GP-led continuation vehicles growing in popularity

GP-led continuation vehicle transactions involve a sponsor selling a one or more platforms in a property, or properties, to a continuation vehicle which is capitalised with fee-paying capital from new limited partners (LPs or investors). Existing platform investors are given the option to reinvest or take liquidity.

Global real estate GP-led secondary market transaction volume ($bn)

Source: StepStone Group - Bull Market for Real Estate Secondaries report | August 2023

Exploring the benefits of secondary solutions for sponsors and investors 

GP-led secondaries offer optionality and benefits for both the sponsor and their investors. The GP can gain additional time and capital to drive further value creation across the platform(s), delaying the exit process to maximize eventual sale proceeds. LPs are offered a liquidity option which can be appealing in periods where fund distributions have slowed due to challenges in traditional exit routes. GPs are increasingly using secondary solutions to maintain exposure in high-quality asset(s) rather than as rescue financing for more challenged situations. The additional capital raised in continuation vehicles is primarily directed towards future growth investments or capital expenditure, providing firepower that may not be available in the current fund structure.  

GP-led secondary solutions can also enable the GP to spin out investments in a specific subsector to form a thematic, sector-specific vehicle that will appeal to more focused investors. As platforms mature, assets can be moved into their own dedicated vehicle where the style and risk profile are more reflective of the return profile going forward – for example initial development assets that are now stabilized.

Continuation vehicles offer opportunities to optimise alignment and capital structures

Continuation vehicles can be used to realign the share of profits on the contributed capital to the deal (promote) to the active team and mitigate any existing promote leakage due to changes in the partnership pool. The vehicle provides more concentrated exposure to the asset(s) with the potential to earn higher promote on the eventual exit versus under the existing structure. Sponsors will often reinvest their crystallized promote proceeds in the transaction, increasing their direct exposure to the continued performance of the asset though a larger GP commitment in the continuation vehicle.  

Offering an opportunity to alter capital and shareholding structures, GPs can consolidate asset ownership by using the capital raised in continuation vehicles to purchase the equity of co-investors and inactive management and convert this into fee-paying capital. In the current credit environment, sponsors can utilise these transactions to optimize the capital structure by either reducing the leverage of the asset(s) or avoiding the requirement to refinance advantageous financing packages triggered by a change of control in a traditional sale process.    

Navigating conflicts of interest

These transactions can require navigation of delicate conflicts of interest given the GP is acting both as a buyer and seller in the transaction. DC Advisory aims to ensure a market price for the asset(s) through a competitive auction process and mitigates execution risk by advising on the best route of sale, through a traditional exit, a continuation vehicle, or a combination thereof. Market valuations and rates have moved materially over the past 12 months, prompting LPs to increasingly seek third party valuations to validate the sponsor’s fund marks. Valuation can be supported via an auction process, a direct minority stake sale to a third party, a ‘go-shop’ process and/or a fairness opinion, all of which can be facilitated via transactions that DC Advisory can execute.

In recent years, real estate and hospitality private equity funds have ballooned[1], and we expect many GPs with funds approaching the end of their terms, to take advantage of the benefits that secondaries solutions can offer. We believe continuation vehicles are becoming increasingly popular with both real estate and hospitality private equity funds, due to the volatile market environment, as they can provide solutions to those who see greater value generation over the longer term. GPs can take advantage of secondaries solutions to deliver a longer time frame in which they can deliver returns for their LPs.

We expect that as sponsors embrace new strategies to optimize returns, liquidity, and alignment across their portfolios, combined with the significant number of funds in the market, will continue to drive growth in the real estate and hospitality secondaries market long into the future.

To discuss the themes explored in this article, get in touch with Real Estate and Hospitality Managing Director, Hoong Wey Woon, and Secondaries Managing Directors, Sabina Sammartino and Michael Wieczorek.

DC Advisory has prepared this material solely for informational purposes and it is not a research report. This material does not constitute or form part of, and should not be construed as, an offer to sell, or a solicitation of any offer to buy, or any recommendation with respect to, any securities.

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