A fundamental shift in private equity with GPs increasingly seeking ways to hold assets longer than allowed under traditional private equity fund structures, is a topic with which Buyouts readers are well acquainted. We recently chatted with Andrea Auerbach, global private equity head at Cambridge Associates, on this emerging trend.
What are some structures GPs are using to hold assets longer?
The trend we’re exploring fully is when GPs contact us to say something along the lines of: “We have an old portfolio or a portfolio company we’ve had for a long time, it’s been a great return generator, we don’t want to let it go, can we sell it to our next fund? Or spin it off and stay in it and we’ll all agree we’ll hold it a lot longer than a traditional private equity fund.”
You want to hold your winners as they can be productive return generators for investors, and PE structures don’t allow for really long-term holds. I don’t conflate this with long-dated funds. This is a PE shop or a growth equity shop that has a few really strong performers, they’re reaching the end of that fund’s life, they don’t want to let it go. Let’s figure out a way to hold this one investment or two investments for a lot longer.
How are GPs accomplishing this outside traditional PE fund structures?
One way that can be done is by getting amendments and approvals to sell from one fund to another fund, keeping it in the family, so to speak. That’s cross-fund investing. That trend will continue and it’s something that, as investors, you have to think about the alignment: are valuations being done on the up-and-up, independently? What’s happening with the carry associated with that investment? The devil is in the details and so it’s something an investor needs to understand. Obviously, the GP knows the company better than anyone, so provided valuations are done at an arm’s length basis and alignment in terms of carry is appropriate, LPs can get comfortable with it.
Or you could spin the business out into an SPV continuation fund. The question is, how are you doing that? I do think investors will see this a lot more. The GP knows this company really well, they’re still trying to go out and find great investments. Let me buy that company from another fund.
Another approach is the creation of an opportunities fund, which is formed to hold stakes of prior portfolio companies that were sold forward to another sponsor and the selling GP reinvested proceeds and retained a reduced stake in the company.
TA and Insight Partners raised opportunity funds. What’s the rationale?
For control investors, reinvesting for a minority stake in a former portfolio company is arguably off strategy for a main fund, but is a way to retain that ‘intellectual property’ for the benefit of interested LPs. Venture capital and growth equity funds are doing this quite a bit as portfolio companies progress through various stages, raising additional rounds of capital, and wanting to retain and maximize their pro-rata rights for the benefit of their platforms, rather than cede to a later stage investor.
Have you seen GPs do this through traditional M&A?
The other splinter trend off this topic: PE groups if they’re holding investment for longer, maybe they do a partial monetization to crystalize the value. What we’ve observed, in certain situations a PE firm sells a portion of its deal to another PE fund, gets a partial distribution, crystalizes the mark and continues to hold the deal. This is different from consortium investing; this is sort of like, “hey I have this great company, don’t want to sell all of it now, we’re five years into the fund’s life, let’s show LPs that there is real value to holding this investment.” This is a variation of the theme of, “I have a runner, I don’t want to sell it, how do I hold onto it and how do I signal to my LPs this is worth holding onto?”
This interview was lightly edited for clarity.