A slowdown in mergers and acquisitions activity along with higher interest rates and lower fundraising has closed many avenues of liquidity for private equity investors. Now, limited and general partners across the industry are seeking creative solutions to their liquidity problem, according to a recent report by investment bank William Blair.

The bank’s private capital advisory team conducted a survey of 76 secondary market investors in December 2022 and January 2023. The survey revealed that there is immense pressure for GPs to post realizations and return capital to shareholders this year. 

However, traditional sources of cash such as M&A and fundraising have slowed down over the past year, which has compelled GPs to seek alternative sources of cash. “We expect any extended slowdown in liquidity to drive creativity in deal structuring, and potentially decreased valuation sensitivity among both GPs and LPs,” the report claims. 

One of the most popular structures to emerge recently is a continuation fund. This structure allows a GP to roll out some assets or a single asset from an existing fund into a new fund to continue holding it separately. This creates a liquidity event for investors in the existing fund and allows the manager to sell the asset at a later, perhaps more optimal time. 

A whopping 84 percent of all secondary market deals closed by GPs in 2022 were either single-asset or multi-asset continuation funds. 

“Some of the most attractive targets for continuation funds are companies with resilient performance, stable cash flows and recession-resistant qualities,” says Mike Custar, William Blair’s head of private capital advisory. “This can include businesses with some contractual, recurring revenue component, or providers of mission-critical products or services with a clear ROI to customers and high cost of failure.” 

These continuation funds are particularly popular in five sectors: healthcare, business services, industrials, consumer and retail and technology. 

Besides continuation funds, other creative deal structures are also expected to become more popular in 2023 and 2024. “One example is an annex fund, a side-car vehicle raised by a sponsor to fund portfolio company growth and liquidity for shareholders,” says Custar. “Other solutions include co-control and minority recapitalizations, which help portfolio companies to address capital needs, both primary and secondary. In a challenging financing environment, we are seeing these structures become more common.”

Vishesh Raisinghani