Latest / Committed Capital / Unlocking Value: GP-Stake Sales and Seeding Transactions

Transcript

Unlocking Value: GP-Stake Sales and Seeding Transactions · Committed Capital

• 0:09
  Intro: Welcome to Dechert's Committed Capital, where private equity leaders open their playbooks to discuss today's trends.
• 0:18
  Sam Kay: Hello, everyone. I'm Sam Kay. I'm a partner in the private equity funds practice here now in its 40th year, and I'm based in the London office.
• 0:26
  Sam Kay: In this episode, we'll be discussing GP stake sales and seeding arrangements. And for this podcast, I'm delighted to be joined by Demetrius Sidberry from New Catalyst Strategic Partners, and Magnus Goodlad from Rede Partners. And just to kick things off, perhaps the two of you would be able to briefly introduce yourselves and describe the role you and your spective firms play in this very exciting developing markets. So maybe I'll hand over to Demetrius first.
• 1:04
  Demtrius Sidberry: Sure, and thanks for having me. It's a pleasure to be here, Sam. So I'm a part of the founding team of New Catalyst Strategic Partners, and I've spent the last 15 years or so in the private markets, including time with Hamilton Lane, a private markets asset manager. And prior to that, I was with the buyout firm called ICB partners. So I've had the fortune of seeing the private markets from a variety of angles. In terms of where we're focused at New Catalyst, it's largely in the name. We make catalytic and strategic investments in next gen managers, and we do this by providing working capital, co-investment dollars and scaled LP commitments targeting US$50 to $75 million per partnership.
• 1:41
  Demtrius Sidberry: And we also provide operationally intensive business building support to help our partners launch and scale their firms, and in exchange, we receive a minority interest in the manager. So the simple way to think about our platform is that it is a structured way to invest in the emerging manager space. The other aspect that I think is worth mentioning is that while New Catalyst is an independent firm, we do have a strategic partnership with Apollo Global Management that gives us much greater reach and resources than you would typically see with a firm focused on this part of the market.
• 2:12
  Sam Kay: Delighted to have you join us, Demetrius. Maybe Magnus, I could hand over to you as well.
• 2:17
  Magnus Goodlad: Thank you, Sam.
• 2:17
  Magnus Goodlad: So I'm Magnus Goodlad, and I'm a partner at Rede partners. We're a leading private markets advisory firm. We're about 12 years old, with offices in London, in New York, in Amsterdam and in Hong Kong. We partner with a combination of emerging managers of the type that Demetrius is describing, of first-time funds through to long established managers with US$10 billion+ AUM. We help them with primary capital raising, with capital solutions for GPs, for sponsors of the type we're going to talk about today, combination of debt solutions M&A and equity financing alongside a range of fund solutions, including GP-led secondary transactions, and NAV financings as alternative liquidity for funds. My background is originally as a lawyer with Slaugher & May, and I was then a GP for 10 years investing in technology businesses in the UK with a group called Top Technology Ventures, which spun out from Hambros bank. I was then an LP for 10 years, indeed how I first got to know Sam was as one of the founding partners of Hermes GPE, a leading fund and co-investment investor. And then I ran the Rothschild Family Office and endowment firm investment programs in private markets before joining Rede in 2020 it's very good to be with everyone today.
• 3:38
  Sam Kay: Excellent. I think we've got the perfect combination of people to talk about GP stake sales and seeding arrangements. So perhaps just to start things off, I'd be keen to get your views on the motivations that GPs have when they're considering some kind of GP stake sale process or a seeding deal transaction. I hear about succession planning or Cornerstone investments that are helpful for a GP, but keen to get your views on what you think the reasons are for GPs to be thinking about these types of transactions. So maybe I'll hand over to Magnus first for your views on that.
