Big increase in deals seen as industry adjusts after COVID-19 disruptions

Alternative investment general partner-led secondary market transactions are expected to increase in 2021, giving managers additional exit options and relieving the pressure of selling companies during the COVID-19 pandemic.

GP-led transactions involving single assets or portfolios are not just for troubled funds. Alternative investment managers with some of the most sought-after assets in sectors such as health care and software are recapitalizing on the secondary markets to give them more time and capital to accelerate growth of the portfolio companies in the funds, industry experts say.

“We’ve recently seen an upsurge in GP-led transactions for a couple of reasons. Firstly, the pandemic has certainly delayed GPs’ exit plans — IPOs, trade sales, etc.,” said Larry Abraham-Ajayi, Toronto-based vice president at secondary market broker Setter Capital Inc. “Accordingly, GPs have tapped the secondary market to speed up liquidity for their LPs while staying on to manage assets for longer.”

Second, Setter Capital executives have seen a “stronger buyer appetite for GP-led transactions” from managers that invest on the alternative investment secondary market, “particularly single-asset continuation funds for resilient companies with good growth trajectories,” he said.

Despite the pandemic, secondary managers have been raising larger funds, with a couple of managers raising dedicated funds to invest in GP-led transactions. Direct secondary transactions, including GP-led restructurings of existing funds, increased as a proportion of all alternative investment secondary market activity to 38.7% in the six months of 2020 ended June 30 from 37% in the first six months of 2019, Setter data show. In December, Carlyle Group’s AlpInvest Partners unit closed its latest alternative investment secondary market fund, AlpInvest Secondaries Program VII, at its hard cap of $9 billion, exceeding its $8 billion fundraising target and 38% larger than its predecessor. In October, HarbourVest Partners closed its 10th secondaries fund, Dover Street X, at its $8.1 billion hard cap. AlpInvest and HarbourVest both invest in GP-led transactions as well as in positions in existing private equity funds through buying fund interests.

Smaller portion

GP-led transactions are a smaller portion of the secondary market than the sale of limited partnership interests. But unlike LP interest sales, which fell by 56% to $28.6 billion in the six months ended June 30 from the year-earlier period, GP-led deals are expected to take up a somewhat larger share of the market.

“On the sell side, LPs are tired of fund extensions and GPs are realizing that one-year fund extensions are not cutting it anymore. They need more runway than that,” said Jill Shaw, Boston-based managing director of private investments at consulting firm Cambridge Associates LLC.

It gives limited partners that have been in funds for a long time and want to deploy capital elsewhere a way to get liquidity, Ms. Shaw said. It is also a way for limited partners to take managers they no longer wish to commit to in future funds off the books, she said.

For managers, the GP-led transaction resets the timetable until that they have to exit the asset and “takes the pressure off,” Ms. Shaw said.

GP-led transactions are one more new route alternative investment managers are taking to exit existing investments. A combination of a robust initial public offering market as well as publicly traded special purpose acquisition companies, and public market managers and hedge fund managers acquiring private equity-backed companies have led to more distributions than expected, she said.

“It’s been a surprisingly good year distribution-wise,” Ms. Shaw said. “It’s been a little bit down from the last year, but the last few years have been on fire with distributions. It’s sort of shocking and not what we would have expected given the first and second quarters.”

Cambridge expects private equity distributions will be slightly lower than contributions and that venture capital distributions will exceed contributions in 2020.

Jumping in

Some of the largest alternative managers are taking advantage of the strategy.

Blackstone Group Inc. is in the midst of recapitalizing a real estate fund, selling a portfolio to a new $7.4 billion continuation vehicle, Blackstone BioMed Life Science Real Estate LP, which is a perpetual open‐end fund with a four‐year initial lockup period, according to a memo by its real estate consultant, The Townsend Group, to the $28.3 billion New Mexico State Investment Council, Santa Fe, for its Nov. 24 meeting.

The council committed up to $50 million to the new fund, composed of a portfolio of life science properties in an earlier Blackstone fund, Blackstone Real Estate Partners VII, in which the council is an investor. That fund, with co-investors, acquired the portfolio by taking private real estate investment trust BioMed Realty Trust Inc. in 2016.

