How can GPs hold on to golden assets while releasing liquidity to LPs that are already full up on secondary deals? More and more are finding the answer lies in minority reinvestments, with sources telling PE Hub Europe that they are even passing continuation funds in popularity.
Valuation mismatches and a torrid capital market background have hit dealmaking over the last 12 months. That includes exits, leaving sponsors keen to find new ways to give LPs liquidity. While continuation funds have often been the way to release cash while holding on to assets, minority reinvestments are muscling them out, Adam Creed, partner at international law firm Proskauer, told PE Hub Europe.
“There’s been more of these types of deals than there has been the continuation fund deal,” he said. “It’s something that’s relatively new in my experience.”
Proskauer advised financial data provider With Intelligence on its takeover by private equity firm Motive Partners, in which previous owner Intermediate Capital Group (ICG) retained a minority stake. It also advised ICG on its investment into ferry booking company Direct Ferries, from which Livingbridge made a full exit and realisation but made a new follow-on investment.
Part of the attraction of minority reinvestments is that they simplify the exit process as the buyer determines the valuation. With continuation funds, “there’s a potential conflict of interest” that often require a valuation report, said Creed’s fellow Proskauer partner Andrew Houghton.
Valuation mismatches between buyers and sellers – a more general problem for private equity over the last 12 months – has made the issue more acute.
“You can be uncertain on valuation because of the market dynamics at the moment,” said Houghton. “It just makes it a bit little bit trickier. So historically, before the downturn, there was a lot of continuation fund deals.”
The continuation fund model has in some ways become the victim of its own success over the last few years, said William Barrett, managing partner at Reach Capital, a GP advisory company headquartered in Paris.
“When you speak to a secondary buyer now, he’ll tell you, ‘I’ve done a number of single-asset secondaries’. When you look back at their mandate, they are supposed to deliver some diversification to their own LPs. We hear they need to slow down a bit on the GP-leds and especially on the single-assets because of a lack of diversification.”
LPs are also pushing back when it comes to fundraising, he added.
“A lot of LPs are saying very directly, ‘you want me to reup in fund IV, but your fund II is at 50-70dpi. Send me back another 30 percent then we can talk. It’s that straightforward now.”
But that same LP bullishness, concern over varying up assets and desire for private equity firms to earn their fees will likely place a cap on the popularity of minority reinvestments.
“GPs can say they know the company already, it’d be a pity to miss out on that growth, plus they are doing it for their LPs, which need the liquidity. But if you were to do that for half the fund, as an LP I’d certainly ask you to do something about the fees. Especially as if you had done a continuation fund, I’d have not paid 2 percent.”
Other sources, speaking off the record, expanded on the marketing point.
“You can say as a GP, ‘look, I can do every type of exit. I also deal with the likes of, say, KKR, and can ride their investment now,” said one investment banker.
KKR is just one of the private equity firms to use the minority reinvestment tactic lately. The New York-headquartered investor in mid-August agreed to sell a majority stake in A-Gas, a UK supplier and manager of refrigerant gases, to San Francisco private equity firm TPG’s climate investing strategy TPG Rise Climate.
The deal, which a source close to the matter said valued A-Gas at over £1 billion ($1.3 billion; €1.2 billion), also saw KKR retain a minority stake in the business, having first invested in it via its European Fund IV in 2017.
KKR believed that its work helping A-Gas strengthen its circular economy business model and expand its geographical footprint still had some value to offer, Mattia Caprioli, co-head of European private equity at KKR, told PE Hub Europe.
“Entering into the partnership with TPG Rise Climate created a significant monetisation event that enabled us to distribute sizeable returns to our investors whilst offering us further exposure to the structural trends that are driving the company’s success, and we look forward to support its future growth,” he added.
Freeing up liquidity has been front and centre of sponsors’ minds thanks in part to the valuation gap that Proskauer’s Houghton touched on, according to Sunaina Sinha Haldea, global head of the private capital advisory group at investment bank Raymond James.
“The headwinds resulting from the valuation gap between buyers and sellers and the rising cost of credit have slowed exit routes such as IPOs, trade sales and sponsor-to-sponsor secondary sales,” she told PE Hub Europe.
She pointed to figures from Bain & Company’s Private Equity Midyear Report 2023 that in the first half of the year, buyout-backed exits were 65 percent down on the period before, while on an annualised, based, exit value is tracking down 54 percent and exit count is off 30 percent compared to 2022.
“This has drastically slowed distributions to investors and the weak cumulative distributions over recent years have left LPs cashflow negative, leaving them struggling to make new commitments. GPs are thus increasingly turning to innovative liquidity solutions for their investors in the absence of traditional exit channels.
“Similarly, GPs have recently taken to exiting assets from their existing funds and reinvesting through the most recent vintage of their flagship fund.”