoming more difficult for sponsors.

At Investec, our fund solutions and private capital teams take a collaborative approach, which can help facilitate these deals by providing the support on the financing side to GPs. Because of the lack of exits, these GPs are not seeing carried interest coming back at the moment, so many welcome that support.

What kinds of innovation are you seeing – or anticipating – in GP-led transactions as the market becomes more sophisticated?

The market keeps on innovating and every year we see new types of transactions. As the market for GP-led deals becomes more sophisticated, we anticipate a variety of new developments.

We are seeing, for example, a surge in structured liquidity solutions, which we define as a bucket of NAV financing and preferred equity, providing alternative routes for addressing liquidity needs. Not every deal is suitable for a continuation vehicle and sometimes a different financing solution will be needed to provide liquidity.

The market is also starting to look for ways to incorporate ESG considerations into GP-led transactions, reflecting the growing importance of sustainability for secondaries buyers looking at these opportunities. That is a trend we see just getting started, and in the long run there is little doubt that ESG will be a growing feature of these transactions.

Meanwhile, we see several asset managers introducing new investment strategies focusing on GP-led secondaries, and every year there are more new entrants into the market.

One key trend in the last 24 months has been the rise of dedicated funds for single-asset continuation vehicles, as well as the rise of pools of capital for credit secondaries or infrastructure secondaries. So, we see a growing trend towards specialisation in the market from the buyers as the ecosystem matures.

In general, both GPs and LPs are becoming more comfortable with the plethora of secondaries transactions available and GP-led deals are the new norm.

In the last few years, these transactions have become more commonplace, better understood and better accepted, so we expect their adoption to continue to increase in the market.