Preferred equity: an alternative to secondaries and debt
While the secondaries market is providing a convenient avenue for limited partners to sell fund stakes and access to liquidity, alternatives such as preferred equity have become welcomed opportunities for LPs looking to preserve portfolio upside, explains Pierre-Antoine de Selancy, managing partner and co-founder of London-based 17Capital.
How does your strategy of providing preferred equity fit within the secondaries market and what makes it so unusual?
I founded 17Capital in 2008 to address a gap in the market between secondaries firms and debt providers. We are a specialist preferred equity investor with €800 million under management across three funds. Preferred equity enables investors to unlock liquidity without selling on the secondaries market or to increase investment capacity without the constraints of debt financing.
Investors with high-quality private equity portfolios can generate liquidity to meet obligations such as debt repayments and capital calls, or reduce private equity exposure. This may be a limited partner looking to manage the strategy and asset allocation of its private equity portfolio, or a fund of funds accelerating distributions to meet upcoming capital calls. Investors benefit from more competitive funding than a secondaries sale because institutions maintain ownership of their portfolios and the underlying fund manager relationships, and they also preserve the future-upside of their portfolios.
Private equity investors can raise capital to increase assets under management or to fund new or follow-on investments. This may be a general partner investing more in its portfolio companies, a manager of an evergreen or listed private equity vehicle making new investments, or a GP funding its team’s co-investment. Investors benefit from more flexible funding than with bank debt since there is no liability, term, covenant, guarantee or cash coupon; and investors keep control and ownership of their private equity portfolios.
What are some typical transactions you have done?
17Capital’s investment strategy is relevant across the market cycle. Since the global financial crisis, many of our transactions have been with private equity investors looking to raise capital to fund growth. They see us as a good way to take advantage of these investment opportunities. During the crisis, we worked closely with LPs and fund of funds, providing them with liquidity at a more competitive price than on the secondaries market.
We do a lot of on the ground work to identify our target market. We have built a team of best-in-class professionals to address our market and successfully deploy our €500 million fund, which closed in December 2014.
So far this year we have completed seven transactions across Europe and North America. Most recently, we provided top-up capital for a buyout manager to fund further investments, and for a GP to send liquidity back to its investors. In both situations, investors in the funds kept their portfolio’s future upside, which would have been lost with a sale on the secondaries market.
We have also completed a number of transactions with listed private equity firms. These include Altamir, the listed group managed by Apax France that raised capital to fund further investments, and Candover Investments, the listed investment trust that raised capital to refinance its existing debt and ongoing working capital requirements. Both transactions enabled the listed groups to avoid the constraints of traditional debt financing.
How do you usually get your money back?
As 17Capital is a passive investor, the quality of the private equity manager is paramount. Each of our investments involves a rigorous analysis of the manager, who has to have control over exits and be motivated to sell.
17Capital invests preferred equity in a counterparty’s fund, providing them with immediate liquidity. By investing alongside them, we form a fully-aligned partnership. Our senior position means we receive the first claim over the portfolio distributions until we have recouped our initial investment along with a preferred return. The counterparty receives all or the majority of the remaining distributions – the ‘portfolio upside’. It’s a way for investors with high-quality portfolios to achieve liquidity without selling to a traditional secondaries buyer and losing the upside.