GP-Led Secondaries: From Uncommon to Conventional
A Conversation with Amir Malayery and Lindsay Sharma at Industry Ventures and Bronwyn Bailey at First Republic Bank
First Republic recently had the opportunity to discuss the secondary market, and specifically GP-led secondaries, with Amir Malayery and Lindsay Sharma, Managing Directors at Industry Ventures. While Lindsay focuses on small tech buyout deals and Amir makes venture secondary investments, both are optimistic that GP-led secondaries will offer limited partners (LPs) and general partners (GPs) the liquidity options needed in today’s volatile environment.
This article is an excerpt of the discussion Bronwyn Bailey, Managing Director, First Republic Bank, had with Amir and Lindsay, drawing on their views of the current investment environment, as well as their firm’s two decades of innovating in the dynamic secondaries market.
Bronwyn: Let’s set the stage. GP-led secondaries have experienced tremendous growth in the past decade. In 2021, these transactions surpassed the volume of LP-led transactions and are expected to make up an estimated 42% of the forecasted $120 billion-plus in secondary transaction volume in 2022, almost double from 24% in 2017. No longer stigmatized as a type of last-resort financing, today “GP-leds” have become conventional transaction structures that unlock more investment opportunities for GPs, LPs and portfolio companies. Walk us through the history of how GP-led deals have become so popular.
Lindsay: GP-led secondaries are part of the natural evolution of the secondary environment, which has been highly innovative in terms of identifying new structures and approaches to gain access to attractive companies. In the construct of a GP-led secondary, the benefit is that you are effectively presenting LPs the opportunity to either exit and gain liquidity or choose to stay on for the ride over the next couple of years and potentially benefit from incremental upside. At larger buyout funds, a lot of activity has been driven by challenges faced at the end of a 10-year life fund when companies within a GP’s portfolio still have meaningful value. A GP may want to continue to hold certain “trophy assets” given their high quality. At the smaller end of the tech buyout market where Industry Ventures focuses, GPs may be driven to the structures by lack of capital to continue to scale their companies. Raising a single-asset continuation vehicle, as one GP-led option, enables a GP to further finance a roll-up strategy prior to a later liquidity event. LPs like Industry Ventures love it because we can get more concentrated exposure to top performing companies at reduced economics. And GPs love it because it allows them to continue pursuing add-ons and have additional time to capture greater upside.
AMIR MALAYERY
MANAGING DIRECTOR
INDUSTRY VENTURES
Bronwyn: What is the role of Industry Ventures in this investment segment?
Amir: Industry Ventures is a potential buyer in a GP-led secondary investment: We source, underwrite, structure and fund these transactions. We work with GPs of tail-end or earlier funds to provide liquidity for their investors. Through our hybrid venture fund of funds (FoFs) and hybrid tech buyout FoFs, Industry Ventures also gains a valuable perspective as an LP ourself and by taking seats on limited partner advisory committees (LPACs). Altogether, this gives us a unique view on both the buy and sell side and greater ability to think about best practices that will benefit all parties.
Exhibit 1: Annual Secondary Transaction Volume ($B) and Annual GP-Led Share
Source: 1H 2022 Global Secondary Market Review, Jefferies LLC, July 2022
Bronwyn: What have been the key drivers of the demand for GP-led secondaries? Will growth continue, or are there factors that may impede it?
Amir: I think one of the key drivers behind secondaries broadly and GP-leds is that high-quality businesses are taking a longer time to gestate and mature; thus,companies remain private for longer. For example, the average time to IPO has increased from 7–8 years in the 1980s and 1990s to 12 years in 2021. This has increased stakeholder demand for liquidity on the company’s path to an exit. At the same time, GPs understand that there are important LP relation benefits in providing liquidity, especially prior to a fundraise.
GP-led deal structures benefit multiple parties and stakeholders across the ecosystem because, ultimately, they do not have to be forced upon anyone. Instead, they allow for optionality, and each party makes their own decision on what makes sense for them. When done right, these deals are about structuring win-win-win transactions that resolve multiple issues for LPs, GPs and portfolio companies. The more the market has created structures that provide mutual benefits rather than zero-sum games, the less resistance there has been and, therefore, the more growth in these secondary transactions.
Lindsay: In the current market, IPOs are grinding to a halt, and strategic acquisitions are starting to slow, so we are about to find out how this affects the growth in GP-leds. With limited prospects for liquidity through IPOs and M&A, what will LPs do when there are opportunities to exit through continuation funds? Will they choose to exit or roll over their positions? It will be interesting to see how this plays out and whether it impacts the near-term growth in GP-leds.
Bronwyn: You mentioned exit conditions as a risk to secondaries’ growth. Are there other perceived risks that could disrupt GP-led secondaries?
Amir: The potential for conflicts of interest is often a risk. However, the Institutional Limited Partners Association (ILPA) has done a great job providing GP-led best practices and making themselves a resource to help GPs navigate transactions that could be perceived as having potential conflicts. A lot of this comes down to disclosure. This is especially true around the economics in new continuation vehicles and making sure GPs give ample time for LPs to analyze transaction details.
If a GP doesn’t take a best practice approach, their reputation can be damaged. New buyers will not want to work with GPs who are too aggressive or too self-interested. Having an experienced buyer walk through the process to make sure GPs are cognizant of regulatory restrictions and reputational considerations is an important safeguard.Lindsay: I would just underline what Amir highlighted — that GPs need to be cognizant of any apparent conflict of interest in these types of structures. GPs are motivated to maintain strong LP relationships, which encourages them to manage these conflicts. As a GP you want to be mindful of balancing the goals of the GP-led secondary with how it is received among existing LPs.
