Nigel Dawn - Secondaries in Private Markets (EP.378)

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2:31Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at CapitalAllocators .com. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions.

3:11Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast. My guest on today's show is Nigel Dawn, the global head of private capital advisory at Evercore, where he leads the secondaries business he started a decade ago. Under Nigel's leadership, Evercore has become the market leader in transaction volume and is involved in approximately 30 to 40 percent of all secondaries market activity. Our conversation covers Nigel's observations on the growing secondaries market, including its history, rationale for LPs and GPs, incentives, critiques, other liquidity options, and advice for both sellers and buyers of GP interests.

3:56Before we get going, it's springtime in New York, and that means it's time for Yankee baseball. Like each of the last 53 years, I've started dreaming about a perfect season with the Yankees finishing 162 -0. Now, that's never come remotely close in the history of Major League Baseball, and it never will. But after watching the Yankees sweep the Astros on the road the first four games of the season, thanks to the fielding and hitting exploits of star signee Juan Soto, I'll quote the great comedian Jim Carrey in the movie Dumb and Dumber. So you're saying there's a chance. It's highly likely by the time you're listening to this that the perfect season will have ended.

4:41But in this moment, I'm still dreaming. So as the weather turns and you find yourself outside enjoying the sunshine, but a little sad that your baseball team, hopefully the Yankees, won't be perfect again this year, at least you can turn to that podcast app on your phone and listen to Capital Allocators for about as perfect an hour as you can get each week. Thanks so much for spreading the word. Please enjoy my conversation with Nigel Dawn. Nigel, great to see you. Great to be here. Appreciate the invitation today. Why don't you take me back to your upbringing and path to being in the sea? So I grew up in Sheffield, England, which is a northern industrial town.

5:24Many people will know it from the Full Monty, which is, of course, a movie about male strippers who are redundant workers. I went to Newcastle University and studied politics and then East Asian studies and spent a year in China learning Chinese, which was very early. That was 1985. So that was many years ago. And got into banking, actually, commercial banking with a group called Standard Charter Bank and moved to Hong Kong to work for them and then ran a business in China, which was actually a lot of fun. I enjoyed in the south of China in a city called Zhuhai, which was one of the original special economic zones.

6:04And I met my wife there and followed her back to the US, needed something to do, got an MBA, after my MBA, become a management consultant, and then eventually wound myself around through UBS and then Evercore to this seat. your time at UBS. How did you find your way into these nascent secondary market? I started off in business strategy and fixed income. And then I was the chief operating officer of the global trade finance business. And somehow I ended up running a portfolio of e -commerce investments. When the banks were worried about the technology companies eating their lunch, they got together and they formed various platforms to transact their business on.

6:50For example, FX became FX All. US government bonds became TradeWeb. Off the back of that experience, I was asked to sell a portfolio of LP interests. It was about a $2 billion portfolio, which had come together through M &A activity. UBS merged with Swiss Bank and bought Payne Weber and Dillon Reed. Everyone had a few funds. When you put them all together, it was $2 billion. People said, wow. So I was given the job of selling them into the market, which didn't really exist. So when I first found out, there's only one advisor and they were a startup in Dallas called Cogent Partners. I Googled secondary buyers, came up with a number of names, and then ran a small auction in 2001.

7:35And then to remove most of the other funds, we actually executed a large structured billion transaction with Harborvest partners led by a young associate called Jeff Key, who is now one of the leaders of that business. It is amazing in this business what they've achieved. We put together a transaction, which probably looks a little bit like one of today's securitizations. And during the course of the transaction, we explained it to the CFO at Harborvest, who said it was not possible what we were contemplating as she swept out of the room. we did it anyway, we closed the transaction. And that's the history.

8:14How did the secondary market develop from that initial significant harbor -vest transaction? It's interesting. So on the back of that, I was asked by Richard Alsop, who ran UBS's private funds group, the fundraising, to come and consider starting an advisory business to advise LPs who were interested in getting liquidity, which is very, very new at the time. The trust transaction got a lot of press, so there's a lot of interest, so why not go and do that for other people? Also, maybe 40 to 50 % of the flow in the market was actually bank selling, similar to UBS. We also found out institutional limited partners who felt like for a variety of reasons, they need to remove non -core exposure.

