There has been a lot of recent coverage in peHUB about rising interest in the secondary market, and a rising interest of bankers looking to become secondary market intermediaries. Some have argued that what the market needs is more buyers and not more intermediaries, but there hasn’t been a lot of discussion of what intermediaries really do to earn their keep.
The secondary market is tremendously inefficient for a number of reasons, and secondary intermediaries are paid in part to navigate what are uncharted waters for most sellers. Limited Partnership Agreements are not standardized (Does it have a Right of First Refusal sales clause? Are commitments net or gross of management fees?), GPs approach their right to approve sales quite differently (some notoriously so) and, in a market such as we are in now, pricing seems to change daily. For a seller, achieving the best price isn’t simply a matter of ringing up the five largest secondary funds and asking for a price, but understanding in depth what they really have on their hands and where the strongest interest lies in the market
So, what specifically should an intermediary do?
Develop a sales strategy with the buyer. Given its familiarity with current market dynamics, the intermediary works with the seller to develop the most effective sales strategy to meet its objectives. In selling a portfolio, trade-offs often need to be made between such objectives as the certainty of a sale, confidentiality, timing of execution, and maintenance good relationships with the fund managers of positions being sold. During this process, a target also needs to be set as far as an acceptable sales price for the seller, and that price needs to properly reflect the current pricing dynamic in the secondary market. Key issues to be addressed:
What is to be sold? This is where the sellers needs and the marketability of a portfolio intersect. Different GPs and different types of funds trade differently. For example, funds of funds and secondary funds are notoriously difficult to sell, and unless a seller is planning to totally exit private equity holding those positions back usually makes sense. Funds that are not well known to the market and infrequently trade can be difficult to sell – though if run by a well known GP they could also have scarcity value.
How is it to be sold? Different buyers have different interests, and sellers need to cater to that. Especially with a large portfolio that might threaten to swamp the market is sold as a whole, it may be better to carve the portfolio up by sector (buyouts, VC, mezzanine, etc.) or geography (North America, Europe, etc.) into smaller, more digestible pieces that are easily presented to specificly-targeted groups of buyers. And achieving best pricing may require a roll out of positions for sale, allowing one portfolio to clear the market before the next one rolls out.
Piecemeal sales vs. portfolio sales. Certain investors hope to achieve the best possible price by selling the portfolio piecemeal, looking to attract strategic buyers willing to pay top price for individual positions. This strategy works best if the seller has flexibility, but not if their need is to sell the entire portfolio no matter what. Especially in a crowded market, their may be no bid for funds perceived to be weak, and in this case bundled portfolio pricing serves their strategic goal best.
What’s your reserve price, and are you likely to achieve it? An intermediary can be crucial in providing a range of market pricing in advance of an auction to give a seller a good idea of where a position or portfolio will trade. If their price expectations are vastly different from that of the market, often the best advice an intermediary can provide is not to go through the time, trouble and expense of a sales process at all, but to revisit the market at a latter date – or take a hard look as to whether the reserve price is too high and the market won’t be getting better soon.
Are you concerned about your relationship with GPs and access to future fund? Selling a partnership position or part of one, especially if it is part of a targeted portfolio rebalancing effort as opposed to a wholesale exit from private equity, may communicate the message to a GP that its efforts and the relationship are not valued. A seller seeking to maintain a relationship and future access to a fund being sold needs to proceed carefully and may need to take into consideration the GPs desires on the profile of potential buyers.
Targeting potential buyers with specific interest in the position being sold. A detailed knowledge of buyer appetite is necessary to maximize price for the seller. It’s easy to target the specialized secondary funds that have a broad interest in the market. Maximizing price, however, often requires targeting primary investors and funds-of-funds that may have the strongest interest in specific positions being offered for sale. Even in a market such as we are in now there are new LPs with money to invest that have an interest in building relationships with target GPs – finding them is key to the sales process.
Developing marketing material and running the sales process. The most time consuming aspect of an intermediary’s role is to develop the material to be used to market the sale, especially if it is a large portfolio, as well as running the sales process. Marketing material usually requires summary documentation on the positions for sale that are widely distributed to potential purchasers as well as more detailed information available through an on line data room. The auction process itself may be complex, requiring multiple pricing rounds.
Dealing with GPs to best effect. GPs are often the forgotten partner in a sales process. However, at the end of the day, they have the right to approve transfers and their willingness to provide up to date data during an auction can impel or impede a sales process. Developing a relationship before an auction has begun, understanding their motivations and dealing with such key items as “Right of First Refusal” clauses can have significant impact on both the sales process and any future relationship the seller might want to retain with a GP. An experienced intermediary can provide insight here that a seller may simply not be aware of.
And it’s not done until the paperwork is finished. The sales process itself covers not only running the auction on behalf of the seller, but also assisting in transferring the positions once sold – a process that can be long and time consuming depending upon how cooperative the underlying GPs are. In extreme cases, a seller may need to take alternative action such as executing a sale through a swap if a GP refuses to sign transfer authorizations.
As is clear from the above, intermediaries are paid for their experience in dealing with a complex and opaque market – and not because they have the phone numbers of Coller, Landmark and Lexington in their contact software.
Kelly DePonte is a partner with Probitas Partners, where he is responsible for the firm’s research and due diligence operations.