As we near the end of the year, a recovery in the private equity exit market still looks some way off.
In the first nine months of the year, there were just 885 PE exits in the US worth a combined $182.9 billion, according to PitchBook’s Q3 2023 US PE Breakdown, putting the year on track for the lowest annual totals in a decade. Europe, meanwhile, has seen 775 exits close over the period, PitchBook data shows, compared to 1,455 for the entirety of last year.
This lack of liquidity has driven private equity firms to use ever more creative ways to redistribute capital to their LPs.
A recent example is Swedish PE giant EQT, which is planning to conduct private stock sales for its portfolio companies in order to provide liquidity to its LPs, according to the Financial Times.
The proposal would see the firm hire an investment bank to find interested parties on both the buy and sell side, with said bank then leading negotiations on valuations. The unusual part here is that only EQT’s existing LPs will be involved in the transactions.
This proposed method appears to be more directed at companies that would have gone public in a more attractive market. EQT CEO Christian Sinding reportedly said that the plans were being driven by “dysfunction” in the IPO markets—only nine PE-backed public listings have completed in the first nine months of the year in the US, along with 12 in Europe. EQT declined to comment further for this article.
While not many details are known, it appears that EQT would sell a stake in a portfolio company to an allocator as a direct investment. This sale would give EQT a realization on the fund and thus capital could be returned to LPs.
The strategy appears to share similarities with continuation funds—an ever more popular tool in the current hunt for liquidity.
In continuation funds, a GP rolls over an asset or multiple assets from a fund into a new vehicle in order to maximize value that would otherwise be lost if sold to a third party. Existing LPs have the option to either cash out or participate in the new fund, although it has now become more common to bring in new secondaries investors, which differs from EQT’s proposal.
Given the exit downturn that privately held companies now find themselves in, private stock sales appear to be a novel way to keep LPs happy on potential winners on a much quicker timeline and at a lower cost than an IPO—and most likely, at a better valuation than could be had at the moment.
But as with any untrodden path, particularly those that are hazy on specifics, questions arise as to whether this is the best way forward. A potential auction of portfolio company stakes between LPs of the same firm could face difficulties with potential impact on long-term relationships.
While it’s expected that the investment bank would take charge of the pricing in order to achieve a fairer result, navigating valuations could still present challenges. Selling at a discount could leave the fund LPs unhappy as their returns are diminished, while offering a premium would likely not attract many bids.
Furthermore, how much liquidity will these LPs get if they are also the ones buying stakes? And if they are taking direct stakes, do these LPs have the necessary operating capabilities to manage these assets as an active investor?
if EQT decides to take this route, it will be interesting to see the results. But the plan is indicative of the intensifying hunt for liquidity on the part of PE firms. New or relatively underused avenues are being increasingly used by investors in order to return capital to their LPs.
The secondaries market, for example, has attracted significantly more investor interest in recent times as LPs and GPs seek to exit entire portfolios or companies. Continuation funds have helped spur activity in the GP-led secondaries market.
Several new funds have been raised this year to capitalize on the opportunity, including a Glendower Capital $5.8 billion vehicle and Goldman Sachs’ $15 billion fundraise for private market secondaries strategies.
Net asset value financing—which allows fund managers to borrow against their vehicle’s investments—has also seen an increase in use by PE firms.
This type of facility again allows investors to hold on to their assets for longer and support portfolio companies in a tougher fundraising environment. It was reported earlier this year that firms including Vista Equity Partners and Carlyle have used NAV financing this year in order to return capital to their LPs.
After years of fruitful exit markets, it’s impressive to see the ingenuity of the private equity market as it tries to solve the issue of liquidity. But while we can all accept that the exit environment is significantly tighter than in previous years, it seems to me that is not the only problem that has prompted these creative solutions.
EQT’s CEO told the Financial Times while talking about the dysfunction in the IPO market that the barriers are “quite high,” and one can assume that sales to corporates have similar hurdles given their lower numbers. So maybe the problem isn’t that PE firms can’t achieve liquidity at all, but that some of their assets are just simply not worth what they think they should be.
Featured photo illustration by Jenna O’Malley/PitchBook News
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