8:56One of the early ones, very notable, very public, Ohio Bureau of Workers' Compensation. We worked with various public pensions, financial institutions, and this business started to develop. And I think LPs realized the stigma that was associated with selling LP interest was gradually receding. In those early transactions, you mentioned that stigma. What was that dynamic between LPs and GPs? Most LPs were very concerned about asking the GP for the right to sell because every transaction, and you require the consent of the GP. And often then, less so now, that was in the GP's sole discretion. In some ways, it was considered similar to asking a spouse for a divorce.

9:42Why would you do this? It's embarrassing. At that time, it was definitely considered odd. How did it evolve from that in that period of time as you built this advisory business at UBS? There's a few catalysts. Definitely, world financial crisis was one because then a lot of LPs had to sell. Probably remember you went from the years 2004, five, six, seven, where LPs made somewhat unprecedented commits on private equity. And then the economy fell off a cliff and there was a challenge funding a lot, particularly endowments and foundations who are way overweight private equity. There was a big concern they couldn't meet the capital calls.

10:23So during that time, we worked with endowments and foundations and the principal reason for the transaction was to remove unfunded exposure that they were concerned they could not fund. And during this period, public pension funds, in addition to banks and others, were sellers. On the back of that, it became more usual and more normal to be a seller in this market. As a result of that, a momentum developed where it was okay to sell. And selling was not just about being distressed. It wasn't just about removing non -core exposure. You could actually use the secondary market strategically to reposition your portfolio and think about it in terms of more of a relative value transaction.

11:06I can sell these funds at a certain price. I can reinvest into this exposure and perhaps get a better return. So I think during that time, the development of the secondary market and the sophistication probably matched the development of LP sophistication at the time. If you look at that post -GFC transaction volume, just rough sense, what did numbers look like that for the industry back then? When I started off, it was about a $6 billion market. Back then, it was probably around a 20. Still pretty small. If you roll the clock forward to today. Last year was about $115 billion. 2021, which is a high watermark up to this point, is about $130.

11:52And I suspect we will beat that number this year. So as this business is starting to get traction in the community post -crisis, you have a little change in your career. So what was the dynamic that led you to join Evercore? I had a great run at UBS. I loved it. I'd been there 16 years. I felt like I was given a great opportunity to set this business up and grow the business. I was looking for a new opportunity, perhaps a little more entrepreneurial. So I met Ralph Schlossstein, who was the CEO of Evercore at the time. And he convinced me that Evercore would be a good platform to grow a business like this.

12:31Also, I think that these are pure advisory businesses that require no capital. And the They're challenging to run in big integrated banks that do require a lot of capital. So I thought this was a natural platform. And also Ralph was one of the co -founders of BlackRock. I thought it was very interesting to work for someone who really understood the asset management business and was willing to lean in to help us grow this business. What are the subtle differences you've seen between a leader who came from asset management compared to a leader that's running a bank? Well, I thought in the case of Ralph, it was a business builder.

13:06somebody who's built a business rather than somebody who's just focused on doing deals. It's a founder's mindset. Evercore has a more long -term perspective on clients and how we work and realize it's not all about doing the deal this year. What's the scale scope of your team today? We started with 10 people in 2013 and 10 who miraculously all appeared on the same day, happened to be at UBS coincidentally. We're about a hundred people right now and spread between Chicago, New York, London, and Singapore, we really focused on two main things, which are advising limited partners on the type of business that most secondary groups still direct most of their capital do, and a very active GP -driven business, which is mostly, but not exclusively, continuation funds.

13:56So let's break apart those two. You started talking about this original distressed interest from the LP and turns into more different use cases. How do you think about the breadth of why an LP does one of these transactions today? There's a number of reasons. It's usually strategic in a sense that it could be I have non -core exposure. I'm not going to re -up with these particular managers. I would rather use that capital that is invested in those managers right now and redirect it to core managers going forward. That's one reason. Sometimes it can be actually that it's core managers, but it's old funds.

14:35So I will sell my old funds to reinvest in the new funds so I can generate co -investment business. And old funds don't generate co -investment business. Many LPs these days have very active co -investment program. So they would do it for that reason. I think other reasons are strategically pivoting between buyout and venture and growth. So I might be overweight, buyout, maybe this is a great time in a market like this to be in growth. More relative value transactions are being executed these days, particularly with, I would say, public pensions who are over -allocated to private equity compared to their benchmarks.

