With a large team of experts sharing a singular focus on secondary deals, Setter Capital has expertise in every area of the market. Kristina Kulikova, VP, LP Advisory Team, chats to Private Equity Wire about some of the current challenges and opportunities in the space…
PEW: How are current economic conditions affecting the secondary market overall?
From the sell side perspective, the secondary market tends to do well when market conditions tighten. Slower pace of distributions, higher increase in capital calls (either to support existing companies or new deal making) puts a strain on LP’s cash flows. As such, they are more likely to explore the secondary market as a way to either alleviate unfunded obligations (particularly to less core Gp’s), increase cash to support calls/new investments with core GP’s where they want to strengthen a relationship, or simply need cash to fund their own internal obligations. Slower exits also force some funds to seek extensions from their LP’s which also pushes the potential sell button.
In terms of buy side activity, a general “flight to quality” and core relationships has certainly been more pronounced. A pick up in interest for newer vintage funds which have the ability to deploy capital in a “down market” have also been more in favor than prior years. Generally however, it’s a much better environment for secondary deals with more alignment on both the buy and sell side this year then we have seen in 2022. With more dedicated secondary players coming to market and increased fundraising, we are set for another banner year in terms of volumes this year.
PEW: Are there any creative transaction types you see emerging as a way to bring secondary deals to the finish line?
On the deferred payments front, which tends to be a market favorite alternative to cash, we have seen the duration of deferrals lengthen past the 50/50, 12 months standard, driven by both increased opportunity cost through higher interest rates, and the longer likelihood of seeing distributions. Seeing deferrals as long as 24-36 months in some cases is not uncommon, although back end heavy deferred payments has eased up in comparison to 2022 since the need for cash is more pronounced versus the over-allocation consideration driven by the denominator effect. We have seen some market participants get creative with combining primary commitments to funds supported by a secondary transaction that provides a form of collateral to help with their risk/return trade off, and simultaneously building stronger relationships with GP’s. Often, what might start out as a deal in an LP stake, could morph into a broader conversation at the GP level and help provide a solution for multiple LP’s at once, whether in the form of a GP recap/CV etc.
Lastly, the use of preferred equity transactions and performance based structured solutions have been more commonly seen in the venture market to bridge the bid/ask spread and align the views of both the buyer/seller.
PEW: What has been the biggest driver of sales this year in the secondary market?
The denominator effect, which drove a lot of rebalancing due to over-allocation, has subsided as we have seen a recovery in public markets, and now the phrase ‘cash is king’ is really at the forefront. A lot of family offices in particular have opted to sell in order to redeploy into direct opportunities they have found to be more attractive in the current environment – even if that means selling some of their fund stakes at a substantial discount. Given that our firm covers both GP- and LP-led deals, as we as the VC company minority stakes part of the market, we really get a full picture of the cycle that each market participant goes through and each consideration for a sale in part depends on the actions of the others. GP’s sell to give back cash to investors, often so they can back their new fundraise, LP’s sell often for the same reason – to back their preferred GP’s and free up capital while founders/initial investors often sell due identifying better opportunities that could call on their locked up cash and/or reduce their concentration in a single asset in light of market volatility.
PEW: How do you see the level of intermediation in secondary transactions going forward? What stands behind your team’s current success in the secondary market?
As a firm, we have grown tremendously over the past almost 20 years. What started out as a team of three and a strictly LP advisory business, has morphed into three lines of business – GP-led, LP Advisory and VC Minority Directs) – and over 40 individuals all passionate about secondaries leading to over $45bn in completed sales to date. We are grateful to be one of the first independent secondary advisory firms to work in the secondary market and see it grow from its nascence to now a $100bn-plus volume market annually. This in part is driven by a larger acceptance of the secondary market as a viable tool in a portfolio manager’s tool box.
The demonstrated outperformance from a return perspective as well as shorter turn-around time of investments and diversified cash flow steam of distribution pacing has driven money being poured into secondary funds which in turn has “normalized” LP and GP selling activity and standardized a lot of the processes for transfer.
Any time this dynamic takes place, the ease of a transaction increases which in turn decreases the friction it takes to get a deal done. Specifically as it relates to level of intermediation, this has grown in parallel with the expansion of the market, predominantly due to the increased number of buyers in the market which are impossible to track unless you are a specialist in the space, the varied profiles of those buyers (ranging from family offices to insurance companies to pensions and of course secondary funds for example, and the standardization which is easy for allocators to understand and trust to an experienced professional. We expect the level of intermediation to only increase as Gp’s gain more comfort with Lp sale transactions and Lp’s gain comfort around Continuation Vehicle processes/frequency and we are prepared to support this growth.
PEW: Could you see AI being a part of secondary market deal making in the future?
Absolutely! Already firms like Clipway and others have integrated AI into their deal evaluation processes and we expect that only to continue. In an industry that is so heavily reliant on data, it is unavoidable. As an intermediary our goals are two-fold: to ensure we understand and stay on top of exactly what is top of mind for each buy side player in the market and in turn show them the opportunities that fit those parameters best; and to provide the seller a solution which maximizes pricing, ensure certainty of close and minimizes a drag on legal costs and internal resources – we can only do this with digesting and analysing vast amounts of data on a daily basis to find the perfect solution. Whether at the sourcing or execution level, AI is here to stay in increasing efficiency, speed and certainty of transactions.
Kristina is the Vice President on the LP Advisory team of Setter Capital and has had the pleasure of working at Setter since 2013, recently celebrating her 10 year anniversary with the firm. She holds a Bachelor’s degree in International Economics and Finance from Toronto Metropolitan University.
She has advised on several billion dollars worth of transactions to date , varying from single fund to complex multi asset portfolio sales across a large variety of investor profiles globally.