• 4:20
  Magnus Goodlad: Sure. So, as you've indicated, Sam, there are a range of both individual, and potentially in combination, reasons why groups might seek to undertake a minority equity transaction. This first principle for which groups will start is they will want to undertake a transaction which their investors will support and will consider to be enhancing of the franchise, there is complete alignment between either continuing and or departing partners in terms of ensuring the future strength and health of the business. That can range from facilitating, as you said, succession - so allowing partners who are no longer going to be active to exit and potentially providing financing for the successor group to both acquire the interest in the manager and to support their commitments to successor funds, to increase commitments from the continuing partnership group to future funds. And clearly, we've been in an environment which continues of ever increasing fund size, and since 2022 where the vast majority of managers, where employment has exceeded the rate of realization, and where, on an ever increasing basis, as I refer to in in my background, groups are undertaking GP-led secondary transactions where they're reinvesting their carry. And therefore, that's proceeds which are not available to commit to successor funds because they've been reinvested in assets which have been previously held and then realized in terms of what I was describing. In terms of franchise growth, it also has been people have undertaken transactions to enable them to support hiring new teams, and therefore being able to launch platform extensions, new strategies, but complementary to the flagship to the established group and or to acquire teams through through M&A.
• 6:09
  Magnus Goodlad: So those are examples of some of the sort of core rationales for undertaking minority equity transactions. There are a final set of partnerships which have been undertaken to support direct investment into the manager's funds, so groups who've acquired interests, and in doing so concurrently, committed to making investments in, in some cases, multiple generations of successor funds.
• 6:35
  Sam Kay: Thank you. That's very interesting. Good to hear. Maybe I'll just hand to Demetrius as well, just to understand what the arrangements are with seeding deals and transactions.
• 6:45
  Sam Kay: What is the other end of the spectrum, if you like, when these are starting out, what are the motivations there?
• 6:51
  Demtrius Sidberry: Yeah, happy to tackle that. And I'll say there are some common themes amongst the emerging manager space to what Magnus has described, but for emerging managers considering a seed partnership, it usually starts with the same story around it being difficult to raise capital, which is pronounced for emerging managers in any market environment, but even more so in the current environment. So getting some level of support from a seed investor not only provides that tangible benefit of having capital to put to work, but it can also serve as some form of validation if you have the right partner. So capital support is typically at the top of the list. As far as motivations for new managers, emerging managers, etc., there are other factors at play, and what's often less appreciated are the sheer costs that come with launching a new private markets firm, from hiring a high caliber investment team or team in general, to having the right technology infrastructure, to compliance and legal. That meter starts running on these important components, and usually well before you raise one dollar that pays any management fees. And it's because of this that it takes anywhere between US$5 to $10 million, or at least it's estimated that it takes at least US$5 to 10 million in liquid cash to launch an institutional quality firm. So the average 35-to-45 year-old founder doesn't usually have that as a starting point, and so it comes back to capital. But then there's also this administrative aspect of setting up a firm, and not every investor has experience in actually building businesses, and I think that's the bridge that we're looking to provide for new managers. So if you take that combination of a tough fundraising environment and the meaningful upfront cash need that is typical, it makes that idea of having a strategic partner who could potentially solve for both very appealing if you're sitting in that new founder seat. So the concept is de-risking and, dare I say, catalyzing for the founder.
• 8:42
  Sam Kay: Thank you very much.
• 8:42
  Sam Kay: Maybe I'll hand over to Magnus just to ask about the regional variations that may arise in the market. So in our latest annual global private equity report, one of the questions we've been asking GPs as part of the survey for that report is whether they are considering GP stake sales in the next two years. And there seems to be in the answers that were provided, there seems to be a clear gap between, for example, North America and Asia when GPs are considering those types of transaction. I wonder if you you have a view on the reason for the variation, or, more generally, how you are seeing the markets growing and developing in the various regions, whether it be America, Europe or Asia.
• 9:33
  Magnus Goodlad: Sure, I'm happy to give perspective on that. The greatest weight of stake sales, although this is evolving, have been in more mature managers.
• 9:39
  Magnus Goodlad: And so to some extent, the level of investment activity has has mirrored the maturity and penetration of private equity in markets. And so the US is obviously the longest established, deepest market, and therefore there's been the highest concentration of minority stake sale transactions to date. And if one unpicks some of the reasons behind that, it's because the managers have been in business for longest, so there's more likely to need to be succession management in some form. There's greater weight of AUM, I'm generalizing here, but this is the sort of direction, the context for the data that you've seen, Sam, and have described. And where there are more managers which are multi-strategy, minority stake investors are often looking for diversity of income upstream to manage their risk and to ensure growth behind the managers that they're investing in. So that's why the sort of hierarchy, if you like, of where minority stake investment has occurred in private market managers has very much mirrored private market AUM overall, with greater concentration in the US and then in Europe. And then with Asia behind, although there was an early deal with PAG back in 2018 where Strategic Partners acquired an equity stake. And then, more recently, in 2022 with MBK where Blue Owl acquired a minority interest. And there was obviously a control transaction in the same year when Baring Asia was acquired by EQT. So those are obviously all scale, long, established, successful managers who were completing transactions of the type that we're we're talking about today. I think there's a particular focus in Asia at the moment, on the long term private markets perspective on China, where over the last 18 months, there's been a pronounced hiatus in developed market commitment, particularly to US and European LP commitment to funds where there's material China exposure.
