Where are the most attractive continuation fund opportunities?
In the second video in our series focusing on the growing interest in GP-led secondaries, Christiaan van der Kam explains why the small and mid-sized buyout space is a particularly compelling segment of this evolving market in which to invest.
Autheurs
In the first part of our video series focused on continuation funds, otherwise known as GP-led secondaries, we highlighted the significant growth seen in this part of the market in recent years as wider exit options have narrowed – and the potential for this to continue in the future.
But a key question for investors seeking to gain exposure to this dynamic and rapidly-evolving segment, is where might they find the most attractive investment opportunities?
In the second episode in the series, Christiaan van der Kam, Head of Secondary Investments at Schroders Capital, highlights our conviction focus on continuation fund transactions in the lower mid-market. This refers to acquisitions of portfolio companies in small and mid-sized buyout funds, with enterprise values of less than $750 million.
In particular, he discusses the potential for these deals to deliver transformational growth thanks to a combination of:
A very wide and diverse investment universe, within which deals are often marketed directly to secondary investors with whom a fund manager has an existing relationship.
Lower entry valuations compared to transactions for large-cap buyout companies, in line with trends across the wider buyout market.
Greater potential for growth within the underlying companies compared to larger businesses, through expansion into new product areas, sectors or geographies, and by using new growth capital to fund strategic add-on acquisitions.
A broader array of eventual exit options, including sales to larger private equity buyout funds or strategic corporate buyers, with less reliance on IPOs.
Look out for the final part in the series, which will highlight a case study showcasing how GP-led secondaries can be used to gain exposure to compelling, growing companies.
Click here to read more about why we see compelling continuation fund opportunities in the lower mid-market.
Transcript:
Continuation funds are a growing and compelling part of the private equity landscape, accounting for around 50% of total secondary transaction volume each year, with expectations that the market will continue to expand in the years to come.
Within the continuation fund space, we believe market conditions will favour a focus on the lower mid-market. This refers to private equity backed companies and small and mid-market buyout funds with enterprise values of less than $750 million.
This space is particularly attractive due to its combination of a very broad investment universe, comparatively favourable entry valuations, and strong potential for transformational growth within investee companies, supported by a wide array of future exit options.
Given the wide opportunity set, the lower mid-market can also bring valuable diversification to investor portfolios, and recent history has demonstrated its potential to offer resilience during periods of market volatility.
To give a sense of the scale of the opportunity set in a lower mid-market, consider that there are at least 10 times more fund managers and individual funds with less than $2 billion in capital to invest, compared to the larger PE market. This is the potential investable universe from which new continuation deals will be sourced.
This large deal funnel, coupled with the fact that companies in a lower mid-market are less well known, makes sourcing transactions in this space more challenging. In fact, continuation fund opportunities for these companies often do not hit the broader market and are marketed selectively to secondary investors with whom a fund manager already has a relationship.
As a result, secondary investors that specialise in the lower mid-market, and that also have broader platforms through which they invest on a primary or a co-investment basis, have a significant advantage in sourcing potential transactions.
On valuations, continuation fund transactions for lower mid-market companies are typically executed at lower entry multiples on average. This is in line with the wider private equity market, where small and mid-sized buyouts are priced at a significant discount to large-cap transactions.
This valuation discount in smaller and mid-sized transactions can be extended to an increased focus on operational value creation. We believe this is where the key attraction of investing in lower mid-market comes to the fore.
Companies in this space have greater potential for transformative growth. Put simply, there are many more value creation levers for companies that are smaller in size compared to larger companies that have already scaled, or that are already well diversified across segments.
These levers range from governance enhancements, to expanding into new geographies, product areas or sectors, or even consolidation via strategic add-on M&A deals.
In addition, small and mid-market companies have a wide range of exit options available. This means that there are multiple avenues for GPs to realise the value of the growth achieved during the life of the investment, irrespective of wider market conditions.
These options include sales to other larger private equity funds, which currently have a substantial war chest of capital to deploy, or sales to strategic corporate buyers.
We anticipate GP-led transactions will continue to represent a particularly compelling opportunity in the current exit stressed market – and especially within the lower mid-market. Furthermore, as these transactions solve for key limitations of private funds concerning investment thresholds or life span, we expect this growth to persist in the future even as deal and exit activity fully recovers.
Subscribe to our Insights
Visit our preference center, where you can choose which Schroders Insights you would like to receive.
Autheurs
Topics