Private Equity Spotlight – "What’s making the GP-led market tick"

Date: April 26, 2023
Host: Madeline Farman (Senior Reporter, Secondaries Investor, PEI Group)
Guest: Adam Lay (Senior Editor, PEI Group)
Additional Expert Voices: Michael Hacker (Managing Director, Head of Portfolio Finance, AlpInvest Partners); Harold Hope (Partner, Head of Secondaries, Goldman Sachs)

Episode Overview

This episode dives into the evolving landscape of GP-led secondaries in private equity, analyzing insights from PEI’s March 2023 GP-led Secondaries Special Report. Madeline Farman and Adam Lay break down the three most pressing issues for LPs and GPs:

• The reality of “status quo options” for LPs in secondaries
• How leverage is being used in GP-led deals, and evolving attitudes
• The growing presence of non-traditional and primary capital on the buy side

The conversation features detailed commentary from leading industry voices and explores changes in market practices, investor motivations, and the implications for the secondaries market’s future.

Key Discussion Points & Insights

1. The Myth of the “True Status Quo Option” for LPs

[01:53 - 06:50]

What is a Status Quo Option?

• The term refers to the possibility for LPs to replicate their original investment terms when a GP launches a continuation fund.
• The language, while familiar, is increasingly misleading due to structural and economic shifts in the nature of GP-led secondaries.

Why Is It Elusive?

• Michael Hacker (AlpInvest) explains:

  "The concept of a true status quo option is misleading... transactions have gone from fund recaps... to today's continuation funds which are company oriented transactions with new capital." ([03:25])

• Dilution is a key issue: New money entering the vehicle influences existing LP economics. LPs are often asked if they want to put in more money, but participation varies widely.
• Fairness across all parties is difficult to achieve: Structuring continuation vehicles to exactly mirror the original fund is almost impossible.
• Terms have become more LP-friendly, evolving away from the earlier “second bite at carry” for GPs.
• The focus now is ensuring LPs don’t pay significantly more for the same investment experience.

Notable Quote – Michael Hacker, AlpInvest

"We need to figure out an economic package that's actually fair for everyone involved... what we're trying to do is find something that fits within the spirit of the status quo... this very sort of legalistic, is it exactly what the LPs had before? I think it's quite difficult to actually accomplish that." ([03:53])

Re-Evaluating the Meaning of Status Quo

• The status quo is now about economic alignment and fairness for all parties—LPs, new investors, and GPs—not about keeping everything exactly the same.
• Adam Lay’s summary:

  “The only real way to completely unchange anything in a deal ... is just not to do anything at all. Right. So what they're trying to do with these status quo options is to replicate as best as they can ... but there's no way that they can really keep 100% of the terms.” ([05:26])

2. Use of Leverage in GP-Led Secondaries

[06:50 - 15:05]

Market Practices & Data

• Use of leverage is increasing, but reliable market-wide data is scarce.
• Leverage is employed to:
  • Partially fund purchase prices
  • Provide post-closing support for portfolio growth
  • Defer capital calls on the continuation vehicle
• Pre-pandemic, LTVs at ~70% were common; now reduced to ~50% or less.
• LP resistance to leverage in continuation vehicles is waning, especially for short-term, defined-period facilities.

Quote from Report (Paraphrase by Adam Lay):

"Despite rising rates ... GPs are remaining thoughtful about the use of leverage... seeing lower loan to values, pushback still centers on alignment and proper rationale." ([08:30 - 09:53])

Goldman Sachs Perspective – Harold Hope

• Cautious about using leverage in concentrated, single-asset continuation vehicles.
• Rationales for leverage (if considered) must be clear – e.g., a truly under-levered company or a strong, actionable M&A strategy.
• Transparency and alignment are key: Avoid leverage merely to “juice the early IRR” for carry purposes.

Notable Quote – Harold Hope, Goldman Sachs

"The idea that we would buy a single company, put it in a continuation vehicle... and then put some additional leverage on top... is really not something that I think makes a lot of sense." ([10:15])

"We're super focused on situations like that because ... the intention [of carry hurdles] is really not that they’re going to be achieved through financial engineering, but rather ... through performance of the asset or assets." ([12:33])

AlpInvest Perspective – Michael Hacker

• Generally skeptical of leverage; questions whom it benefits in single-asset deals.
• Leverage can create market distortions, especially if it primarily advantages the GP (making it easier to hit performance targets for carry).
• Pushes for early, honest discussions with GPs about their motivation for using leverage.

