Solving the liquidity puzzle

November 29, 2023
This post is part of our 2023 Market Trends Report. Download the full report for more insights into how GPs are navigating the new GP-LP dynamics.

As a majority of respondents surveyed in our State of Fundraising report, fundraising in 2023 has faced some of the most difficult conditions in a decade. Alongside this, respondents reported that investor demand for liquidity has increased, pushing GPs to find creative solutions to meet it while hanging on to marquee assets.

Since the beginning of the COVID-19 pandemic, the macroeconomic environment has played an outsized role in the private capital markets. At the beginning of this period easy money policies reigned, which led to a boom in both private and public markets.

With inflation and the related interest rate hikes, weak IPO markets, and stock market uncertainty, private equity investors face a dynamic environment. Company valuations have changed dramatically, leading to uncertainty from both GPs and LPs as to what exit values should look like.

“The dynamics have shifted,” says Jeff Leathers, CEO and Co-Founder at Tap, a marketplace for secondaries trading. “As late as Q1 2022, almost every asset class was trading at par: 98%, 100%, some asset classes even trading at 103% on average. Those values have changed. Private equity is trading at 15% to 30% off its net asset values. Venture capital is generally trading at 50% off. Infrastructure is a little bit better. It’s anywhere from 5% to 15%.”

The traditional exit routes of M&A, buyouts, and IPOs have all become more difficult over the past year due to the intertwined issues of the rising cost of debt for acquiring companies and the difficulty of calculating valuations based on a volatile public market and fewer private transactions.

In the first nine months of the year, there were just 885 PE exits in the US worth a combined $182.9 billion, according to PitchBook’s Q3 2023 US PE Breakdown, putting the year on track for the lowest annual totals in a decade. The value of PE exits announced in Q3 fell 40.7% from the prior quarter to $44.1 billion, dashing hopes of longer-term recovery for PE liquidity as Q2’s boost in exit value proved short-lived.

With the depressed exit environment, fund managers are having difficulties returning capital to investors. Those investors then have challenges allocating to future funds or more productive asset classes, creating fundraising gridlock for GPs and frustration for LPs.

LPs have been hit with a double whammy as the denominator effect continues to be affected by public markets, while their PE programs call capital as normal with GPs taking advantage of lower valuations. “Exits are down but the capital calls keep coming relentlessly,” says Jeff. “Of course, everyone wants to deploy right now when the prices are low. There will be more contributions than distributions, so you need to find that capital somewhere.”

While short-term liquidity is generally challenging for LPs in private markets due to the 10+ year lockup of most PE funds, an influx of retail investors has created new dynamics. When Blackstone met with significant redemptions in two groundbreaking retail funds last year, it highlighted the complexity of managing a large group of investors with very different liquidity expectations than the institutional investors PE firms are used to.

PE firms are increasingly looking to find creative ways to redistribute capital to their LPs. GP-led secondaries and continuation funds have emerged as a way to meet LPs’ liquidity demands, hold onto promising assets while exit routes recover, and attract new LPs.

Several new funds have been raised this year to capitalize on the opportunity, including a Glendower Capital $5.8 billion vehicle and Goldman Sachs’ $15 billion fundraise for private market secondaries strategies.

Swedish PE giant EQT is planning to conduct private stock sales for its portfolio companies in order to provide liquidity to its LPs, according to the Financial Times. The proposal would see the firm hire an investment bank to find interested parties on both the buy and sell side, with said bank then leading negotiations on valuations. The strategy appears to share similarities with continuation funds and is indicative of the intensifying hunt for liquidity on the part of PE firms.

“Continuation vehicles allow a GP to put certain portfolio companies into an SPV and give their LPs the option to either take shares in the SPV or take liquidity from a secondaries fund who will buy them out,” says Jeff. “These have become popular because they allow the GP to show distributions while still holding onto a marquee asset.”

GP-led deals account for around 35% of deal flow in the first half of 2023 with about $50 billion of activity, according to PJT Park Hill’s half-year secondaries volume survey.

While some have historically viewed GP-led transactions as a way for under performing managers to extend the life of their franchise, these deals have evolved substantially and are now broadly embraced by leading GPs as a flexible means to hold on to key top-performing assets—giving them further runway and capital to generate additional value, while also directly addressing the liquidity needs of existing LPs.

After years of fruitful exit markets, it’s impressive to see the ingenuity of the private equity market as it tries to solve the issue of liquidity. The secondaries market has proved its worth in the current crunch. Its participants now need to bank on interest carrying through in the form of commitments into the next cycle once overallocation concerns have subsided.

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