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A RopesTalk podcast series from Ropes & Gray’s sponsor solutions group focused on issues that matter most to private equity sponsors.
Deb Lussier: Hi, and welcome back to our podcast, A Word for Our Sponsors, where we talk with industry leaders about the issues that matter most to private equity sponsors. I’m Deb Lussier, co-leader of Ropes & Gray’s sponsor solutions practice, and I’m joined once again on the podcast by my colleague Marc Migliazzo. Marc, thanks for joining again.
Marc Migliazzo: Thanks very much, Deb. I’m glad to be back.
Deb Lussier: On this episode, we’re thrilled to be joined by Darren O’Brien, who focuses on GP-led secondaries, and Chirag Shah, who covers GP and LP relationships, as senior leaders of Campbell Lutyens’s secondary advisory team. Darren, Chirag, we’re really happy to have you.
Darren O’Brien: Thanks, Deb and Marc. It’s really great to be here and talk about some of what we’re seeing in the GP-led secondaries market, especially from the perspectives of limited partners (“LPs”), general partners (“GPs”), and secondary investors.
Deb Lussier: Before we dive into the substance of today’s podcast, Darren, will you quickly share with our listeners a little bit of background on Campbell Lutyens and, in particular, its secondary advisory team?
Darren O’Brien: Campbell Lutyens is one of the largest private capital advisory firms. We’ve been advising on secondary transactions for more than 24 years, and over that time period, we’ve advised on $150 billion in transaction volume. We’re not an investment bank, which makes us unique. We’re also employee owned, so we’re really focused on enhancing GP relationships, helping them grow assets under management (“AUM”), and then helping LPs and GPs form meaningful long-term relationships that are durable and sustainable, and that’s how we look at secondaries transactions. With that background, Chirag recently joined us from a very large and influential LP and helps give us a really good perspective—and our clients a very valuable perspective—as far as how LPs look at secondary transactions, some of the hot points, and some of the things that they’re worried about. And so, with the survey and Chirag’s background, we think it’s a really exciting way to look at and understand the market.
Marc Migliazzo: Thanks, Darren. You have a unique position in the market. Can you share your observations—what you’re seeing in the secondaries market these days?
Darren O’Brien: Yes. The secondaries market has grown dramatically. It’s gone from about $20 billion of volume almost 10 years ago. In 2023, it was $111 billion in transaction volume. We think 2024, we’re going to be much north of $135 billion, so that would be the all-time record. A big part of the growth has been GPs initiating transactions to provide optional liquidity to their LPs—we call that “GP-led transactions”—that part of the market is probably going to be about $60 billion in 2024. The biggest part of the market is continuation funds. As the market has evolved, as continuation funds have developed, there’s been a lot of change and evolution. We really spend our time in the market talking to GPs, talking to LPs, and talking to investors, and trying to make sure that the market, the Institutional Limited Partners Association (“ILPA”), and its participants are really doing transactions in the right way and thinking about the market holistically. It’s a really exciting market to be a part of—it’s a very dynamic and a very growing market.
Deb Lussier: Darren, we agree. We often say here at Ropes & Gray that the GP-led secondaries market is entering its 2.0 stage. Where the first continuation funds might have been done out of so-called zombie funds, clearly now, the preponderance of these are being done with prize assets, trophy assets, or gem assets. And they’re being done not only to provide LPs with liquidity but also for a host of other reasons that we’ll get into later in the podcast.
Darren O’Brien: Absolutely—and just to build on that, we really see the continuation fund market as centered around trophy assets and sponsors that have these great, long-term, compounding assets that can continue to grow and deliver value. But LPs have a wide variety of needs and desires, and sometimes, LPs are internal rate of return (“IRR”) driven; sometimes, they’re multiple on invested capital (“MOIC”) driven. Funds have constraints as far as terms and ability to invest additional capital, and so, continuation funds, to us, they’re really about alignment. How do you get a GP and LPs all aligned for the next chapter of growth and provide the runway and the capital that’s required to maximize the value of an asset? We don’t necessarily see the market as competitive with M&A, and we also see it as a market where GPs shouldn’t put every asset into continuation funds. We think there’s a healthy mix of regular way exits, but there’s assets that are just really scarce, incredible assets that are really good candidates for continuation funds, so it’s a much healthier market, as you point out, Deb.
Chirag Shah: Darren, just to add to that, I think the opportunity set is pretty wide. You have obviously a lot of the top-50 GPs that have executed continuation vehicles (“CVs”) the last few years, but you’re seeing more mainstream adoption from lower- middle-market to traditional middle-market firms. So, I think you’re going to see wider acceptance over time as long as some of these principles, Darren, that you’ve talked about earlier, will be adhered to.
Marc Migliazzo: Turning our attention to the survey, Campbell Lutyens and Ropes & Gray recently conducted the survey earlier this year to gather the perceptions of LPs, GPs, and secondary buyers on the current state of play. The survey was focused on North American private equity GP-led secondaries, and collectively, we gathered responses from over 70 firms. Chirag, you’ve had a chance to study the data—what was your reaction to it?
