Where does the money come from in secondaries?
Lots of silly questions, pls be nice:
1) I hear secondary funds tend to take on a range of assets (i.e. growth, buyout, various buyouts etc). Do they add any value, or do they just provide liquidity and exchange ‘ride out’ the remaining maturity of an asset?
2) What diligence goes into making an investment? Is it basically making sure it isn’t a piece of shit asset that someone is trying to hot potato away?
3) What real edge do various funds have? I.e. BX strategic partners vs Ardian secondaries etc…if it’s just buying off someone else, what value is there aside from the largest check?
4) Does doing a secondary on a growth equity deal differ from doing one on say a buyout?
5) Putting it plainly and very offensively, isn’t secondary investing really boring? You essential take someone else’s sloppy seconds of an asset and just hold onto it.
Happy to answer to the best of my knowledge and honestly, not the worst questions to ask. Gonna be a long post so buckle up.
1) Correct, what you are referring to is the LP side of the biz. Secondaries firms will purchase LP stakes in almost any kind of private alts strategy. Aside from the ones you mentioned, they also do infra, credit, VC and many more.
What value do traders add? What value does a merchant bank provide? What value does Ticketmaster provide? If certain entities don't make a market for assets, everything becomes illiquid. So yes, liquidity is the value add we provide. Correct again, that's kinda the nature of an LP deal (passive). The meat of the work goes into pricing the stake (which can be very easy or very complex depending on the shop you are at). On top of that a lot of the work also goes into structuring the deal to get the best risk reward ratio (this is more an MDs job but nonetheless very cool to be a part of)
2) Diligence on the LP side is pretty light tbh. Maybe we'll call the GP if we have a relationship with them to get some color on the funds. Some industry calls and market reports on companies that form a big part of the NAV. The thing to realize is on an LP deal the funds we are buying aren't obligated to give us any information so you are kinda working with imperfect information to get the correct price. On the GP side of it (single asset and multi asset CVs), whole different ballgame. The diligence we do is very similar to that of an buyout shop (sidebar - most of our investment team is ex MF/UMM buyout and they bring their diligence playbook with them). In GP deals you are given every piece of information possible and you underwrite an asset like you would at any PE shop. On top of that you are spending a lot of time structuring the deal optimally as well (terms, earnouts, fee structures etc). Now imagine doing all of this for multiple assets on a multi-asset CV. The workload does get crazy sometimes.
Very reductive way to think about it. As an investor in any strategy, one your mains concerns is always that the asset shouldn't be a piece of shit. Diligence in secondaries has the same objectives as in any direct investing strategy. One major difference is we don't work on the operational stuff as much.
3) Again I make a similar point, what advantage does Vista have over TB when chasing a deal? Isn't a large part of PE also just buying off someone else? PE firms market themselves as sector and operating experts but truly everyone knows it's more marketing than anything else. In the end the best bid always wins. Not to say that sector expertise is all BS, but capital is a commodity. In a similar vein, certain secondaries shops are also known to be experts in certain deal types which can be an edge.
Another part of the edge comes from scale. Large secondaries shops have primaries (fund commitments) and coinvest teams. It behoves a lot of GPs and LPs to maintain relationships with us because we could probably commit to their next fundraise or coinvest with them in a deal. Also a lot of current participants are quite uneducated about market terms and pricing, and so having an experienced player guide lends some comfort and credibility.
And yes, cutting large cheque is also a major edge.
4) Yes, doing a direct GE deal is different than a direct buyout and the same applies to secondaries. Different cash flow profiles means different deal analysis.
5) Again, very reductive. I can say the same thing about any type of private investing. Isn't private equity just buying some other private equity firm's sloppy seconds and holding on to it? By that logic, the only exciting job is to be an entrepreneur (maybe it is lol).
When you do any private alts deal, what you are buying is a set of cash flows. Nothing is different when doing a secondaries deal. Now obviously each strategy has its own spin to it. In a buyout deal you think about the operational side of it. In a credit deal you think about downside and collateral. You get the point. There are different considerations you think about when doing a secondaries deal but it is still and investment role with it's own rigor and fun parts. If it's boring or not is a personal opinion but I can say that it definitely is a interesting investing role from my POV.
6) Bonus: from my POV you'll enjoy secondaries if the following things sound interesting (not an exhaustive list).
You like working on a lot of deals with very short closing time frames (associates close 3-5 deals on an average each year).
The deal structuring and finance part interest you more than the operational and industry experience part.
You like being sector agnostic.
You like seeing unique deal types. Very rarely are 2 deals similar from a structural and execution POV.
Happy to answer any follow-ups
Great response. As far as if you would find secondaries interesting, I like describing it as people that are finance / alternative investing junkies but without as many hardos as the direct side
Great answer here. I’d also like to add to the difference between a growth and buyout deal - typically buyers in growth deals want a larger discount given the higher risk profile of the asset, could be anywhere from 75-90% of NAV, and for buyout typically 85-95% of NAV, based on different scenarios.
Discounts also depend on the liquidity outlook of the underlying. If the asset doesn’t have a clear path to liquidity in the next 1-4 years, then the discount will be higher, and vice versa. Again, this is because the buyer is taking more risk if the asset is more illiquid, meaning they want the price they’re paying to reflect that.
TIA
Wanted to follow up with you folks if anyone could answer.
Would really appreciate it.
1. The shop I am at has a very bottoms up approach to modelling deals (Tbf every secondaries shop will claim this but our shop truly does have this approach). Hence, if time / resources permit, our modeling on GP deals gets quite complex. We will use the data cube and have a very detailed bottoms up build for the company. Modelling is based on unit economics and KPIs that we believe are important and we get quite granular. There's always a trade-off when you have multi asset deals because of resources and time constraints but you best believe MDs will push associates to extract the maximum instead of making this excuse. One thing which is different is that we always spend a lot of time modeling the transaction structure. Think of it this way, GP led deals are quasi buyout deals so the modeling tends to be similar to that of a buyout deal. The added complexity is modelling the transaction as well
2. Similar concept to what I previously said. Most of our investment team is ex MF or UMM buyout so our diligence playbook is similar to these firms. We tap our networks to get references on the business, talk to executives and GPs that play in the space, management + selling GP calls, commercials studies (MBB) and sell-side banker calls, tax, legal, HR, etc. Basically very similar DD to that in buyout. Now here's the caveat, secondaries deals tend to have faster timelines than buyout deals. This coupled with the fact that sometimes GP deals will be multi asset, we might run an accelerated DD process in the interest of time. In these situations, VPs / principals truly show their values in identifying the most important value drivers for each asset, focusing DD on these items and crafting a structure that gets us our return requirements based on the band of outcomes we expect for each key item.
Why reinvent the wheel and not use the model provided by the GP? Like is your methodology really gonna be substantially different that it requires starting from scratch?
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