When PEs take minority stakes, they expect to exit a firm through an IPO or a strategic sale. In many markets such as India, it can take longer for a firm to mature and do an IPO. But most VC or PE funds have a life of 10 years by the end of which they need to return the capital to investors. Secondary deals provide an alternate source of liquidity.
For instance, many PE-backed firms, who had planned their IPOs this year, had to defer them in view of the market correction. Similarly, between 2011 and 2014, there were few IPOs. When that happens, companies and investors start looking at alternate sources of liquidity.
“Limited Partners (LPs, investors in PE firms) have a 10-year window on investments. Liquidity events such as Walmart are fewer and fund managers (general partners) feel that they need to take some money off the table every three-four years,” a fund manager said.
In 2011, Gupta founded NewQuest Capital with three others when they spun out from Bank of America-Merrill Lynch’s Asian PE business to focus on secondary deals in Asia. The opportunity: most PE/VC
funds that had raised money between 2000 and 2007 in Asia had deployed the same by 2011 and were looking at alternate forms of liquidity, as a result of a slowdown in capital markets.
Most of the funds from the 2006-07 vintage have been around for 10-12 years, and many have received extensions. At some point, LPs have to exit. “Over the next 2-3 years, we are going to see many end-of-fund life transactions in Asia,” says Gupta.
While there’s growth in Asia, it takes longer for companies to be large enough to list or be of strategic interest. As such, companies in Asia will have to change hands a few times before they are ready for an IPO or a sale.
Previously, companies would raise money and IPO in three years; now this can take ten years. Investors don’t want to hold them for more than 5-7 years.
NewQuest specialises in providing alternative liquidity solutions to private equity asset owners on a direct and indirect basis. It acquires private equity positions directly through portfolio and single asset transactions and can also partner with incumbent managers to provide liquidity to limited partners. Sometimes, a general partner may need a few more years to maximise the value of a portfolio while an existing LP may not be able to hold on for that long. In these situations, NewQuest would partner with the general partner to restructure these funds and leverage the incumbent partner’s knowledge and relationships to maximise value of the underlying portfolio.
VC firm Lightbox, which bought the India portfolio of two PE firms and then raised a fund, followed a similar path. NewQuest, now investing through its third $540-million fund, typically targets more complex fund restructuring transactions and would sometimes work with other large LPs to restructure funds.
Secondary deals can take place at the asset level where a secondary player directly acquires an asset or a basket of assets from a PE investor. Sometimes, secondary deals can take place at an LP level. For instance, a PE firm, with say 10 investments, has exited five but its fund life has come to an end; it hopes to make meaningful returns on the remaining five if it can hold them for another three years. In this case, a secondary player can partner with the incumbent general partner to restructure the fund.
While PE investments in Asia has been growing, the distribution has not kept pace with investments. In the US, for every $1 invested in a year, PEs are able to return $2 to their investors. In Asia, for every $4-5 of new investments, only $1 has been returned, which means these businesses need more time and capital to grow. For minority investors, liquidity expectations were driven by capital markets. But when IPOs don’t happen, there’s a need for alternate sources of liquidity. That may change as more buyouts happen, and PE firms and investee firms will be less dependent on capital market for exits.
Other players in the secondaries space in India include TR Capital (Asia and tech-focused), Partners Group, Lexington, HarbourVest, among others. Few have some sort of solutions business but a big part of their strategy is buying passive LP stakes.
NewQuest Capital has raised US$1.3 billion from three funds and made over 20transactions across Asia, including 10 in India. It focuses on China, India and Southeast Asia. It has raised three funds: US$390 mn in 2011, US$310 million in 2013 and US$540 million in 2016. It has exceeded its targeted returns for fund 1, returned significant capital in Fund 2 and will start harvesting exits from fund 3 from next year.
Typically, NewQuest targets to deliver an overall return in excess of 2x. PE firms target 25 per cent IRR and 2.5x multiple from its deals. In secondary deals, the investment cycle tends to be shorter at 3-4 years than typical PE firm. Similarly, the fund cycle is shorter at 8 years versus 10 years for PE firms.
The quest for secondaries
Amit Gupta, founding partner of NewQuest Capital Partners
Most funds from the 2006-07 vintage have been around for 10-12 years, received extensions. At some point, LPs have to exit
The need for liquidity is the main driver for secondary deals. Next 2-3 years to see many end-of-fund life transactions in Asia
The fund is getting more active in India. The fund will invest $400 mn in India this year versus an average of $250 mn a year
Secondary specialist NewQuest Capital has raised $1.3 bn across three funds and has done 20+ deals, including 10 in Indi
NewQuest is reportedly in talks to buy US VC fund NEA's India portfolio as well as four firms from IDG Ventures' first fund