Chirag Shah: My main takeaway was that engagement prior to the Limited Partner Advisory Committee (“LPAC”) approval process is increasingly key and ensures success. While 61% of LPs that responded mentioned early consultation with LPs or LPACs was paramount, only 29% of the GPs said that they consulted LPs at the exploratory phase. Therefore, we believe there’s an opportunity, given the wide gap here.
Marc Migliazzo: I think that is one of the more interesting items that came out of the survey. Darren, turning away from the survey for a moment, when you look ahead to 2025 and beyond, what trends do you see developing in the GP-led secondaries area?
Darren O’Brien: We’re seeing GPs use CVs broadly and adopting them as a really important portfolio management tool. As the M&A market has grown more nuanced, as interest rates have risen, and as the IPO market has had extended periods of being closed, we’ve seen GPs use the market as a way to provide liquidity without having to sell their best assets early, and that adoption is really becoming widespread. The other thing that we’re seeing is that private equity is entering a more mature phase, and it is not growing as fast as it may have grown over the last 20 to 30 years. We think CVs will be an important tool for GPs to help motivate and retain talented investment professionals, reward them for future value creation, and really help grow AUM around their best assets and provide capital to fuel that growth. So, it’s a really great product for GPs if they’re thoughtful and if they take into account how their LPs think about these transactions.
Chirag Shah: Yes, I think education of LPs is really important—not just at the most senior levels—across the team. You’re certainly seeing more LPs looking to invest in single-asset CVs given this is some of the trophy assets that Darren mentioned earlier. So, if GPs want to hold on to their best assets for longer, CVs are going to be a big tool to do so, and LPs want to maintain exposure to their top GP’s best deals. I think alignment of interest is really important. Getting a process set up for LPs is also very important. You also have a bunch of direct buyout funds—some blue-chip names in the top 50. And then, you also have some middle-market funds that are looking at strategies to invest in CV transactions—separate fund strategies—but they’re also investing in CVs from their flagship funds as well. So, I think you’re seeing a broad array of ways that LPs and GPs are looking to play the CV market.
Marc Migliazzo: LPs are learning more and becoming a lot more educated about these as they see more and more come across their desks, just as, by virtue of the fact they’re LPs in the funds that are doing these transactions. We’re definitely seeing both of those trends that you referred to, Chirag, and recently, we’ve even seen some endowments explore taking on the role of lead investor in some of these secondary transactions.
Deb Lussier: Chirag, it’s always been a curiosity to me that only about 10% or so of limited partners in the existing fund roll over into the continuation fund. We speculate that that’s for any number of reasons, whether it’s the need for liquidity, or the relatively short time frame (20 business days typically) to evaluate a continuation fund opportunity, or simply not having the resources or really desire to underwrite a single asset, which many of these continuation funds are. Since you were, before joining Campbell Lutyens, at a limited partner, can you talk a little bit about the view of an LP for these continuation funds and if any one of the reasons I mentioned played a role in whether your shop or others like you didn’t participate in continuation funds?
Chirag Shah: Yes, I think that’s a very important point, and I would say all of the above is true. Every LP, as folks know who are listening to this, is different—you have different types of LPs that have different setups and team sizes. The way that I looked at CVs over the years at various institutions, especially the last five years as things have really developed in the CV space, is single-asset CVs, you have to almost treat them like co-investments. And so, what happens is a lot of these deals fall in no man’s land, where you have a separate funds team, a separate co-invest team, and I think those areas are being addressed today for some of those larger platforms that will be really important to further adopt this technology for GPs and LPs if it’s really going to take off to the next two levels that I think it can.
The other thing related to this is if you have LPs that have a combined funds and co-invest effort, I think then that makes it a little bit easier, because you see everything in one deal flow, one deal funnel. The education of LPs is really important, and it starts well before the 20-business-day heads up. I think this is where that communication by GPs with LPs—why they’re doing this, why not sell outright, why do they want to hold on to this, maybe they need a large add-on acquisition that they need to fund—they need to present clear rationales, because I think there is still a very cautious view around CVs. It’s a changing mood—there’s no question about it. I think the communication has been improving dramatically, and I think podcasts like this, and other forums will continue to help promote that communication effort.
Darren O’Brien: From my perspective, one of the more interesting things in the survey was we asked LPs how often they chose to roll or sell, and of our survey respondents, 89% of LPs chose to roll less than 50% of the time, so they’re primarily choosing to sell. Deb, you referenced the 10% roll rate, which is about what we see in transactions as well. But what is really interesting, if we dig deeper, is, “Why are those LPs choosing not to roll or choosing to sell?” And the two highest responses to that question were concerns over transaction valuation—so the ability to pocket and convert a strong unrealized gain into a realized gain is very attractive to LPs—and the desire to de-risk from portfolio companies. I think it’s a really important insight, because LPs are looking to actively manage their portfolios and de-risk, and shift dollars into new private equity investments, and CVs give them a tool to do that. I think the biggest learning for me of the survey is we counsel GPs to really treat their LPs as partners in the transaction and work with them early. As Chirag highlighted, they’re really partners and not transactional parts of the transaction, and you understand what they’re looking for and you approach them early, there could be a really important and really powerful win-win-win transaction through a CV.