Bronwyn: How are higher interest rates and declining valuations impacting GP-led secondaries? Are changes in asset valuations creating friction to completing deals?
Lindsay: Across the ecosystem, rising interest rates have the potential to chill the overall deal market. But as it relates to the small end of the buyout market where we focus, most of the companies are not of a substantial scale to take on meaningful debt. Thus, they are less impacted by interest rate gyrations.
Amir: In venture today, there is a big discrepancy between implied fair market value of last round prices and the mark-to-market basis of companies. The gap between buyer and seller expectations has created friction to complete deals. Buyers are thinking about today and tomorrow, not yesterday. We may apply single-digit revenue multiples on software businesses, for example, as opposed to high double-digit multiples reflective of last year — and that may cause a disconnect between what has been reported so far on capital account statements.
Exhibit 2: H1 2022 Key Statistics
Source: 1H 2022 Global Secondary Market Review, Jefferies LLC, July 2022
Bronwyn: What are the benefits for both GPs, LPs and portfolio companies in GP-led transactions?
Amir: There are several benefits from the GP’s perspective, including the ability to unlock a new path to liquidity, to strengthen existing LP relationships and to forge new relationships with investors who weren’t around at their fund’s inception but may want to join the partnership through a secondary transaction. Depending on the structure of the transaction approach, a GP-led deal may also allow a GP’s economics to be reset. They may want to crystallize some of their carry and reinvest it into their GP commitment for a new fund, or there may have been changes in the partnership team and thus a need to realign economics.
From the LP’s perspective, they are given an option for liquidity when there may not have been a natural exit path. And depending on the transaction type, they can decide to roll over some or all their position to retain some or no upside depending on their needs and risk appetite.
There is also a benefit for portfolio companies. These companies may be a few years away from an IPO or a strategic sale and just need a little more time without the pressure that may come from a tail-end fund.
Lindsay: I think it’s worth emphasizing the potential benefits for new LPs — investors that didn’t participate in the existing investment or fund but may now be able to get exposure to a new manager and what are often trophy assets, at reduced economics. At the same time, this can be highly beneficial to the GP because it helps them expand their base of LP relationships.
Bronwyn: What should GPs consider before embarking on secondary transactions?
Amir: I think the most important thing GPs need to do is start with an honest look in the mirror and ask — what are we truly trying to get done? The answer should inform what is the most efficient path for them to take. Some of these structures may involve transferring assets, which will require coordinating with company management teams. In others, the assets can stay in the existing fund, while membership interests are transferred, with less coordination with the portfolio. The level of involvement GPs want to have related to their portfolio is also a big factor in selecting the most efficient or appropriate structure for their GP-led secondary transaction.
Two other important factors are whether a GP is looking to reset economics and if they have the bandwidth internally to go down the GP-led path. You need to make sure that you have the time and attention to successfully shepherd the transaction from start to finish. In addition, having a good pulse on your LPs is critical. A more concentrated versus fragmented LP base and whether LPs are looking for liquidity or are happy and content may influence the path you take. As a GP, you need to think through all these factors and figure out what strategy will accomplish your goals.
LINDSAY SHARMA
MANAGING DIRECTOR INDUSTRY VENTURES
Bronwyn: As a buyer of GP-led secondaries, how do you approach these opportunities? Is your deal flow based on relationships with top GPs, or do you take a more opportunistic approach?
Lindsay: We pride ourselves on our creativity in structuring deals. That means working collaboratively with GPs to understand what they are trying to solve and what we are trying to do, which is gain access to great assets. And then figuring out if we can structure a deal that makes sense for all parties involved. As a firm, we are not only creative, but we are also deliberate about the companies that we want to seek additional exposure to.
Amir: Our deal flow is based both on our relationships as well as opportunities that may arise when you have been in as many funds as Industry Ventures has and a GP asks you for your perspective about a potential transaction. This is where our 20-plus years of relationships and experience translate into the trust that GPs and LPs know we’re going to do what we say we’ll do and be a reliable provider of long-term capital.
Exhibit 3: Types of GP-Led Secondary Transactions
The table below provides a summary of the most common deal situations Industry Ventures has encountered, which often catalyze GP-led secondary transactions.
Bronwyn: What areas of secondary opportunities are you excited about today?
Amir: We are excited to have a secondary fund in today’s environment because there are so many different types of opportunities across companies and funds, LPs and GPs, and nontraditional venture investors that wished they sold last year or were expecting to get liquidity this year. But exits are not happening today — especially not through tech public offerings. There is an estimated $4 trillion of private market cap value that is locked in private funds. So it’s great to be able to unlock liquidity through multi-asset continuation vehicles, single-asset vehicles, LP tenders — through these different structures that allow us to act as a pressure release valve for investors without being a distraction to the companies.
Lindsay: It’s been a fantastic environment for add-ons at the small end of the buyout market over the course of the year, and I think it will continue. We are confident that Industry Ventures is uniquely positioned to lean into this environment to structure deals that enable portfolio companies to continue to scale their businesses — capturing more value over a longer horizon. These are indeed exciting times to be structuring GP-led secondary deals.
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