Global private equity markets have displayed remarkable resilience in the wake of the pandemic. The secondary market, where investors buy existing private investments either in funds or in underlying companies, is no different. In particular, secondary transactions initiated by private equity fund managers, or General Partners (GPs), have emerged as an exceptional way for investors to access the best performing companies in a private equity portfolio at attractive valuations.
After a temporary blip in Q2 2020, the secondary market burst back into life, particularly at the smaller end. In 2020, secondary managers raised USD 81bn, more than three times the amount raised in 2019[1]. At the current rate, it is likely that 2021 will break the record for the highest amount invested into secondaries.
The main driver of growth in the secondary market is GP-led transactions, which accounted for over 50% of secondary volume in H2 2020[2]. Since June last year, we have seen a rich flow of high quality opportunities in the GP-led space at the smaller end of the market. Indeed, we have closed over 15 deals in the past 12 months, many of which are already yielding impressive returns.
The most critical issue for private equity participants in the wake of the crisis has been cash flow management. As exit activity – and therefore distributions – dried up (see Figure 1), investors, or Limited Partners (LPs), found themselves facing significant liquidity challenges. In particular, this has been exacerbated by the rapid increase in investment activity – and therefore capital calls – in the last two or three quarters.
Figure1: Significant slowdown of exit activity
Therefore, GPs have been seeking alternative liquidity options for their funds in order to placate their cash hungry investors and to continue supporting their portfolio companies. Certain companies, particularly those in cyclical industries with high capital requirements, have required more liquidity. Conversely, stronger portfolio companies – either resilient to, or even positively enhanced by, the pandemic – can benefit from further financing to exploit growth opportunities.
To that end, GPs are offering investors the opportunity to support selected portfolio companies via restructurings or innovative solutions such as sidecar funds that invest alongside existing funds. These solutions are a particularly attractive way of solving the tension between investors’ desire for liquidity and GPs’ desire to avoid selling assets at a sub-optimal time when more value can be created.
For investors, GP-led deals present an opportunity to invest in a portfolio of one or more mature companies at a point where further growth can be achieved, either organically or through strategic add-on acquisitions.
Furthermore, secondary investors are well aligned with the GP through the carried interest and, typically, an additionalGP commitment. This is in contrast to a traditional LP-stake secondary sale, where the GP, who is incentivised to maximise returns for the original fund investors, is largely indifferent to the outcome of a secondary deal.
We are seeing exceptional opportunities at the smaller end of the market, a larger universe that typically falls under the radar of large secondary players. Here, investors can get exceptional access to the best deals, by hand-picking the best performing companies with the strongest fundamentals and supported by long-term investment themes.
Demand for GP-led deals shows no signs of waning given their ability to meet the needs of all three participants – the GP, the LP and the secondary investor – at a time when liquidity challenges persist. And given the strength of our pipeline and the backlog of GPs wanting to give liquidity to investors, we believe the opportunity will continue for the foreseeable future.
By Paul Newsome, Partner, Head of Investment Solutions at Unigestion
[1] Preqin, April 2021
[2] Greenhill,January 2021
