On second thoughts

Over the past couple of years, the private equity industry has seen a significant increase in secondary deals, just as was seen after the great financial crisis back in 2008-9. As a result of the pandemic and wider macroeconomic issues the world is currently facing, institutional investors are once again reordering their portfolios.

The recent surge in secondary deals creates a new layer of complexity and level of work for GPs. From creating new continuation vehicles, which often have bespoke terms, and involve negotiations between sellers and buyers within tight timeframes, as well as completing the secondary transactions themselves - CFOs have been dealt another task to add to their list.

With that in mind, The Drawdown spoke with two industry voices to get their take on the recent flurry of secondary deals, what this additional workload means for them, and how they’ve been handling these transactions and funds.

JAMES YATES

Partner & CFO at IK Partners

TDD: What needs to be considered with secondary deals?

JY: There are a variety of secondary deals and each has its own peculiarities and needs. The simplest type of secondary is where LPs sell to LPs. In this situation, the GP only needs to provide consent and information to the potential acquirers and perform the necessary LP due diligence of course.

TDD: What about continuation funds?

JY: The more complex secondaries are fund continuation scenarios which can be similar to raising a new fund, but with slightly less investor relations (IR) involvement as you are dealing with a known universe of LPs.

In this scenario, there is a lot of work involved, such as negotiation of terms with investors for the new vehicle, obtaining third- party valuations, and as is often required, third party money to support the transaction. Then there will be the normal work streams for raising a new fund, closings, reporting needs and then setting up the fund on systems and so on.

TDD: How do these secondary deals and funds impact you and your team overall?

JY: There is an ever-increasing burden on the support functions as well as IR. Depending on whether the house uses an outsourced solution, or its own resources, will determine the headcount requirement. Typically, you would not expect to have to increase significantly but there is a natural evolution of support and IR teams as the needs and requirements of LPs are continually expanding.

STEPHEN BRANAGAN

Head of Ireland and global head of operations at Pantheon

TDD: From your perspective as an LP, what do you see from secondary deals?

SB: As secondary activity in the market has increased, so too has the diversity and complexity of secondary transactions. At one end of the spectrum there are straightforward traditional LP stake sales, which, specifically in relation to our capacity as a primary investor, really don’t have much of an impact on us.

From a fund perspective, these deals simply result in a transfer of interest we may not even be directly informed of unless the interest being sold is at a level that necessitates the GP seeking investor approval.

TDD: What about continuation funds?

SB: At the other end of the spectrum are a wide range of more complex, so-called GP-led deals, which could involve both new investors and the GP investing new equity to carve out select assets within a fund – and so in some way restructuring the fund, be that through a continuation fund or some other route.

Existing investors may therefore need to choose whether to crystallise or exit at that point, or to “roll” and make what is essentially a new investment into the new deal. Either way this gives rise to operational considerations, not least around assessing valuations for the assets that are included or not included in the sale.

TDD: As a fund of fund, how do these secondary deals and funds impact you and your team overall?

SB: Having both a primary and secondary business, the transactions essentially create two processes: one exit for the original investment with all of the operational elements that entails. And then a second, new secondary investment process. This means there are inevitably more decisions that need to be assessed and made which create additional demand on our resources, but we don’t see this as a negative.

Our primary position in the funds means not only are we getting the benefit of a liquidity event for our investors in these cases, we’re also often being offered early access to a new secondary investment opportunity, so ultimately it’s a nice position to be in.