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Private Equity Spotlight
SI Decade: From frustration to longer holds with single-asset continuation vehicles
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- [00:01]
A
Single asset continuation fund transactions are a relatively new phenomenon exploding in popularity around 2018. They answered a long standing head scratcher for private equity firms. How can we hold onto our crown jewel assets for a longer term without selling them to a competitor? Long hold funds were often talked about but ambition fizzled out given the lack of LP interest fund to fund transfers, although seen today lack the ability to present LPs with an option of cashing in or out. Furthermore, while both types of transactions have inherent conflicts, the involvement of a third party buyer in a CV gives these transactions a favourable shine. Last year single asset continuation fund vehicles took out the largest share of GP led transactions accounting for around 39% of the $48 billion of volume seen in this part of the market according to a year end report from Lazard. Ten years ago, Global head of Lazard's private capital advisory business Holcomb Green, oversaw half a dozen bankers in the firm's secondaries practice representing just a fraction of its 50 bankers. Today GP led deals were called fund restructurings complemented by the second type of deal. Lazard advised on traditional LP led secondaries. Global head of secondaries investing at Goldman Sachs Asset Management Harold Hope was sitting in the same seat investing out of the $5.3 billion Goldman Sachs Vintage Fund 6 backing both traditional secondaries as well as non traditional secondaries. I'm Madeline Farman, a senior reporter at Secondaries Investor and welcome to the third episode of our decade of Secondary's Investor miniseries. In this episode I speak with Green and Hope who have a long working relationship about the evolution of this booming corner of the market. While the term single asset continuation fund has only been introduced in recent years, the pair worked on a transaction mirroring these deals years ago. As Green detailed.
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B
The very first one that we ever worked on was for the Gores Group in Los Angeles. It was in 2004. We helped them to sell a minority interest in a then portfolio company to Goldman Sachs Asset Management long before there was a term called continuation funds but set up a special purpose vehicle to allow Harold's fund to acquire an interest in the business. And they then along with our client went about owning that company and ultimately I think sold it on to another sponsor.
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Fast forward 15 years and Lazard is once again advising on a landmark transaction for a blue chip name marking Lazard. The moment these transactions really started to.
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B
Take off, we executed for Warburg Pincus. It was a large single asset deal and at the time was one of the larger ones that had ever been done. This was pre pandemic and there was an acceleration in single asset activity after the pandemic. But pre pandemic there were not that many billion dollar plus single asset deals. And for us that was a very seminal transaction. And I think for the market as a whole, it was an important transaction.
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If there's one thing that's undeniable about the secondaries market, it's that it's an industry that's innovated. Hope says.
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C
If you look at the different types of deals we've done, and taking the definition of being a liquidity provider to folks who own illiquid assets, I think there's been a lot of creativity, a lot of new transactions, a lot of stretching of that definition. And so while I am a little surprised at how much the industry has grown, I actually think there's still a lot of room for growth because I think the people that are in this industry really view themselves as having a mandate of being a liquidity provider, very broadly defined. And when you look at the denominator of illiquid assets and the growth we've seen in that part of the market, I think there's still a lot of opportunity.
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Looking back to just over 20 years ago, there was a lot of M and A between banks that had direct private equity efforts on their balance sheets. Faced with duplicate investing teams, buyers like Goldman Sachs helped some of these teams spin out from their parent companies with a structure that looks very similar to today's continuation fund vehicles.
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C
We would take a collection of assets, we would buy them, put them into a new partnership, you know, negotiate with the team around what the structure of that look like and spin those teams out. And that continued really for a decade and through the financial crisis of 2008 and 2009. And after that, really the banks had kind of solved their problems. And we were sitting there with this technology without a lot of ways to use it. And we started applying it to these funds who had end of life issues.
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A
These vehicles were given the derogatory moniker zombie funds. Buyers were entering into situations GPs and LPs couldn't solve themselves. Whether it was extending duration, providing more capital, or resetting fees to keep a team around, buyers were taking the same technology dreamt up for bank spinouts and applying it to these problem situations and.
- [05:15]
C
Ultimately, I think, creating solutions that, you know, that were kind of good for everyone. And so that really started the, you know, if you call it the multi asset continuation vehicle market. But there was a lot of stigma associated with it at the time. And I think it was a number of years before. You know, there were clearly discussions around doing it around, you know, single companies. And I think there was some reluctance on the part of secondary buyers, including actually me, to sort of do. You know, we traditionally bought portfolios, sometimes they were concentrated portfolios, but they were always portfolios. And so the idea of doing that around a single company was something that was new.
