GP-led liquidity transactions (“GP-leds”) have gone from niche to mainstream over the last 10 years, with the market accelerating during the period of COVID lockdowns. Many GP-leds that took place in, and directly after, the period of COVID lockdowns were for portfolio companies that were initially lined up for a direct auction sale, which did not proceed due to the various challenges of that period. However, the level of GP-leds has held up over the last couple years, and there are new challenges to direct auction sale processes (for example, interest rates, FX volatility, potential recession, etc.), making a dual track process of direct auction and GP-led a viable option.
There is logic to GPs running a dual track of a direct auction sale and GP-led (the “alternative dual track”). Both tracks require vendor due diligence materials, with the trend of GP-leds starting to shift away from pure transferability reports and more towards vendor diligence reports that would be customary on a direct auction sale. It is now fairly customary on GP-led transactions for GPs to arrange for the buyer vehicle to take out warranty and indemnity (“W&I”) insurance in much the same way that is standard on a direct auction sale process. Indeed, the level of coverage under W&I insurance policies that is typically available for GP-leds is far improved from only a few years back, which has no doubt been aided by the availability of vendor due diligence reports.
Management teams of portfolio companies are also now well aware of the existence of the GP-led market, and many GP-led processes as a consequence involve these management teams cashing out and rolling over in the same way as would be seen if the buyer were a private equity fund on a direct auction sale. If the GP were to undertake the alternative dual track this may mean that instead of the limited business warranties being given by the selling funds in a typical GP-led process, these instead could be given by the portfolio companies, their management teams, and/or a combination of them and the selling funds, backed by W&I insurance in the same way as for a direct auction sale.
Capital available to underwrite GP-led transactions continues to grow, and many secondary funds are now used to acting alongside other funds as co-leads to underwrite together ever larger transactions. A GP-led also often raises less execution risk than a direct sale or IPO, with the change of control risks being easier to manage as the GP controls the portfolio companies before and after closing.
There are, however, some challenges to the alternative dual track, including with respect to the messaging on price. In a direct auction sale process, bidders typically price the portfolio company based on financial information provided by the GP that is then enhanced by the plans that bidders may have for the portfolio company, such as implementing synergies after closing, the bidders’ growth plans for the portfolio company and/or by the bidder’s appetite for leverage. Bidders on a GP-led are backing the GP and its plans for the portfolio company going forward and the price has to factor in the management fees and carried interests that will be charged by the GP. Accordingly, these (and other) different approaches and/or factors on pricing may have to be reconciled in an alternative dual track to ensure that direct and indirect bidders are valuing the portfolio company in the same way. It could potentially be difficult to manage the messaging on price to the market with an alternative dual track.
Additionally, bidders in a GP-led process may be reluctant to participate in an alternative dual track if they are faced with the prospect of having to undertake significant transaction costs to participate in the process and then the GP elects for a direct sale (although this could be mitigated by the bidders on a GP-led having the benefit of a break fee). It also may be mitigated by the GP stating up front that it is running the alternative dual track but which combines both GP-led and direct sale, with a set allocation (for example, 60% direct sale, 40% GP-led) between the two options and that the direct price will be used in the GP-led process as well. Indeed there have been examples in the market of GP-leds that have been combined with a direct auction sale of a large minority position in the portfolio company, whereby the direct sale of the portfolio company sets the price for the GP-led.
Whilst there are some clear advantages in the alternative dual track, it is clear that early preparations are critical and careful thought will need to be given to each option and how to reconcile approaches for the process to be successful. It may be more likely that the alternative dual track will not proceed all the way through an auction process, but instead pivot at an early stage to either a GP-led or direct sale, or a combination of the both.
Authored by Ed Harris, Adam Brown and Leanne Moezi.