Many GPs have raised their last fund, but some haven’t realized it yet. These are the words of Christopher Zook, chairman and CIO at CAZ Investments.
Zook has a good vantage point. Houston-based CAZ has spent the past decade acquiring minority equity stakes in private-market managers and now holds positions in more than 120 such firms.
CAZ, which manages more than $12 billion in total assets for everyday investors, high-net-worth families and institutions, also buys GP stakes on the secondary market, one of the few managers to do so.
Zook recently spoke with PitchBook about how the GP stakes secondary market is taking shape and what the shifts in the private equity market mean for firms such as CAZ. The interview is edited for clarity and brevity.
PitchBook: Could you describe the dynamics in the secondary market for GP stakes today?
Zook: All of these [GP stakes] funds are perpetual, which means there is no definitive exit route. You don’t really have the option to just wait it out and let it liquidate on its own. I would say that probably 90% of the transactions we have done over the last three years have been partial sales, not full sales.
You will occasionally see individuals who want to sell, but for the most part, it’s institutions that are choosing to trim their positions.
The first funds were raised in 2013 and 2014, and much more has been raised since then. But if you look at the bell curve where most of that capital was raised, the largest amount was raised basically from 2016 to 2018. So, we’re now at that eight-to-10-year window, where it would be logical for people to go, “I’ve been in a decade. What are my choices?”
What does a CAZ deal typically look like?
We looked at one deal the other day where a $1 billion secondary was being marketed. There were about $40 million in GP stakes. There are a lot of big secondary firms that will want to buy the $100 million, $200 million or $300 million slugs of blue-chip buyout funds. But they may not be interested in the $40 million GP stakes at all. And it may be just too small for them. That gives us the opportunity. We have done a $1 million secondary and a half-billion-dollar secondary, and everything in between.
How are these positions being priced in the secondary market now, especially compared with a year ago?
The discount hasn’t changed that much this year compared to last year. There is more supply this year than last year, but not dramatically different.
Pricing depends on the asset. Some of these portfolios now have a lot of positions that have gone public. There’s a lot more volatility to those names.
It also depends a lot on whether people really need their cash now. We do a lot of transactions with structuring. If we do structuring and defer the payments, the price is gonna get better. If they want all cash today, and only today, the price is probably gonna be a little bit lower.
Capital flows are also pretty material. If the fund hasn’t had a big exit recently and you don’t expect anything for a while, you’re probably gonna be lower on your price, because you don’t know for sure when the cash flows are going to come through.
Private equity is sitting on a mounting inventory of unsold assets, fundraising is more challenging, and manager performance is diverging. How is this affecting PE management companies?
Talking about buyouts in general, there are a lot of firms that have raised their last fund. Some of them know it. Some of them don’t. For those who know they’re done, they’re beginning to look at what their next chapter will look like in their business lives. It does lead you to the question: who’s actually minding the store on the existing positions?
Obviously, they have, in most cases, a lot of vested interests to stay where they are and see those investments through their full exits. But over time, it becomes harder and harder to justify just hanging around because you might sell your one really good business three years from now. It’s tough.
The second part is the people who didn’t know they had raised their last fund. Those people are gonna have a rude awakening over the next three to five years. A lot of people hope it’s gonna get better. The reality is sometimes, it is just not. I say all the time, and I said this for 35 years, “Hope is not a good investment strategy.”
They have to have a plan and the ability to go out and execute. And if they cannot do that, they owe it to their investors. They need to be honest with them. There is not much of that happening right now, candidly. And that will happen over the next three to five years.
How do you expect the backlog to play out in terms of deal flow?
I don’t know what’s going to clear that backlog. I can say with very high confidence that you will see a lot more continuation vehicles over the next five years. The best assets will either be sold or they will be put into a CV.
The next three to five years will be an incredible buyer’s market in certain segments of the industry, particularly in the middle- and lower-middle markets.
In the lower-middle market, if someone hasn’t delivered strong performance and doesn’t have a big brand name behind them, they are not going to raise another fund. Some of these managers may very well be willing to sell their existing assets for less than they would if they were patient, because they know they gotta get out and do something else to feed their family and grow their career.
You will see tremendous opportunities at attractive prices from people who are not necessarily distressed sellers, but sellers who need to sell within a specific period of time.
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