Article: Behind the Growth and Maturation of the Secondaries Market

Northleaf Private Equity Growth Secondaries Market Northleaf's Michael Flood (MF), Managing Director & Head of Private Equity, and Matt Shafer (MS), Managing Director, recently sat down with David Snow of Privcap Media to discuss the COVID era of secondaries, new solutions for GPs, GP-led continuation vehicles and fund-level leverage strategies. Below is an edited transcript of the podcast.


Today, we will learn about the evolution of the private equity secondaries market. You both had front-row seats for the development of that asset class, so I am fascinated to hear what you have to say about both the market in general and how Northleaf chose to structure its own secondaries business. Mike, what is behind the spectacular evolution of the private equity secondaries market to date?

MF: We have been investing in secondaries since the early 2000s, which was the early days of what has become a fast-growing, innovative, exciting sector of the private capital markets. Sellers and CIOs saw this market as an accepted tool of portfolio management to rebalance and optimize portfolios. The last ten years of fundamental shift in the market has been around increased volume. Within that, we have seen increased GP involvement as they have seen the secondaries market as a benefit for growing their franchises. And, within that, we have seen an emergence of innovative transactions and structures. Finally, as the secondaries market has grown, we have seen private market asset classes other than private equity, such as private credit and infrastructure, increase volumes of transactions.


How has Northleaf structured itself to take advantage of the increasing complexity in the secondaries market?

MF: Our broad private equity program has a mid-market focus. We see market inefficiencies and better return opportunities in the middle market. We have built a one-stop shop where we have built the strategy, the team and the process to be able to execute transactions across the spectrum of deal types, from LP secondaries to more complex, single-company continuation funds to preferred and structured equity transfers.


The secondaries market used to be seen as a place where LPs would transact with each other, perhaps somewhat sheepishly, with the blessing of the GP looking on. Increasingly, the secondaries market has become a place where GPs can go to solve their own challenges. Matt, talk about some of the options that GPs have today from the secondaries market and why they would want to pursue them.

MS: The secondaries market, if we step back, was an indirect way of achieving liquidity on an LP-to-LP basis. Now, it has become a way for GPs to organize themselves, or organize processes, to provide LPs liquidity in ways that were not there before.

I will give you an example of a single-company continuation fund deal we did last year. We did it on a proprietary basis with a GP that we knew very well. They had an investment in a company that had grown tremendously. It is a category-defining business: great market share, but still growing at about 30 percent a year. The company had very high margins, high free cash flows - all the things you look for in a great investment. We came into the process and we capitalized a new fund. The new fund bought the ownership position from the old fund. It sounds straightforward, however, the negotiation, structuring and documentation required was very complicated. This transaction enabled us to gain exposure to a great company at a price that we felt really good about. It also gave the sponsor the ability to continue to have exposure to this great business that they had been working with for years. It gave the management team a lengthened horizon to realize their growth plans, and it still gave great value and a great result to the LPs who sold.


Talk about the extent to which fund-level leverage is being used in secondaries transactions.

MS: The secondaries market has adapted some of the thinking and technology from the leveraged finance market in terms of providing solutions at the fund level. That enables the sponsor to put more capital into the company. For example, if you have a portfolio company that is maxed out on leverage, you can incur debt or preferred equity at the fund level and use that capital to support the portfolio company. In today's environment, people are going to be holding companies a little longer than they thought they were going to be. And that has increased the need for innovative solutions to get capital either for offence or defence at the portfolio company level. The secondaries market has adapted to meet that challenge.


Northleaf Capital Partners is a global firm, a multi-asset class firm. How does that broad range of activities across the alternatives world benefit the secondaries strategy?

MF: Our platform is middle market-focused across our three asset classes, private equity, private credit and infrastructure. Within private equity, we do secondaries, primaries and directs - and each of those strategies is pointed at the middle market. As the secondaries market continues to evolve, it includes assets that have credit characteristics and infrastructure characteristics that the private equity secondaries business will invest in. We can tap our investment teams and talk on a daily or weekly basis to execute on those transactions.


What makes you most excited to be participating in the secondaries market during an exceptionally volatile market?

MS: I am excited about the flexibility that we have as a secondaries investor. This has been an unprecedented time, in terms of the need for companies to be supported by capital in a variety of ways, where smart money is making a difference to businesses across the country and around the world. Private equity is a big part of that.

MF: I am excited about the future and how we can bring our platform – including our private credit capabilities, our infrastructure capabilities and our private equity capabilities – to address the deal flow that is going to come from this dislocation.