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A True Win-Win-Win-Win
A GP-led transaction is a deal in which the GP initiates a process to sell its interest in a fund. There are different types of GP-led transactions, but the most popular one is called a continuation fund. This occurs when the GP believes the portfolio needs more time to reach its full potential, but fund life limitations and LP desire for liquidity are at odds. In a case like this, a new (continuation) fund may be established to take over the assets of the old fund.
Continuation funds are an elegant solution that creates a win-win-win-win. That wasn't a mistype. As explained a bit further down, a continuation fund indeed has the potential to produce four winners: 1) existing LPs, 2) new LPs, 3) portfolio companies and 4) the GP.
The rise of secondaries, in numbers
If you're a loyal reader of The Sounding Line, chances are you're pretty plugged into the boom in secondary markets. But let's put some numbers behind that hunch, shall we?
Per Greenhill — a, if not THE, preeminent investor that specializes in complex / non-standard deals like GP-led transactions — the secondary market was over $60 billion in 2020. While this was down from a peak of $88 billion in 2019, let's not forget COVID. Expert consensus is forecasting a strong bounceback for 2021, with secondary volume topping $100 billion.
Here's the trend from 2012 to 2020, including the percentage that GP-led transactions comprise overall secondary transaction volume:
GP-led transactions: a true win-win-win-win
As you can see in the chart above, not only are secondaries booming. But that among this trend lies an important sub-trend: a meteoric rise in GP-led transactions as a percentage of overall secondary volume.
Why is this?
Winners #1 and #2: LPs, both existing and new
If you're an LP — whether existing (winner #1) or new to the fund (winner #2) — continuation funds offer an opportunity to: 1) avoid blind pool risk and 2) shorten an investment horizon. On the former point, return potential may not be quite as high as investing in a blind pool fund, but risk is certainly lower as the companies in a continuation fund are known entities. And on the latter, because companies in a continuation fund are relatively mature, investors looking for a quicker timeline than a typical 10-year fund are in luck.
Winner #3: portfolio companies
For portfolio companies (winner #3), a continuation fund also releases the pressure of returning capital to the GP. Capital that could continue to be used for growth. Furthermore, if they so choose, portfolio companies can benefit by raising more from the continuation fund to fuel continued growth.
Winner #4: the GP
As stated earlier, if you're the GP (winner #4), sometimes you just need more time for your portfolio companies to mature. And with the rise of growth equity, later-stage companies have plenty of funding options that don't require them to turn to the public markets. If a company chooses to go for growth equity versus IPO, oftentimes earlier investors are given the opportunity to liquidate their holdings. But what if the early investors see more potential in the company? What if they want to hold on without being beholden to the term of their original fund? This is where a continuation fund offers important optionality for the GP.
One fund. Four winners. Try and top that!
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