Private equity turns to fund restructurings in COVID-19 slowdown

General partner-led fund restructurings accounted for the majority of private equity secondaries volume in 2020 as managers sought liquidity in a flat exit market

Private equity (PE) fund general partners (GPs) faced a challenging year for returning cash to their investors, leading many to turn to GP-led fund restructurings to create liquidity for investors as fund lives expire.

GP-led deals—where managers roll assets from an existing fund into a new vehicle—accounted for more than half (52%) of PE secondaries deal activity (where investors buy and sell stakes in funds) in 2020, according to global fund adviser Triago.

Although overall secondaries deal activity dropped to US$71 billion last year from a record US$83 billion in 2019, 2020 was the first time that GP-led deals accounted for such a significant proportion of secondaries deal flow. In 2019, for example, GP-led deals only accounted for 36% of secondaries volume, according to Triago.

PE managers explored the GP-led route during the pandemic due to the difficult selling environment, which left many unable to realize expected returns and make distributions to their limited partner (LP) investors.

For example, there were only 1,467 PE exits in 2020, down from 1,718 in 2019 and the lowest annual total since 2013. Managers were reluctant to proceed with company sales in a volatile market that could compromise exit valuations.

Some managers, however, were also dealing with fund lives that were approaching expiration—PE funds are typically active for 10 years with the option to extend by a maximum of two years. Portfolios had to be liquidated before reaching an expiration cliff edge.

A July 2020 survey of PE managers in Europe, North America and Asia by fund administrator Intertrust found that 75% of respondents expected to see extensions for funds nearing the ends of their terms. For funds that had already been extended, or those with large LP-bases difficult to corral into an agreement on an extension, however, a GP-led solution was an appealing option.

GPs have also considered GP-led deals as a way to provide liquidity for their investors through a period when distributions have slowed.

Capital calls from GPs to their LPs outstripped distributions for the first time in five years, according to Triago. This could limit the ability of some investors to commit to fundraisings in the immediate future. GP-led deals provide a mechanism for upping distributions without having to risk selling assets.

Blue-chip brands lead the way

High-profile PE firms have been at the forefront of putting together GP-led deals in the past 12 months.

In May 2020, European mega-buyout manager Permira partnered with secondaries investor Coller Capital to secure a GP-led deal worth US$829 million that saw the firm roll the last four assets in its fourth fund, Permira IV, into a new vehicle. The deal meant Permira could give Permira IV investors the option to obtain liquidity or remain invested in the assets via the new vehicle, on the same terms as when they originally invested.

Later in 2020, New York-based PE firm Kinderhook Industries agreed to a US$460 million deal with PE secondaries investor AlpInvest, a Carlyle Group subsidiary, that saw the firm recapitalize its 2009 vintage Kinderhook Capital Fund III. The deal gave investors the option to retain their holdings or receive full or partial liquidity.

Other recognized PE managers exploring GP-led processes are reported to include Summit Partners and Audax Capital.

The broad acceptance of GP-led deals reflects their growing credibility. In the past, GP-led deals were approached with caution by investors nervous about how assets would be valued in these processes, but rising GP-led volumes suggest attitudes have changed.

Financing a further spur for transactions

The evolution of the financing options available to secondaries investors and GPs involved in GP-led deals has been another driver of these transactions.

The provision of net asset value (NAV)-financing, where debt is provided against the net asset value of the companies held in a PE fund, has increased rapidly in the past 24 months. Tracking data related to the still nascent NAV finance space is scarce, but several advisers and NAV lenders report record levels of growth for the product during this period.

Initially used by GPs to manage the liquidity of their portfolios, NAV financing is increasingly used by secondaries investors to leverage their investments, including GP-led transactions.

Preferred equity and other credit-based structures have become increasingly popular among secondaries investors and represented approximately 15% of secondaries deal activity during H1 2020, according to investment bank Greenhill.

Secondaries investors financing GP-led deals have been able to underwrite deals with equity and then raise debt financing, post-deal, by accessing NAV-financing solutions. Terms are bespoke, but NAV facilities will typically offer secondaries investors involved in GP-led deals a loan-to-value ratio of up to 40%. Financing is added in the form of a term loan with pricing in the 5%-to-10% range.

The development of the NAV-finance market has given investors in GP-led deals greater flexibility and the tools to manage risk and enhance the upside potential of their investments.

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