As the PE scramble for cash persists, structured equity is emerging as yet another alternative to traditional exit strategies. There are at least three shops currently raising new funds.
Structured equity takes on many forms, but they all combine elements of debt and equity.
They’re more expensive than credit but are cheaper and less dilutive than a straight equity investment. PE-backed companies and non-sponsor businesses in need of cash but reluctant to sell amid the current valuation standoff are warming to them.
Insight Partners says PE-backed assets represent the “highest near-term opportunity.” In addition to the stalled exit environment, many PE firms are facing debt maturity walls that will need to be refinanced.
In May, for instance, Goldman Sachs Alternatives closed a $275 million deal with AEA Investors portfolio company Excelitas to repay and refinance expiring senior debt notes.
“There is demand for alternative transaction types that extend past traditional debt but cost less than common equity,” Insight says in LP marketing material. “We believe the market is moving in our direction with increased acceptance of structured equity deals.”
The target for the New York-based firm’s Insight Partners Opportunities Fund II is lower than its previous fundraise, which closed in 2021 at $1.56 billion. But the New York shop is hoping to raise significantly more, setting a hard cap at $2.5 billion.
Insight partners plan to commit three percent of funds raised.
Insight’s fundraising plans were disclosed by the Connecticut Treasurers Investment Advisory Council at its June 28 meeting. The state’s $55 billion pension system committed $100 million to the new fund and another $150 million to co-investments. The LP, which committed $75 million to Fund I, says it was attracted by the “growing demand for flexible solutions” despite the risk of a “relatively new investment strategy.”
The new fund has raised at least $700 million since launching in 2022. Insight is planning to close by the end of September.
The strategy, also called hybrid capital among other descriptions, sits between credit and equity in the cap stack. It was developed to address the need for capital that was less burdensome to the debt load and less dilutive to equity.
Funds typically charge traditional fees. Insight, for instance, is taking a one-percent management fee on capital committed over the initial 18 months. The fee then rises to 1.5 percent “of net cost basis of portfolio investments.”
Insight will also collect the 20 percent carry after an eight percent hurdle. There are no fees on the co-investment.
Except for “A-plus” companies, PE firms continue to struggle to sell maturing portfolio companies and return cash to investors or grow their newer purchases. So they’ve been turning to several alternative cash-generating vehicles, including NAV loans, continuation funds and stake sales.
They’re now increasingly turning to structure equity and expanding a market its adherents say was already undercapitalized, prompting new entrants in addition to incumbents’ ongoing fundraising efforts.
Chicago-based GTCR formalized its structured equity strategy this year and is raising its first fund dedicated to the strategy.
L2 Point is seeking to raise $300 million for its debut structured equity funds. Kerstin Dittmar launched L2 Point in 2019 as an independent sponsor after leading Sixth Street Partners structured equity strategy.
L2’s first fund aims to invest in growth-stage companies in the technology, healthcare, consumer and media industries.
Established firms in Insight’s software market include Clearlake Capital, Goldman Sachs (NYSE:GS) and Sixth Street Partners.
Blue Owl (NYSE: OBDC), Harvest Partners, Ares (NYSE:ARES), Oaktree and Apollo (NYSE: APO) are also major structured credit players.
Though there are myriad structure equity terms, the investing firm usually acquires a minor ownership interest. The bigger part of the deal is the credit end, which usually pays dividends rather than interest. Often, the dividend payments accumulate and payment is deferred until exit or significant liquidity event.
That’s the plan for Insight’s newest fund, according to a Hamilton Lane investment memo to the Connecticut IAC.
“Across deal types, Insight seeks, key deal terms including accruing dividends, seniority in the capital structure, specific conversion rights, liquidation preferences and expected use of funds,” Hamilton Lane wrote.
Insight’s investment will be senior to all classes of preferred and common equity, meaning it gets paid immediately after lenders.
Insight says the private software deals market has exploded over the last decade, from 370 deals worth a combined $18 billion to 4,457 deals totalling $120 billion last year. Further, Insights says PE’s interest in the industry has also grown over that same period, which is leading to high valuations and bigger equity checks.
PE accounted for 46 percent of all acquisitions last year, up from 33 percent in 2013. Multiples have increased from 17.3 to 28.4 over that same 10-year span.
Insight’s new fund has already invested in two enterprise risk-planning software companies and is expecting to close a third deal by the end of October.
“The general partner intends to invest across a variety of deal types, including sponsor-backed companies, founder-owned businesses, existing Insight portfolio companies, late-stage growth and other special situations,” Hamilton Lane wrote.
The growth stage fund will target middle-market software, software-enabled and Internet companies with recurring revenues and strong margins. It’s aiming for a net IRR of between 11 percent and 14 percent.
It’s targeting companies with revenues of at least $150 million and check sizes will range from $50 million to $250 million.
Hamilton Lane says Insight expects half its deals to convert to equity in promising companies rather than cashing out at the first possible liquidity event.
