Last month Blackstone’s Verdun Perry, who heads up the firm’s global secondaries efforts, told Bloomberg News that he sees the market for pre-owned PE assets surpassing $100bn for the first time this year. To think the PE secondary market was worth $1.5bn 20 years ago.
Much of the growth in recent years has come from the GP-led market. Last year, secondary activity as a whole was down by 32%, from $88bn to $60bn. At the same time, GP-leds maintained their dollar volume of approximately $26bn. This means that GP-leds increased their share of the overall secondary market from 30% to 44%, by virtue of the weakness in the traditional LP stakes side of the market.
A tale of two markets
To understand the stark contrast in these two sides of the market in 2020, it’s helpful to think about what motivates these different types of deal. When a GP arranges a secondary transaction in its own fund it almost always comes with a stapled element. That’s to say that GPs have a huge incentive to pursue these deals come rain or shine so that they can secure further capital for a new fund and to get back on the dealmaking trail. This helps to explain their buoyancy last year.
The LP stakes market was far softer because there just wasn’t enough motivation on the sell-side. Most LPs have been around for long enough to have seen a few cycles in their time and will be rewarded for their patience. Last year’s market uncertainty meant LPs simply sat on the benches, waiting for the volatility to pass. Those that did engage with buyers in many cases triggered material adverse change clauses to break off deals they weren’t happy with.
Now, at least two factors are lining up in the market’s favour. Following the pandemic lull, there is huge pent-up buy-side demand, while confidence has recovered on the sell side as net asset values return to pre-crisis levels, price-to-NAV deltas narrow and good old fashioned portfolio management is back on the agenda.
Advisory squeeze
However, a bottleneck appears to be forming that has the potential to stymie deal flow. Earlier this month, Private Equity News reported that advisors are scrambling to hire new personnel amid a period of staff churn, leaving many with individuals who lack origination, negotiation and execution experience.
As firms look to seize upon the growing secondary market opportunity, they are building out their advisory expertise by poaching from established advisors or buying boutique firms outright. Those losing bodies are on a hiring spree, mentoring new talent to be able to capture rising deal activity.
It would be fair to expect that this advisory squeeze will be felt most acutely in the LP stake market. Advisors have an incentive to seek out GP-led work. These transactions have many moving parts and conflicting interests vying to be satisfied. Negotiations are complex, balancing the expectations of the GP, the existing LPs, both outgoing and those staying along for the ride, and the party bringing fresh capital to the table. Because of this complexity a third party referee is required to mediate.
The LP stake market, however, is undergoing a period of intense disruption. LP interests are far more commoditizable. What one advisor brings to the table is not much different from any other, which puts downward pressure on fees. Because advisors bring more value to a GP-led deal, these situations also typically generate higher fees. There is even some anecdotal evidence that advisors are taking on LP stake mandates as loss leaders to generate further work.
Increasingly, the traditional LP stake secondary market is disintermediating. At Palico, we have seen that investors are growing more and more confident in digital marketplaces. It is now simple for PE investors seeking liquidity to list their holdings and match them to the preferences of a global pool of highly motivated buyers. This ensures the best prices available in the market without the hassle of hiring an advisor who, in any case, is incentivised to chase deals in the growing GP-led landscape.
Six months from now we’ll know if a new volume record has been set. As the size of the cake expands, so too will both mediated and digitally disintermediated secondary activity.
