Providing continuation funds financing
As continuation funds continue their rapid rise in popularity, demand has grown in tandem for the design and financing of bespoke solutions. Financing helps general partners (GPs) make more attractive offerings to limited partners, and can entice a broad variety of secondaries investors.
Continuation funds allow private equity firms to repurchase prized assets via a new, dedicated vehicle, rather than disposing of them at any given point in time of the funds’ lifetime. The vehicles remove the pressure to prematurely sell and enable fund managers to fully unlock the upside potential of the asset(s).
Continuation vehicles are created to acquire the asset(s) from the original fund, and existing limited partners are able to reinvest or exit as desired. To raise the required capital, the manager of the continuation fund will seek new funding from secondary investors. While continuation vehicles can be funded without lending, external financing has become more popular over time as the secondaries universe has expanded and investors have continued entering the space.
The managers of continuation vehicles will consider a range of financing options, including subscription-line financing (also known as capital-call structures) and hybrids. As continuation vehicles vary widely from case to case – with different assets, investors, risks and priorities involved – dealmaking and financing approaches are typically highly tailored.
As continuation vehicles vary widely from case to case – with different assets, investors, risks and priorities involved – dealmaking and financing approaches are typically highly tailored.
Debt is usually provided directly to a continuation vehicle to cover some of the purchase price of the asset, and hybrids – which combine certain elements of subscription line and NAV facilities – are often the right fit, due to the higher advance rate against limited-partner commitments.
A group of investors providing support to a given continuation vehicle is likely to be heterogeneous; secondaries financing specialists identify within larger groups separate “pockets” of investors which, while all being committed to the underlying asset, may have very different timing preferences. In such cases, dealmakers might opt for parallel vehicles, which allow for greater tenor flexibility. Some investors may want their money to go to work immediately, and won’t use financing; others may opt to use financing as a deferral method.
A combined solution, where advisory and lending services are provided by a single company, can produce major benefits for private equity funds and their investors. With deal structurers and lenders working under one roof, general partners can enjoy a rapid and frictionless process with a turnkey solution in the design of the transaction from day one. This allows general partners to focus on achieving the highest level of investor alignment feasible. Through the use of a lender-dealmaker, general partners can ensure that they design deal terms which are favourable across all of the “pockets” of investors interested in taking part in the continuation vehicle.
Besides supporting general partners with the purchase price of the underlying asset, lending can help private equity managers to bridge capital gaps and make additional commitments to outside investors – commitments upon which the ultimate success of the entire deal may depend. Without the right level of financing, general partners may not have enough capital available to commit to the sort of deal terms that limited partners require for participation. Lending can take place at the fund or holding company level, and general partners have made use of debt for a range of purposes.
Debt can be used to fund pricing deferrals; to employ leverage ahead of limited-partner capital calls; and to make bolt-on acquisitions to GP funds. According to Investec’s most recent Secondaries Report, 26% of private equity managers surveyed have used debt to enhance returns, while 30% reported using borrowing to increase operational efficiencies. In GP-led secondaries deals, 52% of loans provided were in the 12—23-month range. 56% of GP-led deals had a loan-to-value (LTV) ratio of 10% to 24%; a smaller number of deals made more extensive use of financing, with 35% having an LTV ratio between 25% to 50%.
