Trends Watch: Investing in GP-Led Secondaries

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.  

This week, Elana talks with Paul Cohn, Managing Partner, Tail End Capital Partners.  

What is your outlook for investing in GP-led secondary opportunities?

The general partner (GP)-led secondary market has fundamentally changed over the ~15 years I’ve been involved with it. Today, GPs recognize they can use the GP-led secondary structure to extend the life of their best investments in order to maximize long-term value while giving liquidity with an attractive return to their current investors/LPs. These investments are usually three-to-five-years-old and they have been de-risked with the early heavy lifting of the GP where generally the C-suite has been built, growth levers have been identified, systems are in place and an acquisition template has been established, etc. The company is performing well and just needs to continue to execute the game plan established. A GP-led transaction provides new dry powder and an extended timeline to maximize value.  Why sell a great company if you think it still has room to grow?

From an investor perspective, it is a very attractive opportunity. 

This GP-led market has grown from a $14 billion market in 2017 to a $52 billion market in 2022. The market, like most, is developing from the top down with many large private equity (PE) firms jumping in first. The market in growing GP-led secondaries is being recognized as a mainstream alternative to M&A. In the last couple years, numerous middle market investment banks have added GP-led focused teams to complement their M&A teams. GP-led secondaries are at the early stages of penetrating the middle market and lower middle market firms and the independent sponsor market is in relative virgin territory. The GP-led secondary market is expected to grow substantially over the next decade.   

Where do you see the greatest opportunities and why? 

Our focus is on opportunities to work with GPs of lower middle market PE/buyout funds including independent sponsors (GPs who raise capital on a deal-by-deal basis). This is the fastest growing segment of the market. The lower middle market, in general, is more attractive in terms of valuation and terms and this extends to the GP-led secondary market. Today there is a shortage of capital to address the opportunities in the market. We see an emerging opportunity to bring the GP-led secondary into the independent sponsor market. Independent sponsors don’t have a pool of committed capital to pull from for their investments. The GP-led secondary offers them the opportunity to give investors liquidity and get more capital for the company bringing with it more opportunity to generate carried interest. We think this is a very compelling opportunity for independent sponsors.

What are the greatest challenges you face and why?

Most GP-led transactions are closed with a syndicate of investors. We generally lead the syndicate but there is currently a shortage of capital to fund GP-led transactions. We need to be sure that each investment we make is attractive enough to build a syndicate. This is in terms of pricing, structure, and company quality. Our screen is very tight on the deals we will do as we don’t want to spend time on a deal that can’t close due to the inability to build a syndicate. On the positive side this is driving a very tight investment discipline where only the best of the best opportunities are pursued.

What keeps you up at night? 

Our transactions are nicely de-risked due to how we get into the transaction but, as with any investment, there are always external factors that you can’t control. We look to minimize risk factors via our ability to see the GP/company execution in the rear-view mirror. We have very disciplined risk-mitigating underwriting too, so that we don’t take risks such as regulatory risk, reimbursement risk, customer concentration risks, etc.  But there can certainly be risks we can’t totally eliminate such as recession risk. While we look to invest in companies that can mitigate recession risk, we can’t eliminate it. The external risks we can’t control are the ones that keep me up at night.

Additionally, fundraising keeps me up. We are marketing a niche strategy (GP-leds) that a lot of institutional investors don’t have a “bucket” for, which makes capital raising a challenge.

The views and opinions expressed above are of the interviewee only, and do not/are not intended to reflect the views of EisnerAmper.