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The term zombie fund didn't allow for nuance. Green noticed that some of these transactions completed over the 2010-2014 time frame did include fundamentally strong businesses that had real need for follow on and transitional capital over that time period, market participants, including Lazard.
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B
We're talking to as many sponsors as would talk to us about the technology that we had available to us and the capital solutions that we thought the secondary market could bring to bear and trying to convince sponsors that were not in troubled situations that this kind of a capital solution was appropriate not only for transitional capital in misaligned situations, but transitional capital in positively aligned situations and where there was positive selection bias and not adverse selection bias. It took us a long time to convince some sponsors to do that.
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A
There was an acceleration of activity in 2015, which probably coincided with an overall belief in the private equity community that the market position was pretty positive and a significant recession wasn't on the horizon. There was also a desire by sponsors to find a longer term solution for portfolio companies that they liked versus selling to another sponsor. Greene explained. And this period also coincided with GP's ability to augment their fundraisings and add to their LP bases through secondary's market activity.
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B
Back then, the sales cycle for firms like us was somewhere typically between six months and two years. You know, sometimes we would have a meeting and the sponsor would pick up on what we were talking about relatively quickly and decide to do something. But more often we were going back in and having multiple discussions with them and they were thinking about it long and hard. And it was a multi year process to not convince them, but to get to a position where everybody thought this was the right solution to whatever the issue was that they were facing.
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Hope agreed that a big driver of this market was the frustration that sponsors had with selling one of their best assets to a competitor and giving the.
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C
Competitor the playbook and watching their competitor basically run their playbook and double or triple their money. And you know, that that was frustrating and a lot of these sponsors I think felt like they were selling these companies earlier than they would have wanted to because of an LP's desire for realizations or because the company had gotten too big for their fund or they needed more money or whatever the case may be. And so I think by taking that technology, you know, the continuation vehicle technology, solving this problem that sponsors felt like they had, I think we really took a lot of share initially from, you know, the sponsor to sponsor buyout market. And I do think, you know, the stigma that was associated with some of those early deals, you know, went away pretty quickly and has been, you know, broadly embraced, certainly by the advisors in the market and the sponsors in the market and many of the buyers in the market as well.
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The emergence of brand name top quartile managers who historically didn't engage in the secondaries market very often was pivotal to the growth of the single asset secondaries market. Hope said these GPs started to embrace the secondaries market and validate it by doing their own continuation fund transactions. They put their name behind the technology in a way that was visible to the whole market, including LPs, which presented.
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C
A big shift because then you could go to other sponsors and say, you know, brand name private equity fund X just did a deal in the space and, you know, if it's good enough for them, it can be good enough for you. And I think that was really the breaking point when this structure got legitimized. And most of those sponsors, you know, were focused on doing single names as opposed to portfolios because it was more natural for them. As they thought about, you know, managing their own portfolio, they typically didn't think about selling companies in bulk. They thought about, you know, selling companies one by one and when it was time, or in the case of the continuation vehicles, maybe when it wasn't time to sell it, but they felt pressure to give some liquidity back. That, I think was the big change in the market.
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The impact of the global pandemic on the growth of the single asset continuation fund market should also not be understated. Hope heads.
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C
When Covid hit in 2020, what you had is you had a number of companies that suddenly needed more time or needed more capital or needed something to kind of get them through to the other side. And that was a big boost for this part of the market because you had sponsors who really believed in their companies and felt like, you know, if they could get them to the other side, you know, there was a lot of value that would be created, but they needed a bit of a bridge there in some cases. And so the continuation vehicle structure was a great structure to allow the sponsors to sort of hold onto the assets, maybe get more capital or get whatever they needed to get through the pandemic and for LPs that were feeling pressure during that time, it was an option for liquidity. So I do think that was a big boost for the market.
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B
Yeah, and I mean the evidence of that is in the statistics. The market more than doubled. The continuation fund market in the aggregate more than doubled from 2020 to 2021 as all of those businesses that Harold's talking about and sponsors that Harold's talking about needed to find solutions and there was really a significant acceleration.
