GP-led secondary transactions are transforming the private fund landscape

GP-led secondaries, also referred to as continuation vehicle transactions or fund recapitalizations, have woven their way from a small segment of the secondaries market to becoming an integral part of secondary transactions and exit strategies for private fund sponsors. 

What are GP-led secondary transactions?
A GP-led secondary transaction is where a fund sponsor sells one or more assets from a fund it already manages to a new fund. This ‘continuation vehicle’ is managed by the same sponsor and generally capitalized by one or more secondary buyers. While the continuation vehicle is controlled by the same sponsor, the pricing and terms of the transaction are generally negotiated by and among the lead secondary buyers and the fund sponsor on behalf of the existing fund. Investors in the existing fund are given the opportunity to sell their interest in the underlying assets being transferred (i.e., liquidation option), roll their interest into the continuation vehicle on the same terms as the existing fund (i.e., status quo option), or re-invest into the continuation vehicle on new terms negotiated by the lead secondary buyers, often with an additional capital commitment (i.e., rolling or reinvesting option). That said, recently we are seeing more transactions that do not offer the status quo option, especially in single-asset continuation vehicles. Importantly, continuation vehicles are just one type of GP-led secondary deal, but such vehicles have become the most common structure for sponsor-led secondary deals.

Explosive growth
GP-led secondary transactions have experienced explosive growth over the past five or so years. In 2016, GP-led transactions represented 24% of the secondaries market (see Jefferies, 1H 2022 Global Secondary Market Review, July 2022). By 2021, they represented 52% of all secondaries transaction volume. The market for GP-led secondary transactions has remained strong in 2022 despite the uncertain macroeconomic environment, with market volume for H1 2022 reaching an estimated $24bn (42% of all secondaries volume for the period). While this represents a 17% decrease from H1 2021 volume, it is still 71% higher than the prior peak in H1 2019. While GP-led secondary transactions can include the sale of multiple assets of a fund, over the past 12-18 months we observe that single-asset transactions are more popular. Historically these transactions were used primarily by buyout sponsors, but as the market has developed such transactions are now commonly done by growth equity, venture, and various other private fund strategies.

Benefits of GP-led secondary transactions
To the extent GPs see future upside in an existing portfolio company, GPs have found a new avenue to manage their portfolio companies and hold an investment beyond the 10-year life of a typical buyout fund to maximize value for investors. Such transactions are also beneficial as sponsors do not have to renegotiate existing leverage on investments in connection with a realization event. Further, portfolio company management teams do not have to adapt to a new board of directors as they would in a traditional exit strategy, such as a sale to another PE sponsor. Finally, LPs can either cash out or roll into the new continuation vehicle to maintain their exposure to the investments, often at more LP-favorable economics.

We’re seeing GP-led secondary transactions as a new tool in a sponsor’s toolkit when considering exit strategies for its portfolio companies. With the IPO market having its slowest year in decades (Driebusch, Wall Street Journal), and M&A activity slowing, typical exit strategies for sponsors have been removed. GP-led secondary transactions, therefore, give sponsors access to liquidity events that can provide proceeds to existing investors at favorable pricing. The LP community has seen the benefit of these transactions. Such support is evident in the larger secondary funds being raised, higher allocations to GP-led secondary transactions in such funds, and secondary funds being formed that only invest in GP-led secondary transactions. They can also provide liquidity to LPs which can help them continue to commit to new funds. 

Conclusion
GP-led secondary transactions have experienced explosive growth. They provide LPs with options to obtain liquidity or continue their exposure to an asset or group of assets with the potential for future growth. At the same time GPs can maintain exposure to, and continue to manage, an asset they see as having additional growth opportunities without the need to dispose of it due to arbitrary fund term limitations. While these transactions vary in complexity due to structure, number of assets involved, and varying conflicts of interest, they have provided GPs with another tool to meet their LPs’ objectives and also generate returns. GP-led secondaries will continue to develop and remain a large part of the future private fund landscape.

About
Debra Lussier is a partner in Ropes & Gray’s asset management group and the co-leader of the buyout and growth equity funds team. Deb counsels sponsors on issues ranging from internal compensation to succession planning and bet-the-company matters.

Marc Biamonte is a partner in Ropes & Gray’s asset management group and the co-leader of the firm’s buyout and growth equity funds team, working with funds of all sizes and types. Marc is also co-leader of the firm’s institutional investors team.

Ropes & Gray is a pre-eminent global law firm with approximately 1,400 lawyers and legal professionals serving clients in major centers of business, finance, technology, and government. The firm has offices in New York, Boston, Washington DC, Chicago, Los Angeles, San Francisco, Silicon Valley, London, Hong Kong, Shanghai, Tokyo, and Seoul.