Chirag Shah: Yes, and just to add one more point here: I think the communication and the experience on CVs can also impact the primary views on the GP by the current LP and obviously prospective LPs. So, I think how GPs manage this process is crucial for long-term success on multiple fronts for them.
Deb Lussier: Tying together a few things that you both mentioned and really this idea that we’re in continuation fund 2.0 land—and I’ve mentioned this on the podcast before—we’ve been seeing some continuation funds where the rolling limited partners enjoy either reduced fees in carry or no fee in carry. I’m, of course, not trying to take money out of the pocket of sponsors, but the reason that that was offered to rolling limited partners in these particular cases was in the spirit of partnership, that, in a way for the rolling investors, it was seen as a co-investment, to your point, Chirag, on a single-asset deal. Co-investments are often offered at a no-fee, no-carry rate, and so, that was the decision that actually several of our sponsors have made. I think some of that is based on the fact that the historical data shows that only about 10% are going to roll, and so, it’s an amount of capital where the sponsor feels comfortable on a no-fee, no-carry basis. Having that narrative, talking with the limited partners early, treating them as partners, and offering them better economics in the spirit of partnership is something, I think, we might see as sponsors and all market participants get more creative in the space.
Darren O’Brien: Deb, that’s a really good point. Philosophically, I think it highlights the view that we bring and how we think of the CV market. It is really a partnership with your LPs—not an M&A transaction, not a sell-side. It’s an opportunity to deepen, broaden, and extend your partnership with your LPs and really grow AUM, and enhance and deepen LP relationships in a challenging fundraising market. So, it’s a really powerful tool if you think about the nuances and think about the multidimensional aspects of CVs, because there’s really three parties—the GP, the secondary investors, and the LPs—and the transaction, again, really needs to work for all three of those participants and make sure that everyone is in a better place.
Deb Lussier: Darren, I’d love to come back around to something that you said earlier about CVs being an opportunity to properly incent the current investment team. And by that, I think you mean that some former members of a general partner may be entitled to carry on an asset, but they’re no longer there, they’re not continuing to work to improve it, and are not contributing to the appreciation. In a continuation fund, there’s often an opportunity to “clean up” the capital structure, where the former members of the GP are cashed out, and there’s a redistribution of carry among the existing investment team so that they’re properly incented. I just wanted to focus on that, because that’s alignment, right? We saw this in the survey, that alignment is very important to the limited partners. But it’s not always crystal clear what we mean when we say “alignment.” What you mentioned, making sure that the people who are actually rolling up their sleeves and working on the portfolio company are benefiting in the form of carried interest, that is alignment that we refer to.
Darren O’Brien: Deb, it’s a really good point. We’ve seen CVs being used as a way to recognize and value the historical value created by GPs, but also, it’s a market-based solution to allocating the past-created value and carried interest that’s associated with that to the current members of the GP and the more established members of the GP. But what we see from investors, it’s very important to also shift some of the value creation going forward to the people and the team that is creating value going forward. One of the trends that we’re starting to see in the CV market is of spin-outs or transactions where existing assets can be used to really define new investment strategies, so to focus more on industries of expertise or even teams using assets to form new LP relationships and launch new strategies or spin-outs. So, it can be a very powerful and creative tool if you approach it from a strategic mindset.
Deb Lussier: Similar experience on our side, Darren. We’re even seeing one example of a management team at a portfolio company seeking to become the new general partner of a continuation fund, which, in essence, is a management buyout that’s being done under the rubric of a CV. So, I think they have a lot of uses, and as long as you have that partnership with your limited partners where you can create a win-win situation, there’s just so many use cases for the continuation fund.
Darren O’Brien: The core way that we look at the continuation fund market is if a GP has a strong asset that has delivered a good outcome to LPs but has future growth and there’s strong rationale for a continuation fund, if the GP treats its LPs like partners, there could be some really powerful strategic uses for CVs—but it really comes down to that strong asset that’s outperformed and can deliver future growth. We work with a lot of our clients—our fundraising clients, our CV clients—and help them think about the pros, cons, and carefully design a transaction that we think is going to enhance their stakeholder relationships across the board.
Deb Lussier: Darren, you mention a key factor in the continuation funds is the right asset. Are you, or, Chirag, finding that these assets are in a particular industry sector or vertical?
Chirag Shah: I think within the different industry focus areas, business services and technology, for the survey, were top investor preferences. Obviously, those two areas cover a wide swathe of sub-verticals—those two industry areas were followed by health care, industrials, and financial services. I think we’re going to see continued growth across all these verticals and even other areas as well across private equity.
Deb Lussier: Darren, Chirag, thank you for joining Marc and me on today’s podcast and sharing your reaction to our market survey and just more generally your views on where continuation funds might go from here—we really appreciate it. For more information on the topics that we discussed, please visit our website at ropesgray.com. Of course, if we can help you navigate any of the topics that we discussed, don’t hesitate to get in touch with us. You can also subscribe to A Word for Our Sponsors anywhere that you listen to podcasts, including on Apple and Spotify. Thanks again for joining us.