The Discount Is the Wrong Question in Private Equity Secondaries

16:42Richard Chow:So those two things happened maybe in the first three months of the year. Some of these universities, unfortunately, then hit the headlines as they're thinking about liquidity needs for your own programs. And how should they access the secondary market potentially to, one, exit from companies that maybe were disfavored? But two, from the standpoint of real liquidity needs, that they needed to go fund a budget shortfall. So a lot of that is more done strategically. There's not done reactively. But certainly there were some people that were paying more attention to what their private markets portfolio look like.

17:16Richard Chow:So usually if that happens, some less reaction is more directive of let's manage for risk and let's actively manage some of that tail risk, if you will. And this year, no different.

17:26Kison Patel:That's a good example of a driver. Then somebody goes to ask their chatbot who's the best advisor for the secondaries deal. And then they call me. To talk to Richard.

17:35Richard Chow:From the advisor's perspective, the PJT model is one where we're trying to give a really good perspective on what the market can bear. and we're not the complete solve when it comes to bid-ask spread because everyone's trying to manage the risk. And again, in terms of fairness, it's the attribution and offloading of that risk onto your counterpart. But we try to give a very balanced view in terms of our activity and we're probably 50-50 in terms of LP versus GP-led deals.

18:03Kison Patel:This is similar to like a typical bank sell-side process where you have a meeting, you've helped understand the value, what expectations should be if you end up taking this asset to market, and then you essentially go market the asset and find a buyer and lock it in.

18:19Richard Chow:So the first question people usually ask, what's the discount?

18:22Kison Patel:Exactly.

18:23Richard Chow:What has been the pricing of these assets? And I always say, you have to have some context for what you're selling. In the case of Chinese tech, there are very few US persons, US firms that were willing to take on some of that risk. But in a regular way, let's start with that. There's a reference date to some of this activity. The GP has marked their book as of a certain date. And a lot of activity has happened since that reference date. And it could be that you have some assets which are public, which the price of those stocks have moved up or down. Some of those assets might have, in the case of last year, real meaningful exposure to tariff for pricing.

19:01Richard Chow:And so it's really hard to anticipate in some of those cases what the actual operating margins were going forward. today, if you think about that for a second, the real supply chain risks that some of these companies are facing given straight-up or moves. So things have happened in the macro post that time that the GDP has marked the book. So we can't take that away when a buyer then thinks about discount or premiums that they're willing to pay. So that's one. The buyers are aware, and I think the sellers should then be much more thoughtful about the questions they do ask outside of price. It should be, what does the buyer's cost of capital in this point in time?

19:37Richard Chow:So you may be much more off risk because of the things that are happening in certain assets or asset classes, strategies like software, or in the case of tariffs, where you have companies that are much more exposed to the cost of labor, for example. What is the remaining upside in these assets? How long do you think the GP is going to be holding onto these assets? What do you think the right point of time of inflection and exit is going to look like? And in some cases, like a mortgage broker business, which is very, very susceptible to interest rate movements, what is your view on interest rates?

20:08Richard Chow:Is that going to soften anytime soon? Are you going to have a more accommodative fit? And the last piece of this is, if you were to sell this asset, and you were able to take that price and capital back, do you have a home for that asset where you redeploy that asset into a higher generating return investment? And over what time are you going to be able to get back to$0 if you have to take a discount? So all those things are more informative questions that we should be helping the seller think through as opposed to the reflexive one, which is, what is the discount?

20:39Kison Patel:Yeah, it's not transactional. You're really coming as a strategic advisor to look at this whole picture, the timeline, the sort of broad view in the market, and then what are you going to do with this money?

20:49Richard Chow:Is the opportunity cost and should it go back to the treasury, the balance sheet, where you're going to be returning a certain return, as opposed to going back to an allocation in private markets, which hopefully is generating higher return. So all of these things are helpful to bring to bear to help the seller articulate that to their investment committee beyond simply what the price is that they can get for the asset. They're real questions. And the other thing I'd say, Isan, is that every seller is different. So I went back to the point earlier I made about each seller, each LP is faced with different circumstances.

21:21Richard Chow:So they may be very much risk-on. They may be getting a lot of capital coming in in terms of additional pensioner contributions. So you may be willing to sell less. You should only trim the things that are really underperforming. Whereas those where there's a real liquidity need, you may need to access the capital and sell through some of that volume in order to generate liquidity for your stakeholders. Those are the things we want to help articulate and bring forward as opposed to just taking a book and putting it out to market.

