Estimated reading time: 4 minutes
The article in brief:
- A recent expert panel showed that GP-led secondary transactions have evolved from an operational expedient for sponsors to a highly developed strategic tool.
- Planning and early engagement with a fairness opinion provider is critical to avoiding serious problems in reaching close.
- After a modest slowdown in late 2022/early 2023, the GP-led secondaries market is picking back up.
VRC’s Chad Rucker recently presented with moderator Katie Stitch, a partner at W Capital, and Mark Boyagi, a partner at Kirkland & Ellis, at the New York Private Equity Network event on the $72 billion general partner-led secondary transactions market. Today it is one of the hottest topics in the private funds space. Rucker offered up his views on the evolution of the market, pointers on navigating conflicts of interest, and a bold prediction about growth.
The Changing Complexion of the GP-Led Market
Rucker noted that he and his VRC colleagues have been providing fairness opinions associated with asset transfers initiated by GPs for years—since well before the phrase “GP-led secondaries” entered the market’s vocabulary. But he and the other panelists pointed out that the complexion of the market has evolved a great deal from the early days when it was largely viewed as an operational expedient to the point where it has come to be viewed by both LPs and GPs as a critical strategic tool for managing liquidity and enhancing asset value.
While the transfer of portfolio assets from one legacy private fund to another fund of more recent vintage was historically undertaken simply to help accelerate the wind-down of the legacy fund after most investments had achieved an exit, transactions in recent years, have become more dynamic and strategic. That may mean providing LPs with differing time horizons and liquidity needs the opportunity to choose an early exit for a so-called “crown jewel” in the portfolio (even when the IPO market is stagnant) or remain invested for the long haul. Or it may take on the characteristics of M&A, for example, when a new fund is undertaking a roll-up that would benefit from the synergies represented by a holding that is stuck in a legacy fund.
The new dynamics of the GP-led secondaries market create the potential for multiple “winners” from a transaction—the sponsor can crystallize some carry and continue to grow an existing asset; existing LPs can decide if they want liquidity or to remain attached to the asset, and new LPs may gain exposure at to an attractive company that has already proven its staying power, but may still have plenty of potential upside.
Getting an Early Start
But with all the different constituencies (including potential Securities and Exchange Commission scrutiny) and the need to get their buy-in, Rucker stressed that it is prudent that the fairness of the transaction is thoroughly vetted by a third party, ideally starting early in the process. “The worst thing in the world is a situation where a deal is fully baked, but you can’t get the fairness opinion over the finish line,” he said.
Rucker shared the example of a GP-led secondary transfer of a multibillion-dollar energy-related asset for which he provided a fairness opinion. Between the time the deal was initially proposed and when it closed, oil prices moved about $20 per barrel. But because he got involved early on, he and the different participants were able to adjust valuations and move to a successful close, which would have been much more challenging had VRC been brought in late in the game.
“It’s best to get engaged with your provider early on so you have early indications of where ‘valuations land,’ and you can do things from a structuring standpoint to get over the finish line,” Rucker said. “That is where fairness opinion providers really earn their stripes.”
The Outlook for Secondaries
The panelists agreed that after several years of spectacular growth, the GP-led secondaries market slowed modestly in late 2022 and early 2023, with the bid/ask spread on deals widening in sympathy with a general slowdown in private equity associated with the backup in interest rates and anxiety about the possibility of a recession. One panelist characterized it as a staring contest between the buy side and the sell side, with sponsors seeing little reason in portfolio company fundamentals to mark their valuations down, while prospective buyers could point to drawdowns in the public markets as reason to expect a discount.
But with inflation and recession fears tempered somewhat in recent months and a backlog of logical deals building, the panel agreed that the market may have found its level and is picking up again. In his fairness opinion practice, Rucker said he was on track to close three or four deals in the last month, mostly at or near NAV (a contrast with discounts he had been seeing earlier in the year). In an added wrinkle, Rucker said he is beginning to see more GP-led secondary deals involving private credit assets.
Notwithstanding the month-to-month ups and downs in deal volume related to the macroeconomy and the overall tone of financial markets, the panelists agreed that with the expanded strategic use cases, growing LP comfort, and the development of ever-more efficient execution capabilities, the sky—or, more precisely, the availability of capital from the buy side—is the only limit on the growth of GP-led secondaries.
Asked point blank about GP-led secondaries as a percentage of the overall private equity market, Rucker went out on a limb. “Over the next 10 to 15 years, 35%,” he predicted. “As more and more capital comes into the alternative asset market, it’s just going to get tougher to find quality assets. The easy thing to do is a GP-led secondary, so you don’t have to go out and buy a new asset. You’ve done all the hard work—why sell it?”