The use of leverage in GP-led deals is becoming the norm, having been very much the exception only two years ago, research has found.
Featuring in Investec’s Annual Secondaries Report 2022, Francesca Paveri, a senior managing director in Evercore’s private funds group, said leverage use is now discussed at the outset of every process the adviser brings to market.
“The space is experiencing a similar evolution to what we saw for both capital call facilities for direct funds and recapitalizations or NAV financing for more mature funds,” she said, adding that the proportion of GP-led deals that use leverage could be higher than 50 percent.
The lender’s survey of secondaries buyers found subscription credit lines are the most commonly used form of financing on GP-led deals, with 62 percent of respondents having used one. The typical loan-to-value ratio of these facilities is 30-40 percent.
Ten percent of respondents have made use of hybrid facilities, which typically allow the buyer to borrow against undrawn commitments as well as the portfolio itself.
The most common reasons for using leverage are as a bridge to an exit or to the refinancing of underlying portfolio companies, according to Investec’s head of secondaries, Ian Wiese.
For example, a continuation fund might comprise three top-performing companies and one lower quality asset that is set to be sold in the near term. Instead of taking equity from the secondaries fund and triggering the clock on carry, the GP can use a credit line.
Growing competition in the GP-led market and the fact that many secondaries firms are in or returning to market also makes leverage attractive from a returns standpoint.
“You’ve got arguments around the optimal use of equity, economic enhancement and at the end of the day, from the GP’s perspective, if you have a line at continuation vehicle level, the initial cash requirement is less,” said Wiese.
This year has seen a shift in the dynamics of the GP-led market, Investec’s survey found. Fifty-nine percent of secondaries buyers believe current levels of GP-led activity will remain the same in the next 12 months, with 28 percent expecting a slight increase.
A lack of available capital to back GP-led deals, differing views on pricing in the changed economic environment and a lack of pressure among buyers to put capital to work are contributing factors, Investec found.
“If you look at the LP side of the secondary business, a lot of people are sitting on their hands and waiting. There are buyers saying, ‘I’ll do this but the discount I’m going to offer is going to be wider than a couple of months ago’. You see it on continuation vehicles, as well. Things are taking longer, and the buyers have definitely got a bit more negotiation power,” said Wiese.