LP Secondaries Modelling
I have noticed a lot of high quality content from people who work in PE secondaries and thought I'd ask this question. How does the modelling process work for LP secondary trades and how does that differ for a 1 or 2 fund portfolio compared to a 40 or 50 fund portfolio? Is the modelling done in Excel or is their some kind of propreitary system that can do a lot of the analysis in an automated manner?
I have a friend who is very dissatisfied at his current shop since his "modelling" consists of inputting rev growth, margin improvement and free cash flow conversion of underlying companies into a "financial engine" that the secondaries firm built in-house. This system then automatically flows the cash flows into the right waterfall and does sensitivities. Dude's bummed that he's learning very little about companies and getting almost no real modeling experience.
Never heard of that before. Most shops just use Excel - it's not rocket science
Can you share a little insight into what type of modeling is done? I would assume if you are valuating a stake with multiple company interests you do not have the time or readily available information to create a DCF for all of the companies. Are comps the main form of valuation here? Any insight would be much appreciated. Thanks!
Yikes, that type of "modeling" sounds brutal. How do you even audit something like that? Trust the black box?
Short answer is you're projecting the exit equity value for each investment for each fund, whether that be 2 funds or 40 funds.
Agree with above.
But if you are buying a portfolio of 40 funds, how useful or even impactful is modeling out the expected cash flows of the 285th company in the portfolio? And given that you are unlikely to get much more than a quarterly report and a capital account statement, how would you model out the waterfall? Like, how do you know how much preferred is already paid, how much is left before the GP catch-up starts etc..? I can imagine doing this in Excel can get quite complex when you have hundreds of companies and a waterfall for each fund.
There's a separate waterfall for each fund, those net cash flows are then rolled into a deal model. There will be enough information in the FS/CAS/LPA to get a sense for the waterfall.
It's important to have a view on each fund so that you can add/subtract them from the portfolio to try and get to the best price or achieve certain other parameters (IRR, funded %, diversification, etc)
Secondaries modeling varies, but what you're essentially trying to solve for is future projected cash flows similar to how you would project a corporate transaction. You look at the fund and the underlying assets and you model the cash flows of each of the assets out, this can vary by asset class as for a credit or RE secondaries deals with predetermined cashflows, you're essentially lowering your basis with each cash inflow. In a PE secondaries deal, there aren't many interim distributions on an asset level and you're reliant on exits (unless you're taking dividends). You're usually taking discounts or haircuts on an asset level for conservatism in order to account for fluctuations in expected cash flows (ex. assuming a discounted exit multiple for a PE asset that has been heavily affected by supply chain constraints that will be exiting in the near term). After that you take out expenses such as fund expenses, management fees, etc., and layer in the promote to the GP to derive your net return. Note returns in secondaries are heavily driven by the discount to NAV you are purchasing the LP interests or assets.
hey! Can you please PM me - have a few urgent questions re this. Thank you!!
Hi, can you please PM me as well?
Just to add to the great answers above since I think you were narrowing in on what you do when there's a lot of funds and a lot of portfolio companies:
It'll depend by shop for sure, but we usually will identify the largest assets, usually by NAV first. We'll apply a gross money multiple and expected exit year to each, let's say the carrying multiple for simplicity. So a large investment currently held at 2x MM vs. a smaller one currently held at 10x MM may change the order of size when you're looking at expected future proceeds by each asset.
After that, we'll pick those largest assets by expected future proceeds and actually model them out. There's no set percentage of total proceeds we try to model out by individual company, it'll depend on the portfolio size and other factors, but at you want to be confident you can talk to the biggest movers in each deal.
We'll then flow the modeled proceeds through the overall transaction model. For the companies we didn't model, we'll ideally have a call with each GP to discuss where they think they'll exit each in terms of a money multiple and exit year, and haircut where we think appropriate if we think they're too optimistic or what have you. This part is more of an art, and if we don't have a call with the GP, we'll judge on our own and probably be very conservative. We'll then put those high level money multiple assumptions through the model alongside the modeled proceeds to construct the overall transaction cash flow.
Works the same if you're modeling 1 fund vs 50 funds (but with 1 fund you're pretty much always going to be modeling out each company vs the high level stuff).
Do you guys just do all of this in Excel?
