Independent Thinking^®

Q&A with Nigel Dawn on Secondary Market Continuation Funds

Editor’s note: Nigel Dawn is the global head of the Private Capital Advisory Group at Evercore, leading a global team in originating and executing secondary market transactions for owners and managers of private financial assets (private equity, private infrastructure, and others). Clients include both General Partners, or GPs, and Limited Partners, or LPs, such as financial institutions, university endowments, publicly quoted investment vehicles, and public pensions. Here are some highlights from a recent conversation with Independent Thinking.

Q: Let’s first address your market from the perspective of high net worth investors and related nonprofits, notably foundations and endowments. Why should private investors be interested in the secondary markets?
 
A: I think the attractiveness of this market is in the potential returns. Effectively, you get to buy private equity at “spot” prices. [Editor’s note: Spot prices are the current liquid market prices of securities.] That’s much better than the primary private equity market where, no matter how good the manager, it’s still 100 cents on the dollar when you are raising a new fund. Also, this is a market where you can deploy your capital relatively quickly and get it back quickly, given you are buying mature assets.
 
Q: It’s also a market that many investors don’t fully understand, perhaps because it’s changed so much. How do you see the evolution of continuation funds, the strategy that you are known for developing?
 
A: The secondaries market has pivoted from propping up low-quality GPs with challenged assets to enabling the very best GPs retain their best assets. [Editor’s note: A General Partner is the manager responsible for running a fund.] The appetite to repurpose the continuation fund structure was around for some time, but the pandemic was a catalyst that accelerated widespread adoption.
 
GPs needed to find a way to ‘buy time’, while providing money back to their investors and while raising new money to support their best companies. We saw that continuation funds could enable them to retain their best companies in all market conditions and offer their investors the choice of selling and receiving cash or continuing to invest in those companies alongside the GP.
 
It was a huge switch, and then it became a natural evolution, with a strong industrial logic. In the continuation funds transactions, the GPs are well aligned with their investors; they usually start with around a 2% ownership share in their primary fund, but that can potentially rise to between 8% to 10% after the continuation fund has been executed – this is the result of the GP rolling their own gains back into the company.
 
Q: This shift must be causing some ripples in the marketplace.
 
A: Good GPs no longer have to sell to another GP and watch them make money in the next phase of growth. It’s a very appealing strategy for them and their investors. Of course, private equity managers who buy a material proportion of their new companies from other private equity managers may see continuation funds as a threat. Continuation funds can potentially generate better risk-adjusted returns for LPs, because the GP is picking the best assets – that’s positive selection bias – and they are putting their own money behind them. There are unlikely to be skeletons in the closet when you “re-buy” a company you already own – which is not something you may know when you buy into a brand-new deal.
 
I don’t think continuation funds are a long-term threat to the IPO market. It simply means that smaller managers can retain their winning companies until they are big, like a recent client that has a one-billion-dollar fund and a continuation fund with another one billion dollars. They are currently so successful that they don’t see why they should sell.
 
So, some ripples. But we are seeing positive changes with recent deal flow and institutional LP guidelines, which can act as a template for future continuation funds.
 
Q: Will we see further layers – continuation funds of continuation funds?
 
A: We are already seeing some managers wishing to extend the time of their continuation funds. The only constraint on the growth of the GP-driven market is capital. Capital is scarce for GP secondaries in general, and for single-company funds in particular. But we are starting to see a lot of capital formation now. I expect this market to grow significantly over the next three or four years, perhaps fivefold to a 500-billion-dollar global market. The more capital, the better.
 
Q: So, Nigel, what are you looking for in your clients?
 
A: Generally, great managers and great assets. They should have already generated good returns, and it should be clear to us that there is additional return to be generated. Usually, it’s an established manager who has held the company for at least two years.
 
The secondaries market is about diversification, by geography and sector. ICG, for example, has a pet cemetery business, a car wash business, and an SAS business. [Editor’s note: See the interview with ICG here.] But mostly, it’s about the people. Is there a great GP, a great management team? Do they believe in their asset – are they putting real money behind it? Do they have a credible growth story?
 
Q: There are plenty of Englishmen in New York investment banking circles, but relatively few from the northern industrial city of Sheffield. Clearly, Evercore is a great fit for you; how did you come to be here?
 
A: After graduating from Newcastle University, I started working at Standard Chartered Bank, in Hong Kong and mainland China, where I met an American woman. That led to a family in New York, an MBA at Columbia, 16 years at UBS, and finally, the move in 2013 to Evercore, where I’ve been fortunate to lead the global growth of this still new and very exciting specialist business. No complaints.
 
For further information on investing in illiquid alternative assets at Evercore Wealth Management, please contact Partner and Portfolio Manager Stephanie Hackett at [email protected].