How selling to yourself became private equity’s go-to deal

Non-public fairness corporations have a brand new set of patrons for his or her portfolio firms: themselves.

Blackstone, EQT, BC Partners and Hellman & Friedman are among the many buyout teams to have bought firms to funds that they management this 12 months, or made plans to take action.

Though the mannequin emerged earlier than the pandemic, its use has been ignited by it. Lazard estimates that the worth of such offers will hit $35bn this 12 months, up from $7bn simply 4 years in the past.

With the disaster leaving company boards warier of doing offers, the personal fairness trade has discovered it more durable to maintain its easy promise to traders of promoting portfolio firms to outdoors patrons after a set interval of possession.

“The fast post-Covid recession brought on declines in M&A markets and within the potential of [private equity firms] to exit these companies by promoting them or taking them public,” stated Holcombe Inexperienced, world head of personal capital at Lazard. “When conventional routes to exit are lowered, the homeowners begin to search for another.”

The transactions enable corporations to hold on to good firms — a lovely prospect because the trade’s $2.5tn pile of unspent cash drives up the competitors for brand spanking new acquisitions. Additionally they present an answer if a buyout fund nears the tip of its ten-year life however has not but bought its portfolio firms.

To execute them, a non-public fairness agency creates a so-called continuation fund, finds traders to again it after which makes use of it to purchase a portfolio firm already owned by certainly one of its different funds.

On the coronary heart of the method are teams often known as secondary funds, specialist asset managers that increase cash from pension and sovereign wealth funds. They’re ploughing extra of their money into continuation offers, partly within the hope of producing faster returns than they might from a standard 10-year personal fairness fund.

However because the pattern gathers tempo, its inherent tensions are drawing scrutiny.

Business executives say it may be a method of offloading struggling firms that rival buyout corporations, commerce patrons or public traders don’t want. That may go away the pursuits of these traders backing the continuation automobiles rubbing up in opposition to that of the buyout agency promoting a portfolio firm again to itself.

“It’s both for actually top quality companies individuals need to preserve, or it’s flaky companies you may’t do away with every other method,” stated a senior dealmaker at a big European buyout group.

Some offers, for instance, contain a bundle of firms that may embody “a canine and a star”, in response to a senior personal fairness dealmaker, as a result of “in the event you’re simply promoting the canine, nobody’s going to purchase it.” 

One fund supervisor who invests within the automobiles stated that traders merely should be “pragmatic” about this. If a fund incorporates 5 firms of which “two are fascinating and three are much less fascinating . . . you’re fixing an issue for [the private equity firm] and also you get entry to the high-quality property.”

The momentum behind these transactions — generally often known as sidecar offers — is anticipated to construct subsequent 12 months.

“I believe each single personal fairness agency will think about doing one thing like this in some unspecified time in the future,” stated David Kamo, head of US personal fairness M&A at Goldman Sachs. “We as a agency are bullish on getting ourselves organised round it” by hiring specialists within the subject, he stated.

For a buyout agency, promoting a portfolio firm to itself is now an “choice like promoting to [another company] is, like an IPO or promoting to a Spac,” stated Mr Kamo.

Continuation automobiles: The way it works

stage one

Authentic personal fairness fund: firm or firms carved out

stage two

Advisers name secondary funds, current the personal fairness agency’s valuation of the corporate or firms to be positioned within the continuation fund, and ask for bids

stage three

Secondary funds say how a lot they might decide to the brand new automobile and at what valuation. They will additionally embody phrases on administration charges and carried curiosity. Sometimes, if a deal wants $1bn of fairness, two or three giant funds would commit about $200m every

Stage 4

As soon as a few giant gamers have signed up, bookbuilding begins: advisers increase the remainder of the cash from smaller traders on the phrases agreed by the larger teams. Within the $1bn instance above, they might commit about $25m every

Stage 5

Buyers within the authentic fund can purchase into the brand new automobile or money out. The personal fairness agency is anticipated to maintain a few of its personal cash within the new fund too 

stage six

Firm or firms transferred to new fund

And with swaths of the federal government bond market providing negligible returns, cash is pouring into such offers. Pension funds have designated $25bn for such offers for 2021, up from $14bn this 12 months and fewer than $8bn in 2019, Cebile Capital estimates.

Ardian and Lexington, two of the most important secondary funds, have raised $19bn and $14bn respectively for funds whose remit contains such offers. Goldman Sachs Asset Administration might allocate about half of its $10bn secondaries fund to continuation automobiles, in response to an individual aware of the matter.

Because the monetary firepower behind the offers swells, buyout teams are in a stronger place to set beneficial phrases.

Paying carried curiosity funds to personal fairness agency’s executives — a profitable 20 per cent share of earnings — within the beforehand small variety of offers was a no-go, stated Sunaina Sinha, founding father of Cebile Capital. However it’s now “customary,” she added. “In case you take a look at the offers accomplished this 12 months, in most of them they might’ve taken one thing dwelling.”

Non-public fairness corporations profit in different methods, stated Eamon Devlin, a lawyer at MJ Hudson, an asset administration consultancy. It could actually, for instance, increase their whole property underneath administration, a quantity many use to market themselves.

With the beforehand area of interest follow changing into extra mainstream, so scrutiny is more likely to develop. Establishing the value at which a portfolio firm is bought stays probably the most contentious a part of the method.

“At [its] coronary heart is a battle of curiosity,” Ms Sinha factors out, as “the customer and vendor are each entities managed by the identical [private equity firm].” There may be “nothing mistaken” with such conflicts, she added, so long as a good course of takes place to agree a worth. 

Some offers, resembling Blackstone’s $14.6bn sale of property group BioMed Realty from certainly one of its funds to a different in October, contain a “go-shop” course of through which bankers solicit increased bids for the portfolio firm from outdoors rivals to see whether or not the continuation fund’s supply will be overwhelmed.

However in response to Ms Sinha and Mr Inexperienced, many such gross sales usually are not open to outsider bidders.

Buyers “need to perceive what the precise worth discovery course of was,” stated Mr Devlin. “Some [private equity groups] are forthcoming with what the method was; some usually are not.”