GPs eye opportunities to invest new capital into continuation pools: surveys

A traditional source of tension with LPs, GPs are finding an outlet for cross-fund investments in continuation fund deals.

Limited partners generally frown upon cross-fund investing, when a GP uses capital from a new fund to invest in a company held by an older fund.

It just gets too complicated, too much room for conflict. The new fund wants to buy the asset at a lower price and the older fund demands maximum value for the company. Who determines fair price? And why can’t the GP find a new business to buy?

That’s been the traditional tension in cross-fund transactions. But lately, a slight variation on that theme is growing in popularity. GPs running single- and multi-asset continuation fund deals are more frequently using capital from a new flagship fund to invest in the deal.

Jefferies, in its full-year 2022 secondaries volume report, found that about 25 percent of closed single-asset deals last year included cross-fund elements. Matt Wesley, global head of private capital advisory at Jefferies, expected that number to approach 50 percent this year.

Lazard, in its full-year 2022 survey, found that around 25 percent of respondents experienced a cross-fund element in less than half their transactions last year. Cross-fund investments are present in only a minority of deals in the market, but GPs are expressing interest in doing more, according to Holcombe Green, head of private capital advisory at Lazard.

“We see more interest from our GP clients in putting more of their own capital into their deals instead of selling more to another sponsor,” Green said.

Driving interest is a simple risk calculation – the GP knows the company that is subject to a continuation fund deal. It’s grown business, worked with management and has a clear idea of the growth path. In an uncertain environment, re-investing new capital back into a known asset, rather than a new company, is the less risky move, though not one LPs in the new fund necessarily appreciate.

Investors in continuation fund deals like to see the sponsor plugging in capital from a new fund, which demonstrates the GPs’ commitment to the deal. LPs, however, don’t always love cross-funding for the same reasons they don’t like it in regular M&A transactions. Conflict is inherent when the GP is on both sides of a deal, and LPs of a new fund would like to see the GP finding new things to invest in.

Despite the tension, GPs are putting their new capital into these transactions. Some recent deals include:

In January, Lorient Capital announced a single-asset continuation fund deal for its asset ShiftKey in which the firm, along with a group of investors, led the deal.

Last year, Stone-Goff Partners invested capital from its fourth fund, which was out raising at the time, into its single-asset process for JSI, which provides regulatory and compliance consulting services to telecom providers in rural communities in the US, Buyouts previously reported.

Stone-Goff held JSI in its second fund, and allowed LPs in that pool to cash out of their interests in JSI, or roll their stakes in the new fund. Pantheon and abrdn were lead investors on the deal, the firm said in a statement.

LP sales come on strong

Overall, total volume last year came in around $103 billion to $108 billion, according to several full-year volume totals. Lazard estimated total deal activity at around $102 billion, with 43 percent of that represented by GP-led deals. Of GP-led deals, around 40 percent were single-asset continuation funds, Lazard said.

The market, however, appears to be moving toward a desire for more diversification, with multi-asset deals gaining popularity, Lazard said. This is being driven by a flight to safety, which is seen in diversification rather than concentration, Green said.

“I don’t think single assets are going away – there’s a bunch that are approaching the market and a couple that are in the market, but the investor base by and large is more discerning about what they want to do and the single-asset investor base has shrunk,” Green said. “A few large investors that were among the largest single-asset buyers have really pulled back from that.”

LP secondaries drove volume last year and are expected to be the driver of much of the early deal activity this year. “The desire by LPs to generate liquidity out of their PE funds is pretty high and the willingness to part with funds in exchange for capital and the desire of investors to put capital to work are going to create more opportunities to trade,” Green said.

“The overall market, ourselves included, is quite bullish on 2023,” he added.