It is no secret that in 2020 the private equity secondary market was dominated by GP-led fund restructurings. Estimates suggest that these transactions approximately doubled their share of secondary trades last year, from around one-third to potentially as much as half to two-thirds of the overall market. Only a few years ago, these deals were more often heard than seen.
There is sound logic for this recent uptrend (and also for a rebalancing back to the traditional LP stake market). Since GP-leds only involve the remaining assets in a single fund, they are easier to value than a large portfolio of multiple funds, especially so during periods of immense economic volatility. There has also been a strong motivation for GPs to pursue these deals at this time. The pandemic has scuppered exit plans, forcing fund managers to extend their holding periods by rolling familiar assets into new fund structures. Preqin puts the value of unrealized assets in funds of vintage years between 2012 and 2017 at $2tn, so there is no shortage of supply for fund repackaging.
• 3 min. read •
The steady rise of GP-leds in recent years, accelerated by the events of 2020, has sparked something of a gold rush. Major investment banks such as Guggenheim Securities and Goldman Sachs have been muscling in on the action. Their innate M&A skillsets fit hand in glove with transactions that often feature just one or two assets.
Despite the relative simplicity of valuing these deals, they are complicated by the number of stakeholder groups with competing interests: existing investors looking for an exit, existing investors wishing to roll over into the new fund, incoming investors backing the deal, and the GP. This complexity not only demands third-party oversight by necessity, the numerous moving parts mean advisors can command higher fees for their service.
This is the latest stage in the evolution of a highly mature secondary market: demand for the mediation of fund restructurings rising, the need for advisory on straightforward LP stake sales falling. In 2021, investors are so familiar with the PE secondary market that investors decreasingly need to hire an adviser, whose attention will be focused on securing more lucrative GP-led mandates, to negotiate a simple transaction between two parties – particularly when the deal involves a single fund position.
The future is digital
This is just one reason why LPs are showing a growing interest in digital platforms that streamline the secondary sale process. Even prior to the pandemic, investors had begun to take a more active approach to their portfolio management. Our research has shown that around 50% of funds in PE portfolios have such small residual value left in terms of NAV that their performance won’t move the needle, creating a drag on internal operations. LPs recognize that, while some fund interests may need to be sold at a discount to par, this capital can be reinvested to lift overall portfolio performance.
This activity has been limited over the past year as investors have had to find their bearings amid the turbulence and attempt to determine the fair value of their private holdings. As a result, restructurings have taken center stage. Despite this hesitancy, there has been a positive shift in sentiment towards digital secondary platforms in the COVID economy. The all-too-familiar ebb and flow of government lockdowns and travel restrictions have legitimized the use of online marketplaces like never before. Not only have LPs come to recognize the benefits of listing assets digitally amid social distancing efforts, but these platforms also deliver added value by putting deal opportunities in front of a larger pool of globally diversified buyers.
LP stake rebound in 2021
GP-leds are here to stay; that much is certain. But their dominant share of overall secondary market activity is likely to be temporary. LP portfolio sales are due to rebound in early 2021, assuming a recovery in the global economy and that stock markets continue to climb. With the benefit of hindsight on how portfolio companies have performed through 2020 and with valuations stabilizing, traditional LP-to-LP trades are set for a recovery. Investors are likely to have more confidence in actively managing their portfolios in 2021 once fund NAVs for 2020 are recalculated towards the end of Q1.
Naturally, when high-profile, multi-billion dollar PE portfolios come up for sale, they will be brought to market by an advisor with secondary credentials due to the size and complexity of those deals. However, when it comes to relatively smaller portfolios or single fund stakes, the future is digital.