21:49Kison Patel:Once you sort of get a lot of that stuff cleared out, there is essentially a deal to be made. You're already taking the asset out to market. Is it typical? Like you create a teaser and start marketing the asset around. And I'm really curious about is like, what does the universe of buyers look like? Because familiar with the typical company asset and you go shop it around to laundry list of PE firms and your laundry list of strategics. But when it comes to an LP interest in GP...

22:15Richard Chow:Exactly. Exactly. To your listener base, it's very similar and a lot of parallels to an attribution-alemnity process. So there's teasers, there's a SIM. You can work with the GPs to re-underwrite the asset in the case of a continuation vehicle. So a key asset might be something where, we have an example where the GPs made three times their money. And that's been great, but it's a paper gain. It now sits at, call it, 40 % of the fair market value of the fund, where you should be hopefully de-risking some of that exposure and providing liquidity back, increasing the DPI for your primary LPs. The storyboard that we want to provide, the new LPs, is great.

22:54Richard Chow:You've made three times your money, but what is left on the table? What is the additional meat on the bone for us to continue owning this asset? We want to draw the storyboard out, which is there's probably another two turns of capital before we end up selling it and growing into the next phase and chapter of ownership. The way I describe this is that when we make the Sims, it's about first telling the story about how through the initial stage of investments, we've de-risked this asset. Now there's incremental upside, which may require some additional capital. But for the most part, we're providing liquidity in a non-coercive way for those LPs.

23:27Richard Chow:And we want to rewrap the vehicle and provide new LPs with additional upside. And we also want to provide some of those LPs to the extent that they don't want to sell the opportunity to roll into the new vehicle. But we're truly in the standpoint of managing for close-end vehicles, which have fixed life, versus the new phase, which is another chapter in the story of owning that asset and maybe getting a couple more turns in terms of returns. That part doesn't change. We still think about the five-year forecasts. We think about what the leverage is that you can basically reopen discussions with your lender in terms of maybe re-levering the portfolio in an effective way, back-levering it, if you will.

24:02Richard Chow:We think about the multiples, the entry, the point at which we walk into an asset, whereas carry today, what we re-forecast the exit looks like. We think about maybe working with the company to also describe what incremental organic growth opportunities there are. So a lot of it mirrors what you think about the M &A process. The only difference, the one nuance and additional complexity is, so from the standpoint of a buyer who's going to be a new LP, what has been historical track record for this GP? Why should we think right now that there's another two terms left in the business? And do we have a GP that has historically carried the asset at a good fair value and has performed well, where we think that there's another couple turns in terms of capital?

24:42Richard Chow:Because one thing is that the LPs need to recognize, and this will get to the buyer universe in a little bit, but those buyers are going to be LPs who sign on to new LPAs with the GP. They're providing a management key stream, they're providing additional carry on the upside for that GP. But they're underwriting, the coefficients that they're underwriting or against are quality of the GP and quality assets. That's the one additional nuance we have to really solve for. A lot of the GPs then are trying to use the CV technology to bring in new strategic capital to the program. So what's been interesting about private markets is that a lot of the LPs that have come forward look like the traditional LPs you would think about in terms of people make primary commitments as a regular day job.

25:25Richard Chow:But there are now more sovereign wealth funds, pension funds who are also saying, we can do this ourselves. And we'd love to participate in this technology in order to get access to compounding assets that aren't coming to an IPO, that aren't coming through an M &A process. The only way that we're going to get access is if we participate in the secondary market. Because if I think about the start of my career in the mid-90s to where we are today, the number of public companies there are in the market are maybe half. So that means there are more private companies by far, more compounding, interesting returning assets which are being kept private that you don't have access to.

26:01Richard Chow:That's what's interesting for LPs, like I said, from pension funds in Canada to Singapore to the Middle East, where if I think about allocation decisions that are being made, I can't get access to those companies because they're private. That's been an interesting dynamic for the secondary market where some of these key crown jewels are staying private. And the only way to benefit from some of that compounding return is to go through secondaries. That's been a new dynamic for us. And it's been a big tailwind.

26:28Kison Patel:So a lot of these LPs just generally have an appetite to invest in secondaries.

26:33Richard Chow:Absolutely does. So some of it is just managing for the J-curve. And we'll talk about that in terms of returns, but certainly managing for exposure as well.

26:45Kison Patel:How do you become the best M &A practitioner? You learn from the best. That's it. That's the whole secret. It's what we've done at M &A Science from day one. 400 conversations with the best operators alive. You've heard them on the show. So we asked a better question. What if we turned that into a product? So we did two certifications. The first M &A fundamentals is for people new to the game, or maybe you just close your first deal and you felt every gap. This is how you close them. The second is buyer led M &A, our flagship. We took the best of 400 deals and built them into one framework for the buy side.

