After a scorching market in 2021, the hottest topic in the private asset world is GP-led transactions. While these deals come with their challenges, many managers have tested the waters or are considering doing so. Clearlake Capital, a private equity manager with $50 billion in AUM, has closed or launched five single-asset deals in the past year. Another deal, the largest in market history, has CD&R raising $3 billion in a single-asset vehicle for Belron.
For sellers however, as a fiduciary, one of the greatest challenges in any GP-led transaction is establishing the price – these are affiliated transactions with buyers and sellers coming into an entity controlled by the same general partner. From a buyer’s perspective, any sales process is just like the classic game show “The Price is Right,” trying to get closest to the right price without going over (and thus giving up potential return). This creates an inherent conflict that can only be discharged through a competitive process.
The continuation vehicle deal technology has been tested and validated by the market, but each process still must be carefully managed. We’ve worked with several GPs who have received unsolicited offers from secondaries buyers but still had to run independent process to determine full and fair price discovery. Without a process, there is no competitive market tension and no way to ascertain if the offer is the best for your LPs. Prioritizing ease and speed over completeness can create a meaningful conflict of interest for a GP, which can be compounded if the sponsor is optimizing for its own terms or for a new primary fund commitment, as both of these can lower the price offered.
So, what is the best practice for a GP to discharge this conflict of interest and ensure best pricing? Taking the example of a single-asset continuation vehicle (though these methods could work for other transaction types), there are three commonly used mechanisms for setting a price.
First, a minority recapitalization. By leveraging the M&A market, a GP can sell a minority stake to a new investor. This provides immediate and early liquidity to investors and an objective market price that can be used for a GP-led transaction. While this method may take more time due to its back-to-back processes (first M&A and then secondary), it ultimately will reduce any conflicts and provide a third-party validated mark.
Next, a secondary process. Most secondary processes do not have an external third-party mark-to-price, so the market relies on the secondaries buyers to set the price. This starts with setting a reference date for the net asset value of the portfolio. Then buyers will generally perform two rounds of diligence, albeit with less granularity than in an M&A process. The transaction will price at par or a discount or a premium to par. In this method, the secondaries phase will generally take longer but this also allows for full price discovery to discharge conflicts of interest.
Finally, the GP sets the valuation up front. This can be done off a recent transaction (ie, funding round) or at a market price the GP believe is fair. Of course, secondaries buyers will need to get comfort and diligence the price. Oftentimes GPs who choose this path will also get a fairness opinion to validate the pricing. This is the least favored method of pricing for market participants.
The key to each of these methods is that they offer a means to discharge any conflict of interest. The relevant Limited Partners Advisory Committee(s) (LPACs) will review and be the ultimate determiners as to whether the process passes muster. It’s been our experience that processes are seldom rejected by an LPAC when there has been clear evidence of price discovery.
It’s clear that the secondary market can be a potent tool in a GP’s tool chest. There’s a myriad of economic, relationship and prestige benefits that these transactions can bring, and its usefulness will be augmented if we see less favorable market conditions return. Despite these benefits, like any expedition, careful and thoughtful planning is required – which is why so many GPs retain an adviser for these processes. A thoughtful and experienced adviser can help guide you on the nuances of your transaction and avoid things getting blown off course.
Sunaina Sinha Haldea is global head of private capital advisory at Raymond James