General Partner (GP)–Led Secondaries
By: Steven Hartt, CAIA & Balaj Singh, CFA, CAIA, Meketa Investment Group
Private market investment strategies continue to expand while providing differentiated risk/return profiles. Capital investments into private market management companies, known as “GP stakes”, are an example of this expansion. GP stakes provide a differentiated way to participate in the potentially attractive economics of private market firms (“GPs” or “managers”).
This is an excerpt from NCPERS Summer 2023 issue of PERSist, originally published July 18, 2023.
GP-led transactions are initiated by the GP, often to restructure the ownership of one or more assets within their funds while providing a liquidity option to existing Limited Partners (LPs). While the bespoke nature of GP-led transactions has produced a variety of structures, the vast majority involve creating a new vehicle, called a “continuation fund,” that purchases one or more companies from the GP's existing fund(s). The continuation fund is managed by the same GP and backed by new investors plus any existing LPs that wish to retain exposure to the asset(s).
Increase in GP–Led Secondary Volume
The secondaries market has grown substantially in recent years. Over $132 billion in secondary transactions took place in 2021. The secondary transaction boom has been accompanied by strong growth in General Partner (GP)-led secondary transactions. As shown in Figure 1, over 50% of secondary transactions in 2020 and 2021 were GP-led deals. Further, GP-led secondary transactions grew from $9 billion in 2015 to $68 billion at its peak in 2021.
FIGURE 1: Secondary Market Annual Transaction Volume
Source: Evercore, 2022 Secondary Market Synopsis.
The mechanics of these transactions
In the GP-led secondary process, the GP decides they would like to continue to maintain ownership of one or more assets in a fund that is nearing the end of its term. The GP causes their fund to enter into an agreement with a continuation fund (also controlled by the GP) to purchase a significant portion of one or more of the assets. As part of this transaction, the GP negotiates with an unaffiliated third party to provide capital to, among other things, offer liquidity to those LPs that wish to exit their investment.
In connection with the transaction, the GP typically offers the existing LPs of the fund the option:
to sell their interest and receive the pro rata portion of the cash purchase price,
to “roll” their pro rata share of the Limited Partnership interests in the fund into the continuation fund established to purchase the asset(s),
to increase their participation above their pro rata share of the new interest, or
in some cases, to receive a combination of options (A) and (B).
Challenges and considerations
GP-led secondary transactions require significant attention from LPs, but the timing and process is often difficult to predict. This can be disruptive for an LP that is reviewing multiple deals at the same time.
The structure of each GP-led secondary transaction is typically unique, making evaluating the impact of an election to buy, sell, or hold complex. Due diligence for GP-led secondaries can often be labor and resource intensive. These transactions require a distinct skill set to respond in a “real-time,” transaction-oriented timeframe to evaluate factors including transaction pricing and valuation, vehicle structure, and economic terms.
Given that the particular asset has likely been “de-risked” (e.g., more diversified revenue base, increased operational efficiency, higher profit margins, lower debt ratio, etc.) under the GP's ownership, the next leg of value development may offer less upside than the first phase. The investor should understand the value creation strategy as well as the scope of the GP's resources to assist the company in its next phase of growth.
GP-led secondary transactions can also present conflicts of interest, as the transaction can introduce different alignments of interest among the parties, including, for instance, payment of carried interest to the GP. The GP has a duty to act in the best interest of the LPs in the current fund while also trying to broker a deal with a buyer which the GP itself controls, thereby giving the GP a financial interest on both sides of the transaction. To address the conflict of interest related to valuations, GPs should consider engaging an independent valuation firm and also consider obtaining Limited Partner Advisory Committee (“LPAC”) or investor approval of the transaction terms, especially the sale price.
For experienced LPs with capital to deploy, there is currently a significant supply of GP-led secondary transactions in which to potentially invest. We expect that there will continue to be a substantial number of GP-led secondary transactions to consider, particularly in today's more challenging market conditions and slower transaction volume. However, not all deals are created equal, and GP-led transactions tend to have different structures and considerations for investors to consider – so due diligence experience is essential.
The information contained herein is confidential. These contents are proprietary Information of Meketa Investment Group (“Meketa”) and may not be reproduced or disseminated in whole or part without prior written consent. All information and graphics referenced herein are derived from sources which we consider reliable; however its delivery does not warrant that the information contained is correct. This document is for education and illustrative purposes only. It is not, and should not be regarded as, investment advice or as a recommendation regarding any particular security or course of action. In considering the prior performance information contained herein, you should bear in mind that prior performance is not necessarily indicative of future results, and there can be no assurance that you will achieve comparable results. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.
About the Authors:
Steven Hartt, CAIA joined Meketa in 2010 and has been in the financial services industry for 36 years. He works in the Private Markets Group where he leads the firm's private equity manager research efforts, as well as our private equity co-investment and secondary transaction sourcing, execution, and research. In addition to his research efforts, Mr. Hartt works directly with clients on their private markets programs.
Prior to joining Meketa, Mr. Hartt was a Senior Vice President at Amalgamated Bank where he was in charge of alternative investments. While at Amalgamated Bank, he managed the discretionary portfolios of private equity, debt, and infrastructure funds, in addition to the development, marketing and management of a private equity fund of funds.
Mr. Hartt received a Master's of Business Administration from Columbia Business School, and a Bachelor of Science degree, cum laude, from the University of Colorado, Boulder.
Balaj Singh, CFA, CAIA joined Meketa in 2022. An Analyst on the Private Markets team, his work includes sourcing, evaluating, and monitoring private equity investment opportunities.
Prior to joining Meketa, he was a research Analyst at West Capital Management, a family office RIA with $1 billion in AUM. Mr. Singh was responsible for investment due diligence on managers, portfolio construction, and performance reporting. Previously, he was a Senior Stock Operations Associate at Broadridge Financial Solutions, Inc. and a Client Service Analyst at Hamilton Lane Advisors.
Mr. Singh graduated from Rutgers University with a Bachelor of Science in Finance and Accounting with a Minor in Economics and he is currently enrolled in a Master of Science in Finance at Georgetown University.