Evolving Structures in the Secondary Market
As the secondary market evolves, LPs and GPs alike are able to access a number of different types of transactions that were previously not common. The market for these alternative structures has become much more liquid in recent years as LPs become more comfortable with creative structuring to achieve certain objectives. On the GP side, these developments have created a whole new opportunity set of capital solutions and flexibility for different objectives. In this post, we will cover a basic overview of some of the more creative structures available in the market in case they fit your capital needs.
NAV-Based Loan: A NAV-based loan is a loan extended to a portfolio company which is guaranteed by the cash flows of the entire fund. This is typically flexible capital and can be used for several purposes. Most commonly, NAV-based loans are used late in the life of a fund. They can be used to provide a “dividend recap” to existing fund LPs – especially those you want to catalyze into a re-up or who may be fatigued from the lack of liquidity from the asset(s) in question. Alternatively, the capital can be used for growth initiatives at the company – a solid option for GPs that are out of their investment period but need additional capital to effect growth at the company. These loans are typically available at a low LTV ratio – in the 20-30% range – and yield significant cash proceeds. Furthermore, they are often available at a very low cost of capital which makes it even more attractive to GPs.
Preferred Equity Recapitalization: Another increasingly popular structure that is similar to a NAV-based loan is the preferred equity recapitalization. This transaction is a fund-level financing in which preferred equity senior to existing LP commitments is offered to new LPs, usually with a rollover option for existing LPs. Essentially, the fund establishes a more senior class of LP interests in the existing fund or in a new fund if the fund is being recapitalized. This transaction can also be paired with a solicitation to amend the LPA to modify the term, fees and any other fund terms, if necessary.
Strip Sale: A strip sale is another new structuring solution created to offer partial liquidity to LPs while still allowing the GP to hold the assets and continue growing them. In this transaction, the GP sells minority equity positions across a defined subset of portfolio companies while retaining control of the investments. The defined “strip” of the portfolio is sold to another SPV, managed by the GP and backed by a secondary buyer. This transaction has several advantages to all parties involved. As mentioned above, it offers partial liquidity to fatigued LPs while allowing the GP to retain control of the assets. Additionally, for deals that have already satisfied their preferred return, the partial realizations generate carry for the GP. Finally, it is a good way for GPs to diversify their LP base with the addition of one or several new LP(s).
The above transactions just scratch the surface of the vibrant private equity secondary market which is continuously evolving and creating new structures. Secondary transactions have always offered a liquidity option for LPs invested in private equity – the sustained innovation we are seeing in the market is a testament to the maturing of the private equity industry.