Private equity firms are prolonging the shelf lives of their aging assets with deals that are proving increasingly popular with managers, but not with all investors.
Firms under pressure to offload assets from their expiring funds are opting to repackage them into new vehicles as the pandemic curbs the usual exit routes via sales or initial public offerings. This once obscure corner of the private equity industry has grabbed Wall Street’s attention, with the likes of Goldman Sachs Group Inc. joining investors and Citigroup Inc. advising on deals.
Buyout firms are becoming more inventive as business models that usually cap a fund’s lifespan at a decade prove too rigid for Covid-stricken markets. As well as offering an alternative exit route for investors wanting to cash in their holdings, so-called general partner-led secondary deals allow firms to keep top-performing assets and juice even more returns from them -- often meaning even higher fees.
“The market used to be the Wild West,” said Harold Hope, head of Goldman’s secondaries investment unit in New York. “Even two years ago we saw some managers go to their investors with GP-led deals and get shot down. Deals are more stable now. There are better standards.”
In July, Goldman led investors in a $1 billion deal that enabled private equity firm Riverstone Holdings LLC to shift renewable energy firm Enviva Holdings into a new separate fund. When Permira decided to repackage four companies from its maturing flagship fund in May, Coller Capital led investors in an $829 million deal. In both cases, some investors cashed out entirely.
But with the manager as both buyer and seller, the deals come with a health warning. Investor body Institutional Limited Partners Association has cautioned about conflicts of interest and urged that investors are on board, while the Securities and Exchange Commission has waved similar red flags. Another concern is that managers can undervalue assets when moving them, and so trigger higher performance fees upon their next revaluation.
“Managers might try to take advantage of Covid-depressed prices and set themselves up with nice lower valuations,” said Simon Saitowitz, a specialist in secondaries deals and partner at law firm Fried, Frank, Harris, Shriver & Jacobson. In the past few months, he’s fielded more requests for GP-led restructurings than for the whole of last year.
While asset valuations has been a focus of the U.S. regulator, it’s also looked at allocation of transaction fees, expenses and broker fees, and whether such deals have been conducted in accordance with the underlying agreements, law firm Torys said in a report last year.
When London-based Permira carried out its May transaction, the firm sought to allay investor concerns by keeping the same terms for those that opted to stay in, said a person familiar with the deal. Around a third of the original investors took the opportunity to exit, said the person. A spokesman for the firm declined to comment.
The advisory side has typically been dominated by boutiques like Evercore Inc. and Campbell Lutyens, but no longer. Citigroup has worked on the transactions since 2017 and now has a 17-person team, according to Anthony Diamandakis, global co-head of asset managers.
BC Partners recently decided to postpone a listing of academic publisher Springer Nature, which could have been Germany’s biggest IPO in more than a year, Bloomberg News reported this month. It also considered a potential GP-led deal for the investment, people with knowledge of the matter said. A spokesperson for BC Partners declined to comment.
Rarely used until about a decade ago, the value of GP-led deals surged to a record $26 billion last year. Since the pandemic upended markets, managers who wouldn’t normally talk to secondaries experts are interested, said Gabriel Boghossian, partner in the private equity team at Stephenson Harwood. He even interrupted a holiday to work on three such deals.
The growth in demand points to booming interest in the broader secondaries market, where some $80 billion of fund assets were traded in 2019, according to Evercore. Some of the biggest private equity players in the space include Ardian, which raised an industry record $19 billion fund in June, and Coller Capital, which has this year been raising money for its latest flagship secondaries fund. Via its Vintage Funds unit, Goldman has invested more than $38 billion in secondaries deals.
While the virus spurred GP-led exits to account for a record 41% of the secondaries market in the first half of this year, their volumes plummeted in line with industry activity. The number of all types of completed sales by private equity firms fell to the lowest in five years in the period, according to data compiled by Bloomberg.
U.S. private equity firm GCM Grosvenor last month said it led deals to return to record volumes in the next couple of years as pent-up demand and less transactions in underlying portfolios send firms into the secondary market.
But as a portion of the wider market, this year could prove the strategy’s most popular yet. The deals are on track to make up 50% of all secondaries transactions by year-end, compared with 33% in 2019, said Nigel Dawn, global head of private equity advisory at Evercore, which advises on the transactions.