Second-hand: could continuation vehicles become 'SPACs of 2022'?

Rachel Lewis , Gustav Hoejmark-Jensen and Jonathan Klonowski
05 September 2022

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So far in 2022, GP-led secondary deals have been holding fast as exits involving special purpose acquisition companies (SPACs) have faded from fashion. As GPs and LPs continue to seek liquidity in a challenging exit environment, are these deals here to stay?

Some joke that continuation vehicles have become the SPACs of 2022. Continuation funds – the transfer of a sponsor's portfolio company to a shiny new vehicle managed by the same sponsor – are now at times replacing IPOs as the backup option in a dual-track process, as weak valuations and choppy public markets close off other exits.

A recent example of a continuation deal was SSI Diagnostica, a Denmark-based developer of in-vitro diagnostic products. Adelis Equity Partners raised a special continuation vehicle for the asset in August.

Global deal values for GP-led secondaries deals are expected to come in around USD 60bn for FY2022, according to a Jefferies report. This figure is expected to fall slightly shy of the record-breaking 2021 but is still 130% up in 2019. Indeed, all but one of the sponsors surveyed by Investec said that they intended to participate in GP-led deals this year, up from 86% in the year prior. Sponsors no longer see the asset class as cast-offs.

Win-win-win
Public relations professionals like to spin continuation funds with phrases like "more exposure to the best assets" being particularly popular.

Industry players argue that continuation vehicles offer a win-win-win to private equity firms and their LPs. The old vehicle is able to lock in an exit at a respectable price, while the new vehicle doesn't have to pay so much that it loses potential upside. At the same time, LPs have the choice to liquidate or re-invest.

We can see this dynamic with Spanish sponsor GED, which earned 4x money returns and a 38% IRR for GED Fund V with a continuation deal for Vitro, an end-to-end diagnostics company.

Continuation vehicles can also act as a Plan B following failed sale processes for the last remaining assets held by a GP fund. Novum's deal for MMC Studios is a recent example.

Keep Calm and Carry On
Specialist secondary funds have seen the opportunity coming, with the amounts raised to-date already eclipsing the total for 2021 with just a third of the total funds, according to Unquote Data.

However, not all are happy about the trend, with some LPs being particularly dubious. Regulators have already increased attention to ensure transparency on valuations.

Many LPs are already squeezed by a busy GP fundraising market, while others don't have the liquidity or resources to assess investment opportunities outside the traditional ten-year window.

At the same time, some LPs are pulling away from private markets. Falling prices in public markets have disrupted portfolio balances, leading to the so-called denominator effect, where portfolio managers have to rebalance their investments in a volatile market.

With LP relationships a priority, scarcity of primary capital and a crowded market that is slow to sell due to dropping valuations, no wonder GPs are turning to faster, safer continuation getaway vehicles. Even if the IRR is down, the money multiple will often be stronger.

Sponsor exits have seen a significant drop and those at the tail-end of the cycle have to go somewhere. GPs are following the World War II advice to Keep Calm and Carry On, even if it means retaining some pre-loved assets.