Yeah, we have a basic excel template set up for both the transaction level modeling as well as the company level modeling that we'll modify for the deal specifics. There are certain more complex deals we'll custom build a model for, but that's rarer and our templates are pretty robust.
Don’t you just model the underlying assets and use your discount to NAV on acquisition for your cost?
How are you arriving at your discount to NAV?
I have only done this once, and it was not at a formal secondaries shop. But we used an IRR target and worked backwards on the discount we wanted
The job I left that for essentially doubled my total comp as well. When I was leaving they matched it, but I had spent months trying to re-negotiate comp and could just see nothing but issues going forward
Thanks to everyone who responded. This is turning out to be a super insightful thread, so just to keep this going - it seems like most folks model out individual assets in Excel and run the cash flows through the appropriate waterfall to get to pricing. Especially if its a large portfolio of let's say, 60 funds, wouldn't modeling individual assets with thoughtful assumptions require a ton of manpower; i.e. bodies to read through all 60 quarterly reports, FS and CAS and then do GP and reference calls? Most secondary firms I have seen run lean deal teams with 3-5 people at most, so how is all that work getting done? Seems even more challenging when you have a Greenhill or Evercore running a competitive process with super tight deadlines.
The secondary firms that look at 50+ fund portfolios are very well staffed at the junior level.
Also, the same funds tend to appear every few quarters, so rather than a fresh model, a pricing usually is just a refresh of the most recent iteration.
I know a few that are sub 10 ppl shops that regularly take down large portfolios. They load them full of leverage and use a top down macro approach. If I was an LP I'd be scared.
We'll ideally chase things that we've done work on before or where we have good insight into the GP which helps with the workload. But otherwise given we're well-staffed, we'll have one associate with the transaction-level model and a few funds, and then delegate the other funds out to other associates who then hold the pen on those before they're flown into the transaction-level model.
It also becomes easier to move through a large number of portfolio companies when the firm is an existing investor in the fund. Given a lot of the large secondaries players also have a primaries team, typically they will have an existing view on all of the portfolio that just needs to be updated. Then you only need to dig into a smaller sub-set of the portfolio which aren't familiar.
And the actual modelling of the underlying portfolio companies is a simple process once you have a view on what the exit value is. The other important part of the modelling process is getting the waterfall right. Most firms have a standard waterfall template, but every fund has a slightly different waterfall so you need to make sure there isn't a quirk that becomes material.
Sapiente earum delectus quisquam corrupti. Tempore error quod eveniet et facere. Asperiores nobis expedita dolorem nisi. Facilis et aut fugiat quae cum.
Cum nam placeat cum debitis quia. Dignissimos maxime est esse occaecati aspernatur provident magni qui. Repellat distinctio eum rem facilis. A harum perspiciatis deleniti consequatur. Nihil qui quaerat earum hic. Et id pariatur et non blanditiis qui. Dolorem quis vel et fugiat pariatur.
Harum atque optio soluta voluptatem aut iste. Voluptas est repellat cumque blanditiis natus omnis asperiores. Officiis autem aut quo neque fugit et. Dolorem unde ut et ipsum doloremque ab perspiciatis dicta. Tenetur nam qui possimus. Natus minus voluptate vel veniam possimus illum.
Aut rem inventore distinctio porro. Rerum aliquid natus eveniet quia amet quia dolor. Dolorem ab officiis voluptatibus. Beatae laudantium consequatur quos quaerat quis. Ipsa consequatur molestiae ipsa. Enim itaque ad quis asperiores consequatur suscipit corrupti.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Quod minima rerum cupiditate neque magni fugiat animi. Quis pariatur vero est sequi pariatur.
Omnis dolor est dicta qui quia. Consequatur ratione modi consequatur minima hic aperiam. Enim cum animi quo veritatis provident.
Consequatur vero soluta veniam nesciunt dolorem tenetur. Optio et ut minima perspiciatis. Occaecati ipsum occaecati dolor. Dolorum ut error est molestiae eius veritatis.
Ad laboriosam aut alias est ut vel. Esse ut molestiae et tenetur ut tempora explicabo. Deserunt cum voluptas possimus numquam velit omnis. Illo impedit et atque nihil tempora. Corporis quisquam dicta modi eaque.