15:15So maybe they're supposed to have 15%, but actually there's very few distributions over the last few years, they may be at 20%. So there comes a time maybe to rebalance towards the benchmark they're supposed to be adhering to. Through most of the early years of this, you said LP -led transactions or some LP use case, they're going to the GP. At what point in time did the GPs get involved in initiating some of these secondaries. When I think the first continuation funds, as we know them now, probably about 10 to 12 years ago, sometimes they're called zombie GPs, franchise challenge GPs. Some of the GP who had a portfolio, they were coming to the end of the fund.

15:57They were what you would say under the pref, so they were not going to generate any profits, but the assets still needed to be managed. There was some upside on them. So the GP would go to the advisory board and say, I'd like to issue a secondary transaction. So I sell my portfolio into a new fund and we'll reset the fees and carry. If you're an existing LPs, you could just roll into this new fund on your existing terms. But for those who want to sell any new investors who would come in, they would pay the new fees to motivate and incent the GP. That was about 10 years ago. If I bring that forward to today, these are the best GPs with their best assets, leveraging the secondary market for a number of reasons.

16:42Often it's a single company continuation. This is often their crown jewel, trophy asset, where in the past, a managing partner may have to sell their best assets to generate liquidity, to get DPI back to the investors so they could raise their next fund. A continuation fund allows them to achieve most of those objectives, to keep a hold of their best assets, to generate the next leg of growth and return for their own investors while at the same time providing an option, but not a requirement for their LPs to take liquidity. So that is a fairly major development. That could be one company. Or in this environment where distributions have almost been at historic lows compared to assets under management, execute a transaction really designed to generate a DPI for their investors across a number of their companies.

17:35And these could be three, four, five more companies, where you would put them together, sell them into a new vehicle, provide an option for their investors to receive liquidity from the buying group, often dedicated secondary groups to roll over into the transaction on their existing terms. What does pricing look like across these different types of transactions? Start with the LP business. So in this market, which is good, good quality buyouts probably in the 90s. Venture and growth, very much name specific. So some managers still very difficult to access. So you pay an access premium, but probably more like 60 to 80 cents on the dollar because there'll be a skepticism still about the manager's marks from 21 deals beginning of 22 deals.

18:19So that's probably where pricing is. Generally on the GP side, that on a single company, it usually transacts around the GP's NAV. Typically not at a discount, but if it is, it's at a modest discount. As you look at the market today, which is north of $100 billion annually and growing, how do you bring these buyers and sellers together? Our job really is on price discovery. A GP -driven transaction is really price and terms discovery, Like an LP transaction is really about price. Our job is to run the auction process to get best price for the LP. And what that can mean, and this market has become more sophisticated, is the best price for each asset.

19:02So if the portfolio, for example, consists of a buyout venture, real estate, infrastructure, we want to find the best price for each particular asset or each particular asset class. The development of the secondary market means there's dedicated infrastructure, secondary buyers, dedicated venture buyers, dedicated buyout buyers, and dedicated private credit secondary buyers. So trying to fix that puzzle just so we generate the best price is the importance of an advisor in this market. On the GP side, given that the GP is conflicted in that on both sides of the transaction, having an honest broker between to make sure the best price is achieved for the selling LPs and terms are appropriately set by the market is really our role there to make sure it is a fair transaction.

19:52When you look at the buying side of this market, what is the composition of the buyer base when you map that to transaction volume? Mostly it's still large dedicated secondary groups, Alpenvest, Lexington, Kala, strategic partners, Harborvest and the like, who have raised large funds that can invest both in the LP market and the GP market. And that is still, in terms of the buyer base, the majority of the market. In addition to that, there are dedicated groups who just focus on LP transactions and those who are just focused on GP transactions. The growth of the market over the last few years has been on dedicated GP transactions.

20:34So what we're seeing right now, I would say a fairly new development is traditional buyout managers actually looking to set up their own secondary funds just focused on investing in single asset continuation funds. And some of these GPs, particularly those who get a meaningful part of their deal flow from other GPs, will look at this as a hedge on their core business and an opportunity. And if one takes a position going forward that in the sponsor -to -sponsor channel, a lot of the really best companies actually won't be in the sponsor -to -sponsor channel. They'll be in the sponsor -to -continuation fund channel, which was around 10 % of exits last year.

