When private equity funds reach the end of their lives, the investment firms that manage them are increasingly selling the best-performing portfolio companies to their next funds.
One version of these hand-offs, known as general partner-led secondary funds, has exploded in popularity over the last six years. GP-led secondary products are new funds with the same sponsor that include one or more companies from a previous fund.
The trend can be seen through proprietary data collected by Duff & Phelps, the number one-ranked provider of third-party fairness opinions for cross-fund transactions. Data from Duff & Phelps, which works with 20 of the top 25 private equity firms, provides one of the most comprehensive looks at behavior that is changing the asset class.
During the six full years between 2015 and 2020, Duff & Phelps issued 106 fairness opinions in cross-fund deals. In 2015, none of those transactions were GP-led secondary funds. By 2020, 42 percent of the total were GP-led secondaries. Limited partners are signing on as well, with 30 percent of LPs rolling over into the new secondary funds last year.
The number of cross-fund deals in general have been ticking up as well during the time period. Between 2015 and 2020, Duff & Phelps issued 106 fairness opinions on cross-fund transactions to major private equity groups. Of those 106 transactions, there were only 7 in 2015. In 2020, there were 33.
After the global financial crisis, private firms started doing several different types of cross-fund transactions, including selling a portfolio company outright from an old fund to a new fund or having a new fund take a stake in a company held by an older fund. In the latter case, a general partner may have finished investing the older fund, but needed fresh capital to help a portfolio company do an acquisition, for example.
With GP-led secondaries, private equity firms get closer to having permanent capital. Many of the larger firms have had only mixed success in raising longer life funds, those with about 15 years to invest.
“Generally speaking, private equity has not been really successful in pushing out the length of their funds. The secondary funds give them the same opportunity because they’re continuing to manage the same asset,” said Andrew Capitman, managing director in the fairness and solvency opinions and M&A advisory practices at Duff & Phelps. “It’s not exactly what the private equity firms would love—permanent capital, where they exit portfolio companies, keep the proceeds and invest it again. Everyone would love to be Warren Buffett. But this moves the goal posts in that direction.”
Capitman explained that these funds are also increasingly popular because deal prices are high and there’s increased competition from vehicles like special purpose acquisition companies, or SPACs.
Fees are also typically lower as well, but they require less management attention. “In theory, if you’ve had the asset for a while, the amount of management effort you have to put into it is less,” said Capitman, who added that he is also seeing the trend with infrastructure funds, which already have a longer life than other private markets vehicles.
Half of the GP-led secondaries have only one company in them, according to Duff & Phelps. These companies are generally home runs for the GP, but may need more capital or could be bumping up against fund limits for portfolio concentration. Capitman said he’s seen this happen with companies that have done well during the Covid-19 pandemic, for example.
Investors are increasingly rolling over into the GP-led secondary funds. Last year, 30 percent of LPs opted in, according to Duff & Phelps data. “LPs are increasingly aware that when private equity sells portfolio companies, 50 percent of them are selling to other PE groups,” Captiman said. “That means that if you are a big institutional investor with exposure to many funds, as most of the LPs are, there is a significant likelihood that you’ll end up with exposure to that same asset.”
