Future Trends for Financial Sponsors: Secondary Transactions

Future Trends for Financial Sponsors: Secondary Transactions
Mergers and Acquisitions

02 of 11

This insight is part 02 of 11 in this Collection.

September 26, 2023 10 mins

Future Trends for Financial Sponsors: Secondary Transactions

Future Trends for Financial Sponsors: Secondary Transactions

Secondary deal activity will likely continue to strengthen as financial sponsors navigate widespread macroeconomic uncertainty.

Key Takeaways
  1. Amid macroeconomic volatility and a decline in global M&A activity, secondary transactions have continued to expand as a viable alternative to traditional transactions.
  2. The secondary market can provide liquidity to institutional investors and growth opportunities for fund managers.
  3. As part of a robust risk management strategy, the use of insurance capital is a valuable tool in supporting secondary transactions.

During periods of market volatility or economic recession, liquidity and financial flexibility are critical. The secondary market is one of the main avenues that can provide liquidity to institutional investors.

What is a Secondary Transaction?

A secondary transaction allows limited partners (LPs) to sell their interests in a fund prior to the end of its lifecycle. This is typically accomplished either through a direct LP-to-LP transaction or a continuation fund created by the fund’s general partner (GP). Secondaries have gained popularity for a variety of reasons, including:

  • The achievement of further economic value by maintaining ownership in certain fund assets or businesses after the expiration of the underlying fund’s life
  • Access to fresh capital to support the underlying business operations of portfolio companies

In such recapitalization or continuation transactions, a GP creates a new vehicle with new investors to acquire assets or businesses from a fund portfolio.

Amid economic headwinds, secondary dealmakers are encountering new opportunities to invest in fund restructuring, equity transactions and single asset deals.

Secondaries Are Helping Financial Sponsors Navigate Macroeconomic Volatility

Macroeconomic challenges have limited the scope for a traditional PE investor exit via a private M&A sale or public market listing. Secondaries offer an alternative that brings liquidity options for a fund’s LP investors and flexibility for the GP to retain ownership in a high-quality asset.

With the current downward pressure on asset valuations, a secondary transaction provides:

  • Existing investors with an exit or rollover option into the continuation vehicle
  • The opportunity for new LPs to invest in contributed assets
  • Additional time for the GP to weather this downward pressure, hold onto promising assets for longer and, potentially, realize greater returns through the value-creation plan

"The amount of capital raised for private equity primary funds has more than tripled over the last ten years."

The Value of Insurance

Due to the complexity of secondary transaction structures, all parties should focus on evolving risks and inherent challenges. In managing both known and unknown liabilities, as well as expediting the transaction process, bespoke insurance solutions can be a valuable tool and provide benefits such as:

  • Obtaining deal certainty for both GP-led and LP-direct secondaries with enhanced coverage for potential exposures, including post-close obligations of GPs and exiting LPs
  • Improving execution efficiency, as key risks are better understood by insurers and a narrower due diligence scope is now the expectation (rather than traditional buy-out due diligence expectations)
  • Accessing flexible and tailored deal coverage to accommodate heightened risks at more competitive rates than traditional M&A markets
  • Providing and immediately releasing sale proceeds to selling LPs as opposed to requiring an escrow
  • Limiting ongoing overheads on closing a fund by protecting long-term tail risks

An Outlook on Warranty & Indemnity and Representations & Warranty Insurance:

Warranty & Indemnity (W&I) and Representations & Warranties (R&W) insurance have previously been used to support PE secondaries, but the recent increase in deal volume has prompted insurers to consider covering excluded obligations, which were formerly out of scope. Excluded obligations are liabilities typically retained by the GP in deals that relate to withholding taxes, other seller taxes, and LP or GP claw-back risks.

Insurers are also now prepared to cover a broader set of transactions — multi-asset and single-asset situations, LP to LP deals, as well as GP-led transactions across a variety of wide-ranging asset classes. These include real estate, healthcare, energy, infrastructure, credit and venture capital.

Additionally, deal execution has improved. This is due to better insurer understanding of the nature and risks of these deals and resulting alignment of their diligence expectations and underwriting process. W&I can unlock value, but it also demands specialist knowledge and experience to accommodate the deal dynamics between a GP and existing and new LPs.

Secondaries Can Drive Better Decisions Amid Economic Volatility

Continued monetary tightening has played a key part in dampening transactional appetite in response to stubborn inflationary pressures. Bloomberg data indicates that deal volume in traditional M&A markets for the first two quarters of 2023 was the lowest since 2017 (excluding the second quarter of 2020, as the grip of the COVID-19 pandemic took hold). Against this backdrop, secondary transactions are stepping into the spotlight and will continue to provide financial sponsors with readier access to liquidity amid macroeconomic volatility.

Managing uncertainty is the responsibility of the insurance market. When products such as W&I evolve to meet the demands of the secondaries market, financial sponsors will be able to make long-term strategic decisions and support value creation.

Find out more about Aon’s M&A capabilities.

Aon Thought Leaders
  • Matthew Wiener
    Managing Director M&A Transaction Solutions, North America
  • Carol Clarke
    Director M&A Transaction Solutions, United Kingdom
  • Jerald Khoo
    Senior Vice President M&A Transaction Solutions, North America

"PE secondaries experienced record growth in 2021 in terms of actual transactions completed, as well as new dedicated funds raised for the secondaries market."

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The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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