Editor’s Letter: Creativity is the way of the secondary market

I was pretty confused recently on how a fundless sponsor could complete a fund restructuring. How does one restructure a fund that doesn’t exist? It’s like that scene in “Seinfeld” when Kramer tells Jerry, “I’m at the corner of First and First. Wait a minute. How can the same street intersect with itself? I must be at the nexus of the universe!”

Here’s how it happens: You create a fund and move your assets in. It’s the magic of the secondary market these days — creating structures that didn’t exist before and using them to provide investors with flexibility.

As you’ll see in the cover feature this issue, the secondary market is being driven to record levels of deal activity, in part by creative transactions fueled by a glut of capital. More money was raised last year for secondary strategies than ever before, and that capital is being deployed across some pretty unusual structures.

Like independent, or fundless, sponsors. From what I’ve seen and heard about in the market, this involves bundling a series of assets that a fundless sponsor has amassed over the years and moving them into a special-purpose vehicle. A buyer or buyers are brought in who buy out original LPs, either in whole or part, and provide capital to refinance debt, or for growth.

Through this structure, the independent sponsor gets a taste of running a fund with institutional investors who impose a time limit on their capital. This compels the sponsor to maximize value and the exit the assets in a shorter period than perhaps they were used to with their original investors, who generally are family offices and high-net-worth individuals.

As a few sources told me, this type of deadline imposes discipline on the sponsor and can be a sort of test to see how the sponsor manages out the asset to exit. If the sponsor generates a strong return, they now have a natural connection to limited partners who might be willing to kick into a closed-end fund in the future.

It’s an interesting solution for an independent sponsor who may not want to sell out assets to another PE firm, who generally want to take control of the asset. The sponsor may not be ready to relinquish control of the asset but wants to help older investors cash out. Maybe a few of their older investments need a refinancing or more capital for growth. Here is an elegant way to make that happen.

It’s one example of the creativity we’re seeing in an already creative niche. It’s why I love covering funds and secondaries — it’s a never-ending source of great stories.