There is a familiar arc in private markets innovation. A sharp mind comes up with something useful, it gets used, it gets abused, an industry debate ensues and then finally best practice is hit upon.
Subscription credit lines are a case in point. They existed for decades, but once someone noticed that cheap credit could be used to boost IRRs, then that is exactly what happened (in some quarters at least). Accusations of trickery were thrown around. Then the debate was brought into the open; investors and consultants started crunching data and forming opinions. Finally, the Institutional Limited Partners Association gathered views to institute some guidelines. Sure, they won’t be adhered to by every GP, but they provide a prompt for LPs to start a proper discussion with their managers.
So it goes also for GP-led secondaries processes. More than once in the last couple of years, our newsroom phones have rung with the sound of disgruntled investors wanting us to shine light on a process that has left them feeling rail-roaded or short-changed. Some took issue with the short timeframe they were given to make a decision (which for some would not coincide with a vital investment committee meeting), while others complained of the costs of the process or “arrogance” in the way it is put to investors.
But now we are into the next phase. In April, ILPA released a set of guidelines to give GPs and LPs a roadmap for how these deals should progress. This can only be a good thing. Done well, these deals are a truly elegant way to solve two shortcomings of the private equity model: illiquidity and time constraints. The more they proliferate – and the more that best practice is shared – the healthier the industry will be. We sought to do just that in our recent Deep Dive.
So what is the next innovation to go through the arc? My bet: preferred equity. This addition to the financial engineer’s toolkit is gaining in popularity. To quote Travers Smith lawyer Ed Ford, “most LPs have not yet fully formed their views on preferred equity […] and when they do, LPs will not all be in agreement, so there will always be a degree of conflict.” Interested parties should prepare for the debate.