Private Equity: Secondaries redefined

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Traditional secondary sales are rarely suited to problematic ‘end-of-life’ or ‘disrupted-cycle’ funds. Jennifer Bollen looks at some innovative, but complex, liquidity solutions

‘Whole fund restructurings’, ‘value-add deals’ and ‘portfolio liquidity solutions’ – secondaries jargon is getting more complicated. And so are the deals. So complicated, that those doing them predict a wave of bespoke transactions that will never fit a traditional secondaries investment template.

NewGlobe Capital Partners, a US-based firm that launched in January, is among those targeting a raft of private equity-owned businesses by using innovative deal structures. It estimates that the current market for ‘end-of-life’ and ‘disrupted cycle’ funds is worth more than $75bn in assets in the US and Europe. The figure implies a huge number of investee companies stuck in older funds, with business plans at the ready but no hope of further investment.

Secondaries deals are typically divided into two types – acquisitions of investors’ interests in funds (known as ‘LP secondaries’) or acquisitions of underlying companies (‘secondary directs’).

But NewGlobe and UK-based Vision Capital are among the firms popularising increasingly innovative secondaries transactions. Similar deals have become a material part of Morgan Stanley Alternative Investment Partners’ activities, while PineBridge Investments hopes to do as many as it can and Swiss fund of funds Unigestion has welcomed the trend – the small portfolios of assets generally involved offer more visibility on what investors are buying.

Andrew Hawkins, founder of NewGlobe, previously led origination at Vision where he came across the idea of structuring a secondaries deal that, unusually, retained the incumbent private equity manager – as part owner and potentially active manager – while offering investors in the fund liquidity, and new capital to the management of the underlying businesses.

“[NewGlobe’s strategy] was borne out of the fact that there is a broken piece of the heart of private equity which revolves around what happens when funds come to the end of their lives,” Hawkins says.

Last August, Hawkins and Julian Mash, founder of Vision Capital, worked on a deal to invest in assets held by US buyout firm Willis Stein & Partners. The transaction is often cited by executives as one of the best examples yet of the new deal structures. Hawkins and Mash say the deal offered a solution to each of the three layers – buyout firm, investor and portfolio company, since Willis Stein raised its last fund 12 years ago. The deal enabled investors to either get liquidity or remain invested, and allowed Willis Stein to pursue further value creation.

Vision Capital formed part of a syndicate that also comprised Landmark Partners and PineBridge Secondary Partners, establishing a new vision-led entity as the biggest investor in an extended Willis Stein fund. Investors were given the choice of selling to the syndicate or remaining in the extended fund for the next phase of investment. The Willis Stein partners who wanted to stay on board continue to manage the businesses in partnership with Vision Capital.

“From the LPs’ point of view they love it because they’re getting cash and they know these situations are incredibly illiquid – there is no secondaries market for end-of-life funds because no buyer wants the hassle of dealing with them,” says Hawkins. “The consequence is these funds go into run-off, which is disastrous from a valuation point of view, or the manager loses interest. With us [the GP] gets a fee stream and they get carried interest in new capital brought in at the new market value, not the historical value burdened by hurdle rates.”

Mash argues that the cash price offered was arguably higher than any of the respective LPs could have realised in the conventional secondaries market. “If you wanted to roll over and keep exposure to those three assets you had the option to do that as well,” he adds.
“From an LP’s perspective you’ve got choice about what to do that you didn’t have before.”
Fresh investment then gives the existing GP the chance to ramp up its returns, according to Steven Costabile, global head of the private funds group at PineBridge. “The time value of money means that each passing day is eating away at my IRR,” he reasons. “So even if I can add the half turn on the multiple, my carry isn’t necessarily growing. If someone can reset the clock that would be a big benefit.”

There are few publicised examples of these deals but in September US buyout firm Behrman Capital formed a $1bn six-year investment partnership with Canada Pension Plan Investment Board as lead investor to acquire the five remaining investments in Behrman Capital III. According to a statement at the time, the deal provided immediate and full liquidity to all of the 2000-vintage fund’s investors and allowed investors in Behrman Capital IV, a 2007-vintage fund that more recently invested in two of the five companies in Behrman Capital III, to see their investments mature fully.

NewGlobe’s approach is arguably even more radical – it plans to buy out the investors in a private equity fund, keep the existing GP invested in the underlying businesses to some degree and then delegate the day-to-day running of the portfolio to the legacy team. It will invest through joint ventures with US alternatives manager Hamilton Lane and Vanterra Capital. Hamilton Lane and Vanterra will provide capital while Vanterra will provide financial, strategic and operational support to NewGlobe.

One of the clearest benefits of retaining the existing GP as active manager is that the team running the portfolio already has deep knowledge of the investments. But some GPs will not be suited to the deals, says Shad Azimi, founder of private equity house Vanterra Capital. “You have to get the LPs on board, the incumbent GP on board and GPs have to be the people you actually want to work with. Some GPs underperform because the GPs are not the right guys. It’s a very complicated transaction.”

Russell Steenberg, global head of BlackRock Private Equity Partners, acknowledges that an LP wants to see the GP reinvigorated and re-incentivised, but adds: “On the other hand, if you have a management team that has a bunch of assets that haven’t performed well, you have to ask questions of the management team.”

The economics of these deals vary. Hawkins says the figures involved are often similar to the 2% management fee and 20% carried interest associated with traditional private equity deals, but are shared between the existing GP and the buyer. In NewGlobe’s investments, fees will be split depending on the division of labour; if NewGlobe ends up doing more of the day-to-day management than it anticipated it will pick up a greater proportion of the management fee.

Nash Waterman, vice-president at Morgan Stanley AIP, says the carried interest can be as low as 15% because 20% carry on discounted assets would not make sense in some cases. The level of carry often depends on the expected future performance of the assets, adds PineBridge’s Costabile.

In addition, the number of parties involved in such deals – including the management of the underlying businesses – makes them complex. “The concept is relatively simple on paper but not always so simple in practice,” says Hanspeter Bader, head of the private equity team at Unigestion.

“There won’t be carbon copies [of the Willis Stein deal] because of the number of stakeholders involved in them and the different objectives and constraints produce a differing array of right answers,” says Mash.

Despite the potential challenges the deals present, activity is expected to rise. “It has become a material part of our practice recently,” says Nash. “Recently we saw a fund that reached the end of its life and subsequently two different teams spun out. Another situation is a general partner backed solely by a family office that is experiencing a change in its private equity portfolio and strategy, and looking to sell the assets and build a future with this particular general partner.”

Yann Robard, a senior principal at Canada Pension Plan Investment Board, expects the deals to account for a significant part of his team’s focus in the coming years. “In the next five years we aim to deploy $10bn in the secondaries market,” he says. “We are excited about these opportunities that we call portfolio liquidity solutions. We have a healthy pipeline of those opportunities right now that we are currently investigating.”

More firms are expected to target non-traditional secondaries but the combination of direct management experience and secondaries knowledge means many straight secondaries firms may be deterred, according to Hawkins. He adds multi-asset managers may be keen but would need a change of traditional mandate, which might not be straightforward. And investors might think a buyout shop attempting such a thing may have lost its mind.


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