Evergreen funds: Accessing private markets alpha
April 22, 2024
Strategy insights GP-led Secondaries: A dynamic market with increasing liquidity benefits
March 29, 2023 | 12 min read
Over the past year, climbing inflation, rising interest rates, the Russia-Ukraine conflict, and ongoing supply chain issues have contributed to significant uncertainty for financial markets. In the near term, we believe the ongoing disruption can serve as a catalyst for increased selling activity and more attractive pricing and terms for secondary buyers. For secondary investors in GP-led transactions, the market dynamic is creating a greater supply of high-quality, lower-risk profile opportunities supported by the continuity of the existing sponsor.
Despite the more turbulent landscape, GP-led deals continue to represent a significant source of future growth in the secondary market, providing:
- GPs with the ability to extend their ownership of trophy assets and greater flexibility to manage their portfolios
- Portfolio companies with more time, and potentially capital, to maximize their value creation potential
- LPs with more liquidity options and flexibility to manage private markets allocations, and
- New investors with access to high-quality companies managed by established sponsors, with the potential for meaningful upside, that wouldn’t ordinarily trade on the secondary market
This report charts the evolution of GP-led deals and explains why we believe they present an attractive investment opportunity. It also outlines the distinct role that these transactions can play in investors’ portfolios as more volatile market conditions drive the need to optimize portfolio construction, both in terms of alpha generation and risk management.
Understanding today's GP-led deals
GP-led transactions are distinct from more traditional secondary deals in which LPs sell their existing interest in one or more partnerships, often involving multiple underlying managers and companies. In contrast, GP-led transactions are initiated by the manager of a private equity fund, often to restructure one or more of their funds and provide liquidity to existing LPs. Some market participants may have historically viewed GP-led transactions as a way for underperforming managers to extend the life of their franchise, which we believe is a view rooted in the early days of the GP-led market from a decade ago. Since then, these deals have evolved substantially and are now broadly embraced by high-quality GPs as a flexible means to hold on to key strategic assets that are often top performers – giving them further runway and capital to generate additional value.
These transactions also provide GPs the ability to offer existing LPs the option to either lock in performance associated with legacy assets and receive liquidity, or to retain their existing exposure, often by reinvesting in a newly formed vehicle created as part of the transaction. Practically speaking, GP-led transactions have evolved to offer all parties a viable solution for navigating current market challenges, while also directly addressing the liquidity needs of existing LPs.
While much has changed over the past year, we believe the secondary market remains vibrant and poised for further growth. 2022 was the second busiest year on record in the secondary market, with $103 billion of transactions closing and the market experiencing a compound annual growth rate (CAGR) of 17% between 2013 and 2022.1 Over the same period, the GP-led segment grew from just $5 billion of volume in 2013 to $48 billion in 2022.2 Once a small subset of the overall secondary market, GP-led deals have soared to account for approximately half of all secondary deal volume since 2020.3
Secondary market growth
Source: Preqin, primary capital raised as of 12/31/2022 and Evercore: Secondary Market Survey, February 2023.
Key Growth Drivers
Growth of private markets – $3.6 trillion in primary capital raised over the past 5 years
Increased churn rate of LP interests
Acceleration of GP-led transactions
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 select companies from the GP’s existing fund(s). The continuation fund is managed by the same GP and backed by new secondary investors plus any LPs that wish to retain exposure to the asset(s). The new vehicle typically resets the fund term and includes a new incentive structure for the sponsor in order to maximize alignment between the sponsor and investors in the continuation fund.
GP-led deals can vary markedly in concentration – from consisting of a single company to dozens of companies. While GP-led transactions have broadly made up close to 50% of annual secondary transaction volume since 2020, single asset deals accounted for 42% of the total GP-led activity in 2022 – giving both GPs and LPs valuable flexibility to actively manage portfolios or meet rising liquidity needs.4
Proportion of GP-led asset deals involving a single asset
Source: Evercore: Secondary Market Survey Results, February 2023.
GP-led deals and a trifecta of benefits
A unique confluence of stakeholder benefits and needs is driving the increasing adoption of GP-led deals and the innovative structures through which they are being completed. As volatility has risen across markets, GPs are increasingly facing challenges and constraints associated with the customary 10-year fund life model in the private equity industry. Many GPs wish to retain exposure to their most attractive portfolio companies to maximize value while also meeting the liquidity requirements of their LP base.
LPs too face increasingly volatile global market conditions and a rising need for liquidity, or in some instances, a need to reduce oversized allocations to private market investments. GP-led deals offer LPs a timely solution to help navigate these challenges – with investors increasingly utilizing the accelerated distributions associated with GP-led deals to meet liquidity needs or to adjust allocations in response to market conditions. In 2022, 78% of LPs opted to receive liquidity in GP-led asset deals.5
Below is an overview of some of the key benefits and features for each of the parties in a GP-led transaction.
