Is Anyone Worried?
Am I the only one that’s concerned about the advent of new innovations in PE? It seems odd that more and more PE firms are utilizing continuation fund strategies to “extend” the timeline of an investment and buying the debt of its own portfolio companies. It seems disingenuous to say the least, but it’s marketed as these great innovations for LPs.
I think of it less as an innovation and more of a sign of where the markets are at. Continuation vehicles aren't really a new concept. CVs are just a legal mechanism for funds to realize economics, while still holding onto an asset. At the right terms, they can be very advantageous for GPs economically
That’s exactly the problem. GPs are acting in their own interests to crystallize gains on an asset by selling to themselves and marketing continuation vehicles to secondary investors that may or may not have been sold in the primary markets (i.e., other sponsors or strategies). It’s just odd that they keep raising funds that are then used to trade assets around like hot potatoes while ultimately the LPs (e.g., pensions funds, endowments, etc.) and portfolio companies suffer with the constant relieveraging of its balance sheets.
as someone who works in secondaries, i feel the way that it is portrayed in the media as the gp "selling to themselves" is a bit misleading. Yes, they still control the company, but the price is set by the secondary buyer*. And the selling LPs have a choice whether to participate or not. It's not some scam where the GP decides the price and LPs are forced to live with it (i.e. the GP can't just say the secondary buyers will buy the asset(s) for $0).
In contrast, when a GP sells a minority stake (often to another GP), the LPs are "forced" to sell their pro-rata at that valuation. With a gp-led, at least they can choose to maintain their pro-rata if they don't like the valuation.
*I'm sure someone will mention that in some GP-leds, the secondary buyers are not able to set the price themselves in the sense where they could say "we will pay x", but rather the deal is presented to them on a take-it-or-leave-it basis (e.g. basically all clearlake GP-leds). The secondary buyer still has the option to reject participating in that deal if they think the deal isn't fair and if the market deems it not a fair price, then the deal won't get done, so i still view this as price discovery.
Do you think the secondaries investors can make money from these CVs?
yes, generally these are great setups. Rather than a new sponsor getting to capture the remaining upside in an asset (i.e. a sponsor to sponsor trade), the current GP can continue to execute their business plan going forward by getting new LPs and allowing them (the GP) to continue owning the asset.
The risk factor is also much lower since the GP should have a good sense already of everything going on at the company whereas a new owner will need time to implement their changes and discover any bones in the closet. this is not to say some GP-leds won't blow up, of course they will, but that's no different than any other investment. There is always risk.
When done correctly (transparent and well attended process), CVs make more sense than many sponsor to sponsor transactions.
Yea - I'd rather invest in a high quality CV than a high quality coinvest, in a CV the GP already knows the asset very well.
lol this just sounds like GP propaganda. Why would you want to pay economics?
How would a CV work for existing management at a PortCo? Say they have hurdles in place for equity to vest and the original sponsor decides to extend their investment timeline, would management RSUs/ownership vest upon the transaction assuming hurdles are met? I know the COO of a sponsor owned company with millions in ownership, but the PortCo is approaching 5 years held now. Wondering where this will lead.
Depends, usually not a full cash out
It honestly seems like a bunch of baloney. Seems like LPs get screwed and GPs get to collect more fees
From my understanding not true lol. LPs get the opportunity to cash out, but they also have the opportunity to roll into the secondary vehicle which will have mitigated j curve, higher IRR, better performance than putting money into a brand new PE fund. Win win: LPs can either choose liquidity or statistically better returns
You’re just regurgitating what the GPs typically tell LPs when they do continuation funds. Yes, the incremental returns may be compelling for a few cases where you have an A or A+ asset in your hands and there is continued opportunity for value creation, but that certainly does not apply for the majority of deals that are happening. Continuation funds have exploded over the past 3-4 years and it seems hard to believe there are enough “quality” assets to fuel the supply of secondary funds that are being raised.
