Secondaries loom large as exit options narrow

IPOs are on pace for their worst year in decades, having raised only $5.1 billion so far, The Wall Street Journal noted this week, citing data from Dealogic. Typically, IPOs would have raised around $33 billion at this point in the year, according to the data, which dates back to 1995.

IPO advisers cited in the article aren’t anticipating significant public filings until at least 2023. And those companies that seek to go public this year likely will have to cut their valuations from their recent dizzying heights. Companies in desperate need of growth capital may also seek it from private markets, where it can be more expensive, but come without the transparency requirements of the public market.

For private equity, the closure of the IPO window cuts off one of the main exit paths for portfolio companies. As IPO opportunities have been effectively shut off, M&A activity has also slowed. GPs have few options left to sell their companies, save to a strategic buyer or another PE firm.

Slowing exit activities mean distributions to LPs also are slowing. With less capital flowing back to fund investors, fundraising will continue to slow as the natural cycle of investors recycling proceeds into new funds gets disrupted.

Some believe that as exit options narrow, GPs will increasingly turn to secondaries to deliver liquidity to LPs and hang on to investments until markets improve, as outlined on Buyouts this week. This could mean a busy second half for the secondaries market, though hefty deal activity will depend in part on pricing, which has been relatively weak this year amid broader economic uncertainty.

“We’re seeing a desire for liquidity that is not being met by the natural driver of liquidity in private equity, which are the M&A and IPO markets,” said Holcombe Green, global head of private capital advisory at Lazard. “When exit markets contract, clients look for other routes to liquidity and [secondaries] are one of those.”

GPs also could turn to secondaries as a way to boost sluggish fundraisings, through tender offers with staple components of fresh capital into new funds. Tender offers are simple: GPs pre-select a buyer and price, and then offer LPs in a fund the chance to sell out of the interests in the pool. LPs can choose to sell or not.

Such deals have not been popular over the last few years as LPs generally have chosen not to sell, leading to much smaller deals than anticipated. But in the new era of liquidity above all else, both sides of the PE coin may look more favorably on tenders.