Navigating the Secondary Market: A Guide to Transaction Types

The secondary market offers a range of flexible solutions for both investors and fund managers in the private equity landscape. Here's a closer look at the most common types of secondary transactions:

1. Fund Restructuring

• Mechanism: In a fund restructuring, often referred to as a fund recapitalization, the General Partner (GP) strategically transfers assets from a mature fund into a newly established special purpose vehicle (SPV). This SPV, known as a continuation fund, operates under revised terms, including an extended lifespan and potentially adjusted economic arrangements. Limited Partners (LPs) are given the opportunity to either cash out by selling their existing interests or roll over their stake into the new vehicle.

• Ideal Scenario: Fund restructurings are particularly effective when a fund nearing the end of its life cycle still holds promising assets. This approach provides the GP with additional time and capital to maximize asset value before exiting while simultaneously offering liquidity options to LPs seeking an earlier exit.

• Potential Challenges: Securing a successful restructuring hinges on achieving mutually beneficial terms. If the proposed pricing doesn't resonate with LPs or fails to attract sufficient interest, the deal may falter. It's crucial to ensure the restructuring delivers value to all parties involved – the GP, LPs, and secondary buyers – rather than solely serving as a mechanism for the GP to reset fund economics.

• Illustrative Example: In a landmark 2018 transaction, Coller Capital and Goldman Sachs collaborated to facilitate a €2.5 billion restructuring of Nordic Capital's 2008 vintage fund. This complex deal involved transferring nine companies to a newly formed fund structure, granting the assets a five-year extension, and infusing fresh capital.

2. Tender Offer

• Mechanism: In a tender offer, the GP initiates an auction process to identify a secondary firm interested in acquiring a predetermined portion of LP interests in the fund. LPs are then given the choice to either sell their stake at the offered price or remain invested in the fund. While tender offers typically don't involve a complete reset of fund economics, they often include an extension of the fund's lifespan.

• Ideal Scenario: Tender offers are most successful when the GP or its advisor conducts a competitive process, ultimately securing a price attractive enough to motivate a significant number of LPs to sell.

• Potential Challenges: The lack of direct negotiation with LPs in a tender offer presents a challenge. Investors are limited to accepting or declining the presented offer, potentially creating a barrier if the price doesn't align with their expectations. If the deal fails to attract sufficient LP participation to reach a predetermined threshold, it may not proceed.

• Illustrative Example: In late 2018, Lexington Partners spearheaded a tender offer for TPG Capital's fifth and sixth Asia-focused funds. This strategic move also incorporated an element of fresh capital injection into TPG's seventh pan-regional fund.

3. Stapled Transaction

• Mechanism: A stapled transaction combines a secondary sale of existing fund interests (often through a recapitalization or tender offer) with a commitment to invest in a new fund managed by the same GP. This structure requires the secondary buyer to allocate new primary capital to the GP's subsequent fund, often positioning them as a cornerstone investor.

• Ideal Scenario: Stapled transactions offer a dual benefit. They can either inject momentum into a fundraising process that's struggling to gain traction or, conversely, leverage the appeal of a new fund offering to enhance the price offered in the secondary transaction.

• Potential Challenges: Stapled transactions necessitate careful management of potential conflicts of interest. The inherent connection between the secondary sale involving one set of investors and the new fund with a separate investor base demands transparency and careful alignment of interests.

• Illustrative Example: In 2017, Lexington Partners executed a notable stapled transaction, acquiring LP interests in BC Partners' ninth fund while simultaneously committing fresh capital to the European buyout firm's tenth fund. This combined investment and commitment totalled approximately $1 billion.

4. Whole or Partial Asset Sale

• Mechanism: In a whole or partial asset sale, a secondary firm acquires either a complete asset or a portion of an asset, typically one demonstrating strong performance. The acquired asset is then transferred to a continuation vehicle, providing it with extended time, additional capital, and the opportunity for continued growth and value creation. Like fund restructurings, the original GP often retains management responsibility for the asset within the new structure. LPs are presented with the option to either cash out or roll their proceeds into the continuation vehicle.

• Ideal Scenario: Single-asset or partial-asset deals are particularly well-suited for situations where a specific asset within a fund has performed well but requires more time to reach its full potential. This approach allows the GP to capitalize on the asset's future value appreciation.

• Potential Challenges: The success of asset-level transactions relies on the asset's quality and attractiveness. If the asset is perceived as high-quality, fewer LPs may be willing to part with their interests. Additionally, the pool of potential buyers for such concentrated transactions may be smaller due to the inherent risk of single-asset investments.

• Illustrative Example: In 2018, TDR Capital executed a strategic asset sale, transferring Stonegate Pubs, a well-performing asset held within TDR Capital II, to a dedicated continuation vehicle. Landmark Partners and Goldman Sachs backed this new vehicle.

5. Preferred Equity

• Mechanism: Preferred equity occupies a unique position in the capital structure, bridging the gap between debt and equity. GPs can leverage preferred equity to raise capital more flexibly than traditional bank debt, as it doesn't carry the same liabilities, strict terms, or covenants. This approach can be particularly appealing for GPs seeking to retain control and ownership of their assets while still accessing capital.

• Ideal Scenario: Preferred equity offers GPs a versatile solution. It can be used to secure additional capital for new investments within a fund, distribute liquidity to LPs, refinance existing debt, or bolster ongoing working capital requirements.

• Potential Challenges: If the preferred equity structure isn't carefully tailored to align with the timing of the portfolio's cash flows, it can become a relatively expensive source of capital.

• Illustrative Example: In 2017, Landmark Partners provided financing to Clearlake Capital, facilitating their acquisition of Reservoir Capital's stake in Clearlake's GP management company. This transaction highlights the use of preferred equity in a complex ownership restructuring within the private equity industry.

Conclusion:

The secondary market offers a diverse toolkit for optimizing private portfolios. By understanding the nuances of each transaction type, investors and fund managers can unlock liquidity, manage risk, and enhance returns in a dynamic market environment.

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