21:18Then these managers will take the view, if my job fundamentally is to get exposure to the best companies for my LPs, even though the majority will still be through my main fund, then I need a pocket where I can still get exposure to those companies. And that might, even if it's via a continuation fund, as long as the returns make sense. And as long as I'm an acceptable investor for the GPU is issuing the continuation fund. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past? Partner with a company that's been defining the future of dealmaking for nearly two decades instead.

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22:54So in this example, you can envision a GP not wanting certain GPs to participate in their deals and have transparency in their process. What have you seen in that GP dynamic for the sponsors who are setting up secondary funds? I would just preface it saying, one, it's very new. So this is evolving. The second thing is the capital base for single asset continuation funds is very, very small right now. And there was about $20 billion of single asset continuation funds done last year out of $50 billion of GP driven. transactions executed. Our sense is, A, they would value the capital right now. Having the capital is valued.

23:43But often it will be a GP investing in a company where the GP is smaller than they are. So they were generally looking to buy from smaller GPs, and then they work on the companies, and then they sell those companies on later. So what we found often, they will bring some capabilities that maybe a smaller GP doesn't have. Even though they are a passive investor in a continuation fund, there's some value added they can bring that maybe increase the value of the company in a continuation fund, but also clearly will position the GP who has set up a continuation fund to be the buyer of choice at the time those assets are then sold.

24:27You mentioned early on that if an LP went to sell, they were looked at to say this is a separation, a divorce. What are some of the interesting dynamics that you see between LPs and GPs in the process of secondary transactions? There's been a big evolution over the last few years. Several years ago, a lot of LPs did not like continuation funds for a variety of reasons. Their concern was they are inherently conflict transactions. LPs generally don't like conflict transactions. However, I think a lot of LPs appreciated the industrial logic of why would you sell your best company, particularly to another GP, to a competitor, so you can watch them generate two to three times the money after you've generated.

25:13So that was a problem. That is the asset you don't want to sell. So if that transaction can be set up in a way that provides a fair option to the selling LP at a fair price, then that would be a good transaction. So it'll about a year ago issued updated guidance on continuation funds. And the key change in the guidance was the LPs in the selling funds need to be offered a status quo option. In other words, the option would mean economically, I'm in the same spot as I am right now, which really means if that LP wants to continue being invested in the asset, their carried interest is not crystallized at the time.

25:57Effectively, it's held in escrow until the final determination of the company when it's finally sold. That change set the guardrails for the growth of this market. The size of this market, you're talking about $100 billion. There's so much more in just private equity alone. How do you think about this mechanism as providing liquidity for a much, much larger industry? The secondary market is around 2 % of outstanding AUM. In some ways, it's hardly a secondary market at all. I think that the change will be the amount of capital being raised by secondary funds right now. We've seen a couple close this year in $22 billion.

26:37There's others talking even north of that. Plus, I think when the new entrants I've just identified, the types of group start their secondary funds just focus on single asset continuation funds, then we anticipate the syndicate market for these transactions will grow rapidly because you'll have well -known GPs entering the market with their secondary funds. Their investors are used to co -investing with them and it comes with their mark of approval on the transaction. Plus, they're working with their secondary fund partners who may be already existing investors in their funds. So I think that accelerates this market.

27:20In some ways, it could supersize it in the relatively short term, short term being three to five years. So alongside this large private equity market with a smaller secondary market, you've got this burgeoning private credit market, also with liquid assets. What have you seen in terms of secondary liquidity to private credit? It's a good question. So it's probably one of the areas of the market that's getting the most attention right now. A significant amount of capital has been raised in the secondary credit market to buy portfolios. It's still early days and it is an asset class that naturally unwinds.

27:59So will it be as big as a private equity market? I doubt it. But at the same time, in the current market, private credit is probably trading in the 90s. So for an LP looking to generate liquidity across their private assets portfolio is a good place to look. So we are positive on the growth of the market, but it's still relatively small compared to private equity. If someone was sitting in your seat and seeing all of the transactions that happen, all the ways GPs are behaving, all the ways LPs are behaving, what are some of your favorite stories of either good practices or bad practices? For a GP -driven transaction, the rationale has got to be there for why you're issuing a continuation fund.