Northleaf Insights: Private Equity Market Update - Q2 2020

Northleaf manages more than $10 billion of capital invested in over 500 private equity funds, secondaries, direct investments and credit investments across North America, Europe and Asia.

With the COVID-19 pandemic continuing to impact global markets, we have noted a pronounced shift in deal activity across the private equity mid-market. At the onset of the crisis, new investment efforts were “defensive” in nature and Private Equity General Partners (“GPs”) were focused on understanding the potential impact of the crisis and the liquidity needs of existing portfolio companies. As portfolios have stabilized, GPs are shifting their focus towards “offense” and have been evaluating add-on investments to existing portfolio companies as well as new platform investment opportunities.

Based on our discussions with GPs and intermediaries and our ongoing monitoring of deal flow, several themes have emerged across primary, direct, secondary and credit strategies.

Primary Fund Investments

Northleaf invests in mid-market buyout, growth and venture funds across North America, Europe and Asia.

Through Q2, capital raising for primary fund investments continued to move forward; however, many GPs slowed their investment pace and delayed their fundraising to focus on their existing portfolios. Fundraising activity has been progressing well for top-performing funds even in a “virtual diligence environment” but has slowed down for many other GPs. 

As in prior downturns, we expect 2020-vintage funds will be strong performers however Limited Partners (“LPs”) are ever more focused on established franchises with experience across cycles. Some market participants expect to see increased interest in special situations and distressed strategies, although LPs are being cautious given the substantial amount of existing dry powder in this segment and the new and opportunistic funds being raised.     

Direct Private Equity Solutions

Northleaf supports private equity-backed companies with a focus on LP Co-investment, Structured Capital and Active Co-investment.

LP Co-investment

Through Q2, we noted a decrease in the pipeline for co-investments with our core GP relationships due to the slowdown in new investment activity. Many GPs were focused on add-on opportunities within their existing portfolios. The majority of deals that continued to move forward were those that had been in progress prior to the onset of the pandemic or where the GP had a history with the company and management. GPs expect deal flow to pick up over the coming months as new platform acquisition opportunities come to market.

Structured Capital

GPs are increasingly exploring preferred equity solutions to support potential needs for portfolio companies. While more expensive than traditional debt, these instruments are often an attractive alternative to additional fund capital, especially where there is increased demand for follow-ons across a portfolio. There continues to be a steady flow of opportunities in this segment of the market as this source of financing is particularly accretive for acquisition-led growth strategies where exit horizons may be extended and/or where credit providers have become more conservative.   

Active Co-investment

There continues to be a steady stream of opportunities to invest alongside entrepreneurial independent sponsors and early-stage GPs who are seeking co-investment capital. The market remains open for deal-specific co-investments, although investors are being highly selective.

Private Equity Secondaries

Northleaf’s secondary investment strategy includes LP secondaries, Continuation Vehicles and Fund-level Finance.

LP Interests

Traditional LP secondary processes were put on pause or cancelled during Q1 due to the market turmoil and valuation uncertainty. Through Q2, large portfolio intermediated processes generally remained on hold, but smaller one-off LP interests started coming back to market as sellers used the secondary market for liquidity or portfolio management. We anticipate more robust deal flow based on Q2 valuations and through the back half of 2020.

Continuation Vehicles

GPs continue to explore continuation vehicles both for single companies and whole fund portfolios to provide liquidity to LPs while giving themselves a refreshed horizon to create value in performing assets. Very few opportunities came to market in Q2; however, it is expected that a pipeline of opportunities is building that will likely hit the market in the second half of 2020.

Fund Finance

Since March 2020, fund finance has been the busiest area of the secondaries market as GPs have evaluated cross-collateralized fund-level debt or preferred equity to procure additional dry powder for their portfolios. This is particularly the case for later-stage funds that are past the investment period with limited reserve for follow-ons.

Private Credit 

Northleaf finances private equity-backed mid-market companies and offers first lien, unitranche, second lien, and mezzanine securities.

Following the onset of the COVID-19 pandemic, loan volumes dropped significantly and activity was largely limited to add-on investments for several weeks. Syndicated private credit slowed and shifted to first lien and unitranche club deals. After a period of price discovery, the new issuance market has been opening up with deal flow and pricing bifurcated based on the magnitude of the COVID-19 impact. Issuances have largely been first lien and unitranches, with second lien and sub-debt in limited supply.

Through Q2, credit terms remained conservative with leverage levels decreasing by ~1.0x-1.5x, but incremental capital was available to borrowers that were relatively COVID-19 resilient. Pricing for new capital was ~150-250bps higher than pre-COVID levels for resilient names and lenders were repricing loans for amendments that required adjustments to covenants, EBITDA definitions or provided for other material concessions.

For more information, please contact any member of our private equity and private credit investment teams.

About Northleaf Capital Partners

Northleaf Capital Partners is an independent global private markets investment firm with $14 billion in private equity, private credit and infrastructure commitments under management on behalf of public, corporate and multi-employer pension plans, endowments, foundations, financial institutions and family offices. With offices in Toronto, Montreal, London, New York, Chicago, Menlo Park and Melbourne, Northleaf’s 150-person team is focused exclusively on sourcing, evaluating and managing private markets investments globally. Northleaf’s portfolio includes more than 400 active investments in 35 countries, with a focus on mid-market companies and assets.