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A
Fast forward to today. There have been a number of chunky single asset continuation funds that have either closed or come to market in recent months. To name a few. Blackstone strategic partners, HarbourVest, Lexington and Pantheon have backed the $3.4 billion continuation fund for home and commercial services platform Apex Service Partners backed by San Francisco headquartered Alpine Investors. Travel and leisure focused KSL Capital Partners closed an over $3 billion continuation fund for US headquartered ski resort business Alterra Mountain Company in Europe, Intermediate Capital Group's strategic equity unit has stepped up as sole secondaries buyer for CVC's transaction to move Italian online university group Multiversity into a new vehicle which is understood to be between 1.5 billion and and 2 billion euros in size. That transaction follows Oakley Capital's Single Asset Continuation Fund for German University Group IU Group backed by TPG, GP Solutions, HarbourVest, Goldman Sachs, Glendower and Pantheon. The vehicle was understood to be over 1 billion euros in size. Secondary's investor also understands that both of these transactions have been advised on by Lazard. I asked Green and Hope why the largest continuation funds have come out of the US private equity market. They didn't necessarily agree with this assumption, noting Europe was punching above its weight. The fundraising market in the US is somewhere between two and three times the size of the fundraising market in Europe, so one would naturally expect there to be more activity in the U.S. as a result, Green explained. That said, the pair say there has been a disproportionate, disproportionate level of activity in Europe, especially in the single asset market and a disproportionate number of the largest deals in the market.
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B
The billion dollar plus deals have come from European sponsors or been around European domiciled companies out of global sponsors. I'm not entirely sure what accounts for that. Two things that occur to me. The first is there are relatively fewer growth oriented managers in Europe versus the U.S. and when the growth oriented managers pursue secondaries they disproportionately pursue multi asset secondaries. And those really don't show up in the European market. The second is that there are by number many more US secondaries and the middle market in the US is significantly deeper and broader. And so you do see a lot more 500 million to a billion dollar transactions here than you see in Europe. I would point to that as more of especially a recent phenomenon where the middle market in the US has really expanded quite significantly. The middle market in Europe has not kept pace. I think the large markets on both ends of the Atlantic have been pretty steady issuers into the large single asset market.
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A
From a buyer's perspective, why might that be the case?
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C
I would say over the last 10 years, you know, we've been steadily reducing our exposure to Europe and to Asia to the benefit of the us and before the pandemic that was I think relative valuation driven. And then coming out of COVID it was a view on, you know, relative growth rates of the economies in a recovery mode and then more recently maybe due to, you know, including some of the geopolitical risk. So in an environment where we've been less willing to buy, you know, call it European Beta, I think what we've been doing in Europe has been single asset continuation vehicles, you know, where we're able to select company by company, you know, with really good sponsors and businesses that we think are going to perform well in an overall environment that still has some clouds on the horizon. So from, at least from our perspective, we're very interested in, you know, the continuation vehicle opportunity set in Europe as a way to invest in Europe but be very targeted in what we're buying.
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A
While there are some sizeable GP led continuation funds that have closed in recent months, last year saw buyers on the whole favour mid market continuation funds as secondary's investor reported at the time. In 2022, KKR moved Internet Brands into a $2.2 billion continuation fund. That process was led by Goldman Sachs and Partners Group with Lazard once again advising on the process. As our colleagues at buyouts reported at the time, since that time there haven't been many large cap sponsors that have flocked to the secondaries market. I asked Green and Hope whether they think there will be a solution available for those largest managers with very sizable companies.
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C
I do think it's going to happen. But I think you're right that there hasn't been a lot of opportunity for large market sponsors to do single asset continuation vehicles because the size of the businesses they own are simply too large for the pool of buyer capital that exists today. I do think that's going to change. I think we're seeing. We're clearly seeing new entrants come in on the buy side that are focused on doing these types of transactions. I think the technology's pretty well established that can be applied to the large market companies just like the middle market companies. What we really need is we need more investors in this part of the market. And I think we're starting to see some interest. I think, you know, this is a relatively new part of the business and you know that no one has track records that really go back 15 and 20 years like we have in, you know, traditional secondaries. So I'm hopeful that as people start to see more performance information, as they start to understand the role that these transactions play both for general partners and for limited partners, that there'll be a little bit more acceptance of it and that the limited partner, you know, buyer community will grow. And I think, you know, if that happens, I think this solution will work, you know, just as well for a four or $5 billion equity business as it does for a four or $500 million equity business.
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A
While it's possible to do transactions around businesses with enterprise values of $5 billion to $10 billion today, where equity needs are $2 billion to 4 billion, the market starts to become inefficient at around the $4 billion equity need range.