Benefits snapshot: A win-win-win
Ability to access high quality, top performing assets
GPs
Existing LPs
New LPs/Investors
Strong alignments of stakeholder interest
GPs
Existing LPs
New LPs/Investors
Accelerated Liquidity
GPs
Existing LPs
New LPs/Investors
Increased optionality/portfolio flexibility
GPs
Existing LPs
New LPs/Investors
Access to unique market exposures
GPs
Existing LPs
New LPs/Investors
Ability to conduct deeper dule diligence given continuity of GP
GPs
Existing LPs
New LPs/Investors
GPs
Existing LPs
New LPs /Investors
Ability to access high-quality, top performing assets
Strong alignment of stakeholder interests
Accelerated liquidity
Increased optionality/portfolio flexibility
Access to unique market exposures
Ability to conduct deeper due diligence given continuity of GP
Source: HarbourVest
Secondary growth: Navigating the trends
Increased transaction volumes for GP-led deals in recent years have buoyed the secondary market to new heights, with today’s GP-led space featuring some of the highest quality assets managed by some of the best-performing GPs within their areas of focus. The rapid growth of the market has led to more opportunities for investors, but at the same time there is a growing shortage of capital with a mandate to invest these transactions.
Overall, there is far more supply of GP-led opportunities today than available capital to invest – particularly given the desire by many secondary managers to maintain high levels of diversification within a typical secondary fund strategy. This dynamic has led some managers to form dedicated pools of capital focused on GP-led deals or other types of continuation solutions – taking advantage of this attractive market opportunity by investing in calibrated assets with a compelling risk/return profile.
For experienced secondary players with capital to deploy, it’s a buyer’s market with abundant supply. But not all deals are created equal, and GP-led transactions are far from simple or straightforward. For example, sourcing and structuring a new transaction requires deep expertise and relationships to manage a process that may take six to nine months to complete. Due diligence for GP-led deals is also often labor and resource intensive and requires a distinct skill set to, among other things, ensure that all parties’ interests are properly aligned on areas such as pricing and valuation, timing, vehicle structure, and economic terms.
Inside a GP-led deal
The transaction
The opportunity
The challenge
The solution
The transaction
- A top-quartile manager looking to wind down several older vintage funds while accelerating liquidity for existing LPs in several newer vintage funds.
- Another key objective for the GP was raising incremental follow-on capital to help accelerate growth opportunities within the portfolio.
- As a result, the GP decided to pursue a multi-fund GP-led transaction to meet its goals.
The opportunity
- Chance to acquire high-quality assets at an attractive valuation.
- Highly attractive portfolio comprised of market-leading companies exhibiting attractive growth and cash flow characteristics.
The challenge
- Significant level of due diligence involved given size and scope of portfolio in addition to meaningful structural and legal complexity.
- Crafting a solution that re-incentivized the GP to ensure their financial objectives were aligned with the new secondary investors and LPs opting to maintain exposure.
The solution
- Negotiations between stakeholders culminated in a $1.7 billion transaction involving over 20 companies across multiple funds being transferred into a newly formed continuation fund.
- Existing LPs were provided the option to either receive liquidity or to reinvest proceeds into the continuation fund, with ~20% choosing the reinvestment option.
- The GP invested over $100 million into the transaction at the same price as secondary buyers, ensuring strong alignment.
A new carried interest incentive plan was put in place to tie the GP’s future economics to performance for the new secondary investors.
The deal summary, general partner, and/or companies above are intended for illustrative purposes only. While this is an actual investment or relationship in a portfolio, there is no guarantee it will be in a future portfolio.
Outlook
The GP-led deal market is poised to continue its rapid growth, providing fertile ground for GPs, portfolio companies, existing LPs, and secondary investors to realize the meaningful benefits they can offer. As market conditions continue to shift, GP-led deals are adding flexibility and optionality for GPs and LPs, along with an expanded, high-quality opportunity set for secondary investors.
We believe that the secondary market has evolved to become a strategically valuable liquidity source and portfolio management tool for both LPs and GPs. As a result, it also presents an attractive opportunity for experienced, sophisticated buyers to deploy capital in innovative ways, especially during periods of elevated volatility and ongoing uncertainty.
1. Evercore: Secondary Market Survey Results, February 2023.
2. Evercore: Secondary Market Survey Results, February 2023.
3. Evercore: Secondary Market Survey Results, February 2023.
4. Evercore: Secondary Market Survey Results, February 2023.
5. Evercore: Secondary Market Survey Results, February 2023.
Diversification does not ensure a profit or protect against a loss.
This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy. The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here. This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.
HarbourVest is an independent, global private markets firm with 40 years of experience and more than $106 billion in assets under management as of December 31, 2022. Our interwoven platform provides clients access to global primary funds, secondary transactions, direct co-investments, real assets and infrastructure, and private credit.