At the meeting, Blackstone executives told the council that life sciences is a sector in which Blackstone has a high conviction that it will outperform in the future, in part due to increased amounts of money expected to be spent for health care by the baby-boom generation.

“We worked through the strategic plan, and earlier this year felt it was time to explore an exit,” Kathleen McCarthy, a senior managing director and global co-head of real estate at Blackstone, told the council.

“Many of our LPs were highly interested in gaining exposure to life sciences real estate and this company in particular” and so, Blackstone decided to create a continuation vehicle to allow investors continue to own the portfolio.

There are a number of new wrinkles in the fabric of GP-led transactions that managers are laying out for investors. Some managers are “stapling” commitments to a brand new fund to the GP-led transactions. In such a “stapled” deal, limited partners will invest in the fund by buying the old fund’s assets — sometimes at a discount — but also commit to another fund as part of the same deal. At times the additional fund may be a new strategy for the manager, such as credit. Existing LPs in the fund being recapitalized are offered the deal but don’t often buy in, Cambridge’s Ms. Shaw said.

“If you’ve got a GP or a firm that may be out of favor or is not a great performer, and (there is) not a lot of uptake in their new offerings, it gives them new life,” she said. And it helps the firm launch a new strategy.

The attraction of stapled offerings for newer investors is that they are investing in assets possibly at a discount, “generating value on day one,” Ms. Shaw said.

One growth manager cherry-picked assets across many of its funds and packaged them into a new 10-year vehicle offering, Ms. Shaw said. Limited partners in the funds from which the assets were taken — which included some relatively new funds — were given the option of participating in the new vehicle or being cashed out.

“Part of it (the need for the continuation funds) is the recognition that some companies will need significantly more fund life to generate the value they want,” Ms. Shaw said.

A few managers are using GP-led transactions to give limited partners the ability to liquidate stakes in long-lived funds, she said. Long-lived funds can throw a wrench into investors’ portfolio construction.

Portfolio construction, including pacing models, is more difficult for portfolios with “mismatched fund lives,” meaning 20- or 25-year funds combined with the more typical 10-year funds, Ms. Shaw said.

Increased acceptance

The boost in GP-led restructuring activity is, in part, the result of increased acceptance of the strategy by investors. Some 85% of limited partners said that done well, GP-led transactions are a “useful tool,” according to the latest biannual private equity LP survey by secondary market manager Coller Capital Ltd., released on Dec. 7. The remaining 15% of 113 survey respondents said that GP-led transactions are “a distortion of the private equity model,” the results of the survey taken Sept. 14 through Oct. 16 show.

“More LPs are bullish on private equity and need capital freed up to make more investments,” said Paul Lanna, a partner in Coller Capital’s New York office.

The main issue is the valuation of the portfolio or asset being sold between the old and new funds, he said.

“In a GP-led recapitalization, if you are the GP, you are conflicted,” Mr. Lanna said. “You are the selling fund and the buying fund. You need to prove to the LPs of the selling fund and the buying fund … that the price is fair.”

Alternative investment managers are not just using GP-led transactions to assist a struggling fund. Mr. Lanna said that Coller Capital executives have seen GP-led deals involving seemingly COVID-resilient health-care and software assets “fairly frequently.”

In health care, managers are recapitalizing these portfolios because those managers see opportunities to merge companies such as dental or other medical practices together to create larger companies, he said.

Likewise, the software sector is not necessarily challenged, he said.

“Many software companies are doing better than ever, but need capital to accelerate growth through M&A, or investments in the business,” Mr. Lanna said.

New types of transactions

Managers are not only restructuring older funds, they are creating new types of secondary market transactions involving private special purpose vehicles that can buy a single asset or a portfolio of assets, explained Jason Thomas, Washington-based managing director and head of global research at The Carlyle Group Inc.

These private special purposes then can hold the businesses for a long period of time with expectations of liquidity in three to five years or as long as 10 years, he said.

This industrywide strategy is “an alternative to selling a business to a successor fund or selling it to a sidecar fund,” Mr. Thomas said. “This is something that is very new. It’s a nascent market. Like everything else there’s a lot of experimentation with terms.”

Source: Pensions & Investments