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B
Green told me the capital is not there to form that size continuation fund efficiently. You can raise that capital, but it might take you a long time and it's not terribly efficient to raise that amount of capital. So I think we need to see some larger dedicated pools of capital that focus on this end of the market, more people or investors that can invest over a billion dollars into a single company situation. I agree with Harold. I think we will see that. I think those large market sponsors that own very large businesses that they believe can continue to compound at private equity rates of return over a further private equity hold period tend to have big followings amongst investors and limited partners around the world. And so you should be able to do transactions for them. Their track records are excellent. If they believe that an investment is likely to compound at private equity rates of return, they're usually right. And where you can create alignment with them to do a very large transaction, you should be able to do that. It's inefficient today to form that capital. It will get more efficient with the new entrants in the market, with additional limited partners pursuing secondaries directly and with hopefully Herald and firms that are like Goldman Sachs are raising A lot more money into their pools to affect these bigger transactions over time.
- [19:06]
A
In 2019, at Kirkland and Ellis's Liquidity Solutions, Academy Green's big prediction for 2021 or 2022 was that the volume in the GP LED market would exceed volume in the traditional LP LED market. While GP LEDs haven't quite outpaced LP LEDs as yet, in 2020, GP LED volume made up half of the $60 billion of market volume seen that year. According to. In 2021, it happened again with GP LED volume accounting for $63 billion of the record breaking $126 billion of volume seen for the last four years. From 2020 through to 2023, single asset continuation funds have made up the largest proportion of GP LED volume seen in the secondaries market, according to Lazard's research. What does the future look like for single asset continuation fund technology and how will the secondaries market respond to demand for single asset continuation fund transactions?
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C
Well, I think it's going to evolve. I think the single asset continuation vehicle structure is going to evolve as a more accepted alternative to other exit methods for certain select companies. I think the issue that we face in this market is that sponsors need to realize this is not really a decision between selling a company or IPOing it or doing a continuation vehicle. The continuation vehicle meets a very different need than either a sale or an ipo. And so while I think it is a, it's a tool for liquidity, it's really not designed for companies that you're ready to sell. It's designed for companies that you actually don't want to sell, that you want to hold on to, that you think there's a lot of value creation, but it's also time for you to offer a liquidity option, you know, to your investors. And so I think as the market gets educated on the use case, you know, I think it will become more established both among sponsors and limited partners. And if used the right way, in the right circumstance, I think there's a lot of growth in the market in terms of how buyers are going to react to it. I think the primary challenge buyers have right now is capital availability. You know, there are many more good deals than there is capital to do. And so, you know, the number one priorities for buyers should be, you know, trying to capitalize the buy side in a way that meets the, you know, the demand for good deals. I think right now just having capital is a competitive advantage. I do think that's going to change over time. And I think Similar to what happened in the traditional buyout market where we saw generalist buyout managers start to specialize by industry or focus or have different edges. I think long term secondary buyers to be successful here are going to have to bring more than capital to the table. I think I'm excited about that. I think we're well positioned to be a leading buyer when that shift happens. But I think that's where the future's headed.
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A
Green expects more traditional financial sponsors to launch secondary strategies. We're already seeing the Green shoots of this with private equity players like tpg, Leonard Green Asdorg and Accel KKR making moves in the space. As Secondaries Investor has reported.
- [22:20]
B
We would also expect more limited partners to invest directly into continuation funds and also more limited partners to put more of their capital into secondary vehicles like the Goldman Sachs vintage funds. As the returns for these kinds of transactions start to be demonstrated and the opportunity for investors starts to be better understood. I would say the one prediction I would have, and this relates to something we talked about earlier, but I believe that there will be much bigger deals in the single asset market over the coming five years and I think we'll see the first 10 billion doll dollar continuation fund in less than five years from today.
- [23:04]
A
For its part, Goldman Sachs is very excited about the opportunity to invest in single asset continuation funds around the world.
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C
Because what it allows us to do is to mitigate some of the broader risk that we face when we buy a diversified portfolio. You know, in the single asset continuation vehicle market we are picking a specific sector, a specific company within that sector, a specific sponsor, you know, a specific go forward thesis that's going to be the value creation driver. And I think when you're getting that micro although the macro environment is always going to have an impact, it has less of an impact than when you're buying a portfolio of 100 fund interests that has, you know, 400 underlying companies and lots of different geographies and many different sectors.
- [23:54]
A
In our next episode, the spotlight is on North America. Senior editor Adam Lay is joined by Aries Edward Keith Dawson's Jan Rabad and Proscale's Christopher Robinson to discuss the evolution of the North American secondaries market, specifically covering off topics from single asset continuation funds to the constraint of capital, new entrant players, the market's increasing specialization and what volume could look like in the years to come. The production editor on this miniseries was Evie Rusman and our audio editor is Eric Fish. For links to the several articles we mentioned from Secondaries Investor in this episode. Be sure to check out the description or head straight to secondariesinvestor.com For PEI and secondaries investor, I'm Madeline Farman. Thanks for listening.