GP-Led Secondaries

The private equity secondary market is becoming more and more popular, which showed strong resilience during the pandemic, with the market value ending 2020 at $60bn and fundraising only down 6% from 2019. More importantly, during 2020, GP led secondary deals amounted to the majority of secondary transactions.

A GP led secondary transaction is a transaction whereby a private equity sponsor will move assets managed by an existing fund into a new fund (“continuation” fund) controlled by the same private equity sponsor. Essentially, current LP’s are given the option to sell all or some of their interests to the buyer. Secondary capital buyers put new money into the deal to buy out the LP’s looking for liquidity or the general health of the continuation fund. Other capital generated in these transactions comes from existing LP’s who want to continue their current fund’s interest and the private equity sponsor. As Simon Witney from Travers Smith LLP writes, GP led secondaries “are generally implemented by GPs to generate additional follow-on capacity for a portfolio (or, increasingly, a single asset) and allow an extended hold period to maximise exit value.” GP led secondaries are significant in that they address the issue of a standard 10-plus-two-years fund in private equity, which does not always align with the growth of the companies in the portfolio.

There are four common types of GP-led secondaries:

• Fund restructuring: A fund restructuring, also known as a fund recapitalisation, occurs when a GP reallocates its assets from an older fund into a new special purpose vehicle. While doing that, he allows the investors to cash out or roll their interests into the new fund. When the GP needs more time and assets before selling and certain LPs are ready for liquidity, this strategy works well.
• Tender offer: A tender offer is a  GP-organised secondary sales process targeted at LPs looking for liquidity. However, because there is no negotiation with the investors (they may accept or decline the offer), the deal may fall through if too many LPs reject the offered price.
• Stapled transaction: A stapled transaction is when the GP arranges for the sale of secondary interests in a fund to a buyer, who agrees to make a primary commitment to a new (or existing) fund managed by the same GP at the same time. A recurring disadvantage with this type of investment is that stapled transactions have conflicts of interest that need to be managed.
• Whole/ partial asset sale: Occurs when a company purchases a whole or part of an asset, which is then moved to a continuation vehicle, where it is given additional resources to expand in the hopes of a better future outcome. The GP normally continues to manage the asset, similar to a fund restructuring. LPs might choose to cash out or roll into the new vehicle.

An example of an extraordinary GP led secondary would be the Kronos deal. In 2018, Kronos, an HR software provider, was restructured. Since 2007, Hellman & Friedman and JMI Equity owned the company, and ten years later, the fund was coming to its end, but Kronos still had significant upside potential. The fund’s LP’s could either continue holding their stakes or cash out due to the nature of single-asset restructuring. Instead of bringing on new investors liquidating LP’s, they were allowed to sell their stakes to current LP’s or H&F itself. As a result, on April 1st 2020, Kronos merged with Ultimate Software for a combined valuation of $22bn, a hefty markup from the buyout of Kronos in 2007 for $1.8bn.

Following the pandemic in 2019, many deals, including GP-led transactions, were put on hold while waiting to see how the pandemic would affect the Private Equity market. However, contrary to expectations, data from Greenhill suggests that GP-led secondaries accounted for 44% of sales in 2020: a 30% increase from 2019. As stated by PEI, secondary fundraising increased threefold in 2020 with a value of $95.6bn raised compared to 2019 with $33.1bn raised. In 2020, roughly 15% of the total was generated through GP-led secondary funds. This tendency is anticipated to continue, given the ongoing interest in GP-led deals.

However, when going through with a GP-led secondary, there are a few key issues to consider. Given that in these transactions, the General Partner is often on both sides of the transaction, conflicts of interest are a common concern. This is especially relevant when it comes to the valuation of the assets since the GP needs not only to maximise the value of the remaining assets but also to assure a good price as the receipt of a carried interest will be connected to the value of the asset. In order to address this problem, GPs should fully disclose any risks involved with a transaction and enlist the help of independent experts to ensure that a competent conflict management procedure is in place. Third-party fairness judgements are becoming increasingly popular as a means of avoiding possible difficulties.