Notable Quote – Michael Hacker, AlpInvest

"If the idea is... to optimize returns in order to hit the thresholds that you've agreed... I don't see that as something that we would buy into or we would do very often." ([13:33])

• Trend: Use of leverage for “financial engineering” has become less frequent as rising debt costs have reduced the incentive.

3. Rise of Non-Traditional and Primary Investors

[15:15 - 26:12]

Who Are These Players?

• Family offices, pension funds, sovereign wealth funds, and primary private equity managers entering as syndicate investors.
• Their involvement is primarily due to capacity constraints among traditional secondary buyers, especially for larger deals.

Notable Insights:

• Harold Hope (Goldman Sachs):

  "Transactions have gotten larger than what a single secondary buyer or even a consortium... can invest on their own. There's been a pretty active syndication market." ([16:31])

  • However, current market volatility is encouraging a shift to smaller- and mid-sized deals with a tight group of core buyers – less reliance on syndication for deal completion.

• Michael Hacker (AlpInvest):

  "The big acknowledgment when we say that there are these non-traditional players... it's really an acknowledgment that there is a lack of capital in those ... specific parts of the secondary market." ([18:37])

  • Market has seen a notable contraction in "dry powder" (available capital) – from 1.5-2 years of transaction volume down to roughly 9-12 months.

Will Non-Traditional Players Stay?

• Michael Hacker: Sees current participation as opportunistic and shaped by recent shifts rather than a permanent change.

  "I think it's not something that will necessarily persist for the long term." ([20:30])

• Harold Hope: Believes there is a long-term place for these investors, provided LP education catches up.

  "If they are good investments... I think the capital pools are going to develop to meet the demand." ([21:19])

4. Traditional PE Firms Entering the Secondaries Market

[21:50 - 26:12]

• Traditional buyout/private equity firms are increasingly launching their own secondary strategies to capitalize on market undercapitalization.
• Many managers see single-asset continuation deals as similar to direct M&A transactions, spurring interest in developing dedicated teams.

Notable Quotes:

• Harold Hope (Goldman Sachs):

  "There's almost a correlation between a private equity manager who does a continuation vehicle deal... and then afterwards feels like, gosh, maybe we should be in this business as well." ([22:26])

• Michael Hacker (AlpInvest):

  "The idea of an existing sort of buyout firm starting to play into the secondary market ... that's going to create some issues and friction with the GPs who are looking to raise a continuation fund..." ([24:41])

  • He predicts tension between traditional buyout approaches and the evolving best practices in the secondaries market.
  • Success for new entrants remains uncertain, especially in the face of well-established secondary specialists.

Memorable Moments & Quotes

• On status quo options:
  “The only real way to completely unchange anything... is just not to do anything at all.”
  – Adam Lay ([05:26])

• On leverage rationale:
  “...We're super focused on situations like that because ... the intention [of carry hurdles] is really not that they’re going to be achieved through financial engineering, but rather ... through performance of the asset or assets.”
  – Harold Hope ([12:33])

• On new entrants:
  "There's space in the market for everyone to throw their hat in the ring and try to figure out different ways. ... I would certainly not want to bet against innovation and change and new players coming into the space."
  – Michael Hacker ([24:41])

Segment Timestamps

• [01:15] – Selection of main discussion topics
• [01:53] – Introduction to the “status quo option” issue
• [03:25] – Michael Hacker explains status quo complications
• [06:50] – Leverage: data, trends, and sponsor perspectives
• [10:15] – Goldman Sachs on leverage in continuation vehicles
• [13:33] – AlpInvest on risks/motivations behind leverage
• [15:15] – Rise of non-traditional buyers and syndication dynamics
• [16:31] – Harold Hope on deal sizes and changing syndication market
• [18:37] – Michael Hacker on capital shortage and dry powder
• [20:30] – Will non-traditional investors persist?
• [21:19] – Education needed for wider non-traditional LP adoption
• [22:26] – Traditional PE managers moving into secondaries
• [24:41] – Market evolution and future outlook

Conclusion

This episode offers a nuanced, up-to-date view on the complexities shaping GP-led secondary transactions in private equity. It highlights how established concepts like the “status quo option” rarely mean what they once did, the cautious but necessary use of leverage, and the dynamic entry of new capital sources (with debate over their staying power). As the market matures, innovation and adaptation—by established and new players alike—will continue to reshape the possibilities and risks in GP-led secondaries.

For further reading, listeners are encouraged to consult the full GP-led Secondaries Special Report on PrivateEquityInternational.com and related coverage on SecondariesInvestor.com.