• 11:38
  Magnus Goodlad: That's where the weight of private market investment had occurred in the previous decade.
• 11:45
  Magnus Goodlad: And there's some repositioning that's going on amongst managers, and development and deepening of investment capability elsewhere in Asia.
• 11:50
  Magnus Goodlad: And so all of that we see is contributing to a slowdown in the kind of sort of stake sale, or equivalent, partnering in the in the short to medium term in Asia, but all of the dynamics which have driven the growth in this, in this part of the market, in in the US and in Europe, we see continuing and it becoming an ever more prevalent part of the landscape.
• 12:14
  Sam Kay: Thank you very much.
• 12:14
  Sam Kay: Maybe I'll pass over to Demetrius as well, just to ask about how you consider the value of a GP. So when you're thinking about a seeding arrangement, how do you come up with your your view on the on the value of that business as it's sort of just starting out at the moment.
• 12:33
  Sam Kay: Obviously, I don't want you to give away any of your your particular ways of valuing and the secrets that you you employ.
• 12:41
  Sam Kay: But I'm sure people who are tuning into this podcast be interested to hear about the way you are viewing GPs, how you assess the value.
• 12:52
  Demtrius Sidberry: Yeah, no, and happy to share some some perspective on that. And I'll say that, you know, unlike the more mature assets, where you can value cash flows, whether it's management fees or expect to carry it and apply it, apply a multiple in a DCF, that's not where we're starting, because many of the firms that we're looking at are just getting started, and so they don't have those. So for us, the exercise is really determining the appropriate revenue share construct for us to hit our return targets given the underlying assumption. So what I didn't mention earlier is when I said, we take a minority interest in the firms. That's typically in the form of revenue share, at least early in the relationship. So when you're determining what level is required to hit those returns, you're taking into consideration the underlying strategy, the expected return profile. How does that align with the manager's historical track record, the scalability of the strategy, and then also what form of capital we're ultimately providing to our partners, because an LP commitment is going to be priced differently or reflected differently in a revenue share, typically, than what you see with working capital. And so as I mentioned earlier, we offer our partner firms working capital LP commitments, as well as CO investment capital. And so those things are all priced differently. And I'd say a final broad consideration is the competitive nature of the opportunity. And so while it's less prevalent than what you see in the GP stakes end of the market, there is this concept of market clearing constructs that exist in the seeding end of the market. So it's really a combination of understanding, you know, the outlook for the business, what the strategy is, how the business can scale, but then also taking into consideration that there are other folks potentially hovering around the table, doing the same thing.
• 14:34
  Sam Kay: Moving on now to the types of investment structure that may be employed. Maybe I'll throw it over to Magnus. I don't know if you're able to give a bit of an overview as to how a transaction would be structured, or the particular trends in the GP stakes markets as to how the transactions are structured. For example, is there a particular focus on using either equity or debt, or any other particular trends that you're seeing at the moment?
• 15:06
  Magnus Goodlad: Demetrius drew am important distinction relative to seeding investment, where the managers who Demetrius should be partnering with won't have historic funds, where there's existing cash flows from management fees or carried interest entitlement, or GP commitment, whereas with established managers, all of those are a feature alongside any partnership in relation to future funds. And there is not a monolithic acquisition structure. Therefore, investors can select which prior funds they will acquire carried interest in, for example, and or GP commitment, and on what basis, and equally, the management fee will generally be included within the perimeter.
• 15:47
  Magnus Goodlad: That's part of what the partnership deal will relate to.
