GP-Led Secondaries Are Going Mainstream. Here’s Why.

Increasing demands for liquidity and struggling IPO and M&A markets have created an attractive environment for these types of transactions.

Illustration by II

Illustration by II

GP-led secondaries are in demand and entering the mainstream.

As the end of the year approaches, 62 percent of respondents to a survey of 64 global investors say they plan to increase their allocations to GP-led secondary transactions in the coming months, according to Eaton Partners, a Stifel company. In these transactions, private equity firms lift out a portfolio company or other investments from one fund, compensating investors, and form a new one.

Peter Martenson, managing director and global head of Eaton Partners’ GP advisory, secondaries and directs services, said private equity firms are increasingly conducting these transactions because exiting their investments has become more difficult amid the market downturn.

Initial public offerings slowed down dramatically, with volumes falling 46 percent and proceeds dropping by 58 percent year over year, according to EY. Against a backdrop of mounting inflation and rising interest rates, mergers and acquisitions didn’t fare any better. According to PwC, deal values declined by 20 percent from the first half of 2021 to 2022, and megadeals — those that exceed $5 billion — decreased by around 40 percent from the second half of 2021 to the first half of 2022.

Nearly half (42 percent) of investors that responded to the survey said they’re now allocating at least half of their invested capital in current funds to GP-led transactions. As these types of transactions have become more common, investors appear to have signed on to the idea. “People rinse and repeat and do more of them,” Martenson told Institutional Investor. “We’re reaching this inflection point where people have gotten comfortable. GPs are bringing more to the market and LPs are embracing them.”

These deals can make intuitive sense and highlight one of the problems with private equity: funds have finite lives and sponsors ultimately have to get out of even the best investments. This type of secondary offers an alternative.

Over half of the respondents said they expect to invest anywhere from $100 million to $500 million in GP-led secondary recap transactions in the second half of 2022. Eleven percent said $500 million to $1 billion, while only 3 percent said $1 billion or more.

In the second half of 2022, survey respondents said that they’re looking at buyout-, growth equity-, and venture-capital oriented companies, which tend to be concentrated in the technology, healthcare, services, and industrial sectors.

But GP-led transactions still pose concerns and challenges for investors. When asked what top issues they anticipate when they underwrite their transactions in the second half of the year, survey respondents cited funds with net asset values that are too optimistic, inflation and recession resilience of underlying investments, mediocre companies, and new or unknown private equity firms. In fact, over 90 percent of those polled said it would take another quarter or more for NAVs to reflect the losses in public markets.

Martenson said that with a GP-led secondary transaction, an investor is underwriting two elements: the portfolio company in the fund and the sponsor, or private equity firm. Investors have to think about whether or not the company is well-equipped to navigate market volatility, rising interest rates, and an impending recession. If it isn’t, the LP is likely to lose money, he said.

When it comes to a GP, reputation is also very important to investors. If a manager is unknown, an LP may be less inclined to trust them with a new type of transaction. Martenson said that despite these concerns, the GP-led secondaries market is “a good investment theme” and is poised for continued growth.