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Investors opt for debt as alternative to secondary sales to generate liquidity
by Lisa Fu, Nicholas Morgan and Kezia Kho
Investors are increasingly seeking financing as an alternative to selling their fund stakes on the secondaries market. Their goal is to generate liquidity as they seek to make new fund commitments, rebalance portfolio allocations, and maintain relationships with private equity sponsors.
In these deals, the limited partner borrows against their private fund stakes. These financings have risen in popularity in recent years, partly because private equity firms, saddled with years of weak M&A volume, have trouble exiting investments and returning capital. The resulting lack of distributions and extended private equity fund terms have led some investors to use debt to generate liquidity.
“The need for liquidity solutions is just much greater in this environment than it was previously,” said Michael Hacker, global head of portfolio finance at Carlyle AlpInvest. “Since 2022, that pressure on LPs has really been a contributor to the growth in [this type of] financing.”
Debt collateralised by fund stakes has been historically used by secondaries firms, but more institutional investors are adopting the technology to generate liquidity. Investors might need the liquidity to rebalance portfolios, commit to new funds or bridge capital needs elsewhere in the portfolio with distributions remaining weak.
This debt can offer loan-to-value ratios of around 40% to 60%, according to Hacker. This compares to the 10% or 20% associated with a traditional net-asset-value loan, which is offered to GPs and backed by the underlying assets of a private fund. Lenders are willing to extend more capital because the collateral of fund stakes is seen as more diversified and safer.
The need for liquidity solutions is much greater in this environment
Michael Hacker
Global head of portfolio finance
Carlyle AlpInvest
In the event of a default, fund stakes are relatively easy to sell, as the secondaries market has grown. With traditional NAV lending, in the event of a default, there is complexity associated with having to foreclose on the underlying portfolio companies.
“It is an alternative for LPs that say they want to sell, but they want to keep the upside and get some liquidity,” said Ed Goldstein, partner and CIO at Coller Credit Secondaries.
Debt collateralised by fund stakes may also become an attractive option to LPs if the discount on the secondaries market gets too wide and they feel they cannot get a good price for their fund stakes.
This debt is also a fast way to generate liquidity compared to a portfolio stake sale. Transactions can be completed within weeks, compared to a secondaries sale, which can take months, one lender said.
Lastly, turning to debt can help some LPs preserve their relationship with GPs, which tend to dislike investors that sell positions often. A sponsor is unlikely to open up its next fund to an LP that has a pattern of frequently selling fund stakes. They may want to save the spot for an LP that will invest with the manager through the life of the fund, said Richard Sehayek, co-head of European alternative credit at Ares.
Family offices and insurance companies have been some of the fastest adopters of fund stake debt, lenders say. Family offices tend to have a flexible mandate, and they have fewer options for financing compared to other institutional investors that can issue public debt. Meanwhile, insurance companies have historically been comfortable with using both leverage and securitisation, so this type of debt feels like a natural fit.
That said, other types of LP have been hesitant to adopt fund stake debt as a financing option. Most institutional investors are wary of leverage in general, a former endowment investor said.
Endowments and pension funds prefer to be unlevered. If they need financing, they will go to a bank, said a consultant to institutional investors. If they are using fund stake financing, it’s likely because GPs are pushing it as a way to get LPs short on liquidity to re-up on the next fund, the consultant said.
