Origination: Pass-the-parcel deals

Secondary buyouts are controversial: some GPs and LPs argue these deals are less likely to generate strong returns compared with primary buyouts, while others have noted they form an integral part of the private equity value chain. Nico Taverna, head of Adveq's secondaries programme, says attitudes towards SBOs are improving: "In the past, people had problems with assets being passed on; companies were considered as squeezed out after the GP's exit. This has changed. Over the past few years, research has suggested that SBOs also deliver."

Numbers looking up
Secondary buyouts are certainly popular for private equity, reaching their height in 2007, when unquote" data recorded 234 SBOs across Europe. The number of deals dropped dramatically during the financial crisis, reaching a low in 2009 with 56, but picked up steadily the following year. In the UK alone, 67% of all deals were sourced from fellow GPs in the second quarter of 2015, for those in the £50-250m range, up from 57% in the first quarter of the year.

For Equistone Partners Europe, SBOs have been an important deal source, with the GP having acquired four assets in Germany via this route since 2014. Peter Hammermann, managing director at Equistone, rejects the notion that they are too expensive and potentially less profitable. According to Hammermann, thorough valuation and good due diligence can reduce the risk of paying too much. If those factors are present, a second or third buyout can generate good profits for the GP. "Businesses are not static and they undergo changes all the time. It is very rare when they reach a point where there is no more growth potential and no more possibilities on the market," says Hammermann.

However, Callum Bell, head of Investec's corporate and acquisition finance team, suggests prices for SBOs can be off-putting in the current climate: "The concern in private equity at the moment is the entry multiples that are being paid. These levels increase the pressure to make the right returns over the course of the investment." At the same time, Bell sees great potential in taking the right companies on a journey: "Private equity's food chain from lower mid- to mid-market to jumbo-market offers a lot of opportunities for GPs."

For Hans van Swaay, partner at family office Lyrique, large amounts of dry powder, together with rising SBO numbers, are a worrying sign of deal shortage. He also believes that high returns are unlikely: "Most buyouts are based on slow-growing, stable, cash-generating companies, but you can only improve companies in markets with little growth so much. It is highly unlikely that you can improve them as much the second or third time."

All in order
However, an SBO offers advantages for the incoming GP. There is more assurance that the books are in decent order based on an institutional shareholder having been invested as a quid pro quo for a more price conscious vendor. Bell also acknowledges their perceived lower risk: "There is a lot of dry powder around in private equity – you need to spend money. Picking up some secondaries is a good way to put money to work and get returns within a portfolio of companies."

Equistone's Hammermann believes the advantages of SBOs are not highlighted often enough. For him, both the company and the GP can benefit from the deal: "A regular investor-change is something that a company can benefit from greatly. It challenges founders or the management to review their business model regularly and to challenge their own perspective." Equistone has observed some fellow private equity houses trying to overprice assets, but this does not worry Hammermann: "If we believe that the vendor asks for too much money, that the company's development does not justify the price, we simply do not buy."

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