The counter argument is that GPs are using continuation funds to extend the timeline they need to “fix” the asset. The secondary investors can “choose” to invest or not, but from my perspective, it’s never the style of diligence that another primary sponsor would do and that’s one of the issues. If one of the blue chip sponsors is doing a continuation fund for one of their assets, secondary investors typically do less diligence and invest within a constrained period of time. It’s like the 2020-2021 timeframe when all the VCs would forgo diligence as another blue chip VC was leading the round.
I do think continuation funds have a role to play in the capital markets, but from my perspective, the pendulum has swung too far in one direction with too much capital being raised in the space. It’s just another asset gathering strategy and these things never have a good ending.
*PCA boys have entered the chat
We (a GP) are looking at CVs as an opportunity more than a necessity. We have a few assets that have been growing like crazy and have strong macro tailwinds that are already several years in but that we’d love to hold for another 5+ years. The prospect of crystallizing current economics and then continuing to compound for another round is pretty compelling, and it’s less risky than buying a new asset because you already know what’s going on under the hood (although there are new risks that get introduced)
I can definitely see how you could try to spin that same story for a shitshow platform that you couldn’t sell, but as mentioned above the “market” will still agree on the price, and you need to sell both current and new LPs on it.
Selfishly though, as a newer VP I’d spend my time on a new deal that I have full economics in rather than compounding something the firm bought when I was an analyst lol
I agree, it seems quite convenient and frankly suspicious that CVs are being approached as an "opportunity" vs. "necessity" in a time like today where multiples are compressed compared to last 2 years and liquidity is tight AF where hardly anyone can get a loan from the bank to do a deal. Even if they can get debt, it's pretty hard to be making the same returns today on 7%+ debt (assuming SOFR + 375 while SOFR currently >4%) eating into your IRR and no one wants to sell their investments at a loss which they bought in the last 2 years. It seems awfully convenient to just avoid taking the "L" and pushing it into a new fund and forcing new LPs to buy into it. Even though yes the GP often does get a fairness opinion from an investment bank, we all know that fairness opinions are bought and are not pure third party valuation opinions. The Ibank just wants the GP's fee and will value it wherever the GP wants it valued to transact at.
As someone that worked on these fairness opinion at a bank, that’s as reliable as the private equity marks on their own portfolio. People have just accepted this as a matter of fact, but it’s shocking to never hear any pushback.
But again, this misrepresents what is happening.
First of all, you need to find a willing buyer. The GP can't force the secondary buyers to buy it. and the existing LPs are given the choice whether to sell or not.
2nd, everyone knows that fairness opinions are a joke, in all transactions. But this isn't specific to GP-leds, this is the same deal with vanilla M&A, restructuring, etc.
3rd, GP-leds are not centered around new assets that are underpforming. It would be hard to find a buyer. Are there underpforming assets in some deals? Of course, but often it's part of a multi-asset deal, and again you still need to find a willing buyer,
I think you misinterpreted my note on forcing LPs to buy in. Yes nobody’s forcing the LPs to buy in, but what I’m saying is the GP’s sort of are forcing them by saying “If you want to invest into our newly vintages Fund X targeting $20 bn, then part of the deal is you’re buying into this $1.5 bn asset we’re purchasing from another fund which we also refuse to mark down nor run a real process on. Also we’ll only give you very limited info on the asset itself in a VDR and you don’t get to run a due diligence on it or talk to management.”
It’s like making the LPs eat a little bit of shit for a chance at a bigger piece of the pie. These are not coinvestment deals, it’s either buy into the new fund at these terms or don’t buy in at all.
There is a reason why Evercore Secondary Advisory makes the most money at the whole firm lol
It makes more money than m&a advisory
It seems odd you aren’t legally required to run a full process for the asset in these scenarios to get a better sense of price discovery / meet fiduciary obligations to LPs.
An interesting recent deal is Brookfield’s transaction of Westinghouse, where Brookfield sold the asset to another division of itself, but ran a competitive bidding process with non-Brookfield sponsors
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