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Private equity investors are opting to cash out rather than roll over their investments when buyout managers seek to hold on to portfolio companies beyond the life of their funds.
Between 85 and 92 per cent of investors have this year chosen to sell rather than remain invested when private equity groups transfer a portfolio company to a so-called continuation vehicle rather than exiting through a traditional sale or initial public offering — up from 75-80 per cent last year, according to investment bank Houlihan Lokey.
Private equity firms have flocked to the structures, which allow them to hold on to portfolio companies beyond the typical 10-year lifespan of a fund by bringing in new investors and offering existing ones the chance to sell their stake.
Buyout managers argue that continuation vehicles allow them to retain their best assets and capture further value creation.
But their critics say the vehicles’ popularity is in part because sellers have struggled to get high enough valuations for assets from external buyers in a tricky dealmaking environment.
Many private equity backers have instead been taking the opportunity to sell their stakes in the portfolio company rather than roll their holdings into the new fund, according to Matt Swain, global co-head of equity capital solutions at Houlihan Lokey.
Investors in private equity funds, such as pension funds and endowments, were “welcoming distributions from [continuation vehicles] with open arms” because they had “experienced a dearth of liquidity in recent years”, Swain said, with a lack of traditional exits.
He added that some backers, known as limited partners, were also “wary of rolling into these vehicles as it has been proven that not all of them will be winners”.
Last year private capital firms sold $62bn of assets into continuation funds, according to advisory firm Campbell Lutyens, an increase of almost 50 per cent on the year before.
Swain predicted that this year 10 to 15 per cent of all private equity exits could be done through such vehicles. Jefferies recently calculated that the vehicles had led to almost 20 per cent of sales across the industry in the first half of the year.
Continuation vehicles usually combine capital from three sources: specialist secondaries funds dedicated to buying existing private equity assets; cash committed by the private equity manager; and money rolled over by the backers of the original buyout fund.
The vehicles can either house just one portfolio company — an approach used on prize assets but which results in a concentrated risk profile — or multiple assets, where the risk is more diverse but the assets can include underperforming bets.
Last year at least two continuation vehicles failed, the first large blow-ups in the industry. Wheel Pros, a car parts maker on which buyout group Clearlake had previously reaped nearly $1bn in profits upon selling it into a continuation fund, filed for bankruptcy, leaving the equity investors in the newer fund with large losses.
Mustafa Siddiqui, founder of secondaries investment firm SQ Capital, said continuation vehicles were used where a buyout fund did not want “to give the future growth in value to someone else” and for “lemons” that they could not sell to a conventional buyer.
The trick for limited partners given the option to roll their investment in an asset into a continuation vehicle — and for secondaries investors considering going into such vehicles alongside them — was to decipher which of “the latter are dressed up as the former”, he said.