• 15:50
  Magnus Goodlad: There is an alignment between both the GP and the investor in creating an ownership structure which, as I described the outset, is something which will be warmly received by LPs. They do not want to create a structure where the particularly the investment function, the control of that is seen to be with an institution rather than the investment team who the LPs are looking to partner with. So governance arrangements very important around any equity partnership and leaving the core controls for the business in the hands of the of the GP and the management team. There's also alternative as which may be used in combination, or, as I said, in alternative to an equity investment with preferred unsecured debt like structures as a way of providing additional capital and or secured traditional debt structures, and those are solutions which have got different potential implications. There's potential lower cost of capital. But you're not obviously selling an interest. You're borrowing capital where there's an obligation to return and repay over time. It's something which typically does not require any level of LP engagement, whereas as a minority stake, or if extreme situations, a control deal, you're going to require LP consultation and consent, or at the very least notification and an important communication stream. So those are the sort of the broad spectrum of solution types and some of the considerations which will guide managers in determining what is the optimal solution for them and or individually or in combination
• 17:31
  Sam Kay: Thank you very much, Magnus. I'd just like to ask you both if you have any any guidance that you would be able to provide to GPs who are thinking about exploring these types of transaction, both seeding arrangements or a GP stake sale, what would you say they should be thinking about in order to have a successful outcome for this type of transaction? I'll maybe throw it open to Magnus first.
• 18:02
  Magnus Goodlad: I think the crucial first step is to be really clear on the partner group's objectives of what they're looking to achieve, and ensure that there is alignment at the outset, and to make sure that all the stakeholders internally are agreed on what the core objectives for potential transaction is whether it's one of the two poles that I described, of an equity or debt and a minority equity of equity or control transaction. And then to obviously, Rede would suggest talking to an appropriate advisor to guide on what the art of the possible is and what the range of potential solutions is, and then to seek the appropriate long term partner where you feel there's going to be a long term relationship, and it's going to be something which is going to, as I said at the outset, it's going to be warmly received by both current and respective LPs, and is going to allow the successful both ongoing management of the business and partnership, whether it's it's debt or equity, and then to seek to accomplish the transaction as rapidly as possible, as people listening this podcast, be aware there's always a risk of a leak or wider communication on a potential transaction, and you want to be in the no man's land between considering one of these transactions or in process of executing and having a final destination for as short a period as possible, obviously, to be prepared if there is a leak, to be able to communicate the reasons for the transaction and the rationale for it as clearly as possible, but to avoid that to the greatest extent achievable.
• 19:36
  Demtrius Sidberry: Yeah, again, a lot of what Magnus says holds true for emerging managers as well, and even the seeding context around sort of the partnership mindset. But I'd say there's also this element of knowing your story, right?
• 19:49
  Demtrius Sidberry: You're new to the market, you're trying to convince investors that there's a reason for you to exist when there's likely another option for that strategy that may be more established or maybe new as well. And so I think understanding how you're differentiated relative to your peers, how do you stack up relative to those peers? And also, are you aware of your past mistakes, or as aware of your past mistakes as you are your successes? And are you open about sharing those because no one's perfect, and I'd say understanding and being clear around the consistency of your go forward strategy relative to the track record that you built in the past that has been successful. And so I think a lot of people know that these are important in standard areas of focus for investors. But then there are other elements when you're a seed investor to take into consideration. Again, back to the partnership piece. And so I'll boil it down to two concepts. First is, are you planning to simply invest a fund or build a firm? And the second is, do you have the true partnership mindset? I'd say for us, a GP with the 15-to-20 year plan in mind, early days is the right starting place, versus the one that is solely thinking about the next dollar for the next deal. And that's a key part of the foundation for a partnership mindset. So we're ultimately looking for groups that are seeking more than just capital, and are ultimately open to receiving strategic advice in areas where we can provide tangible support to help drive results. So it's that intersection of being a great investor with the mindset towards building long-term firm value, that's where we sit. So I'd say I'd encourage managers, if you're thinking about having discussions with seating partners, see how your vision aligns with that mindset.
• 21:32
  Sam Kay: That is very, very sound advice. So I think that brings us to the end of this podcast. Thank you both very, very much for participating and providing your insight. And thank you to everyone for tuning in.
• 21:49
  Outro: Thank you for listening to Dechert's Committed Capital.
• 21:53
  Outro: Please subscribe and for more information, visit dechert.com.