27:28Kison Patel:It's about 10 hours, every stage of the deal covered. We built both with PhD learning scientists. The quality is past anything we'd make in-house and you'll feel it in the first 10 minutes. You've already listened

27:53Kison Patel:I got a question on the continuation vehicles. I just want to get a little clarity on it. Is this another fund that you'll see a private equity fund structure and it's essentially just designed to carry over these interests into this specific fund just for that? Is that how it usually works? Is it like another structured fund? Is it unstructured? It is.

28:18Richard Chow:I'm grinning because...

28:19Kison Patel:Maybe a loaded question there.

28:20Richard Chow:We don't innovate. We just simply just rewrap assets. I'll give you an example where DFJ is a venture manager that invested in SpaceX years ago. That fund had run its course. DFJ decided that they would take the vehicle, take the asset they had in SpaceX and set up a new vehicle that provided a longer runway for that asset because it wasn't going. And this was about five years ago. and they ran the deal themselves. They didn't use an advisor, but it was a clear decision from the GP where they needed to rewrap the asset, wind down the preexisting fund and raise new capital to allow for a longer runway for the asset, which again, there are very few compounders like a SpaceX that have grown like weed in terms of valuation and the opportunity set.

29:07Richard Chow:So you want to continue owning those assets because those are really hard to find, but you're constrained by the structure of the vehicle, which is telling you by contract, you need to wrap things up. But essentially, you're just creating a new fund structure and a new LP base for managing those assets.

29:23Kison Patel:But not just for that single investment.

29:25Richard Chow:Yeah. So usually the easiest construct is to, again, in my crown jewel example, taking the key asset there, moving it off. There are times when we'll do multi-asset CVs. So it's maybe a wind down of several assets where in the case of a tail end vehicle, you may have three or four remaining fund assets where you say, let's move the entire vehicle out and wrap up the fund.

29:47Kison Patel:So it's pretty strategic. You have specific assets identified and then you're creating the continuation vehicle based on that. Not the other way around. We're creating a fund just to find continuation opportunities. And then you're sort of doing like you would a traditional fund structure.

30:03Richard Chow:The catalysts for continuation vehicles and for secondary deals are varied. So in one case, it's truly to de-risk and take money off the table in the case of a winner. In other cases, it's a true wrap-up of the vehicle where you're going to have to take maybe the crown jewel along with two or three other performing assets, but ones that have a longer runway where you need to move those off. So it really is one where there's not a prescriptive answer we give. It's more, let's work through the problem and see what we can deliver for you and your investors.

30:33Kison Patel:And I'd throw you more. I'm working on a podcast now. It's a fund that purchases employee options. I guess that's another form of secondary options.

30:45Richard Chow:Yes, we worked on one of those. What was interesting, I was a buyer of these employee options as part of my career. You create this paper wealth as an entrepreneur, as an engineer, but that doesn't change your liquidity pattern. You still need to pay for your daughter's wedding. You still need to buy a house. You'd like to maybe do some more estate planning. But the struggle is that you have a very illiquid pool of one asset, which represents the vast majority of your wealth. And if you leave the company, what do you do with that option? How do you find enough capital in your 401k to go exercise the option to go buy and then purchase the shares direct?

31:22Richard Chow:Structures have been created, and there's a little bit of innovation here, which is funds have been raised to help provide financing for some of these entrepreneurs to exercise those shares in expectation of future performance, which is you will then deliver those shares once they're unlegended, if you will. And once they go public and from a performance perspective, deliver me free and clear stock, which I can then sell on the overmarket. It's a win-win from the perspective of employees to get liquidity for state planning purposes. But for a buyer, you're able to divide that liquidity, but also participate on the upside as a cost for that liquidity up front.

31:58Richard Chow:So really, so one very small nuance, but very much similar as we described the rubric of what is a secondary.

32:04Kison Patel:I have a lot more questions for you. While we're on this one, this is a comment you made about, because we're getting more into the retail area. You mentioned that managers are mismarketing IRR to retail investors. Can you talk me through what's actually happening?

32:17Richard Chow:Let me first walk through IRR. It's basic finance 101 here. So you have a negative outflow when you buy an asset and then inflow somewhere in the future. And the IRR is the smooth rate of return over time from point of entry to point of exit.

32:34Kison Patel:The golden metric.

32:36Richard Chow:Exactly. We benchmark that against, if I were to buy a stock or a stock index, money goes in and it comes back when I sell it, what's my rate of return? Nothing else matters.

32:46Kison Patel:At the end of the day, it's just, that's your IRR. That's it. That's your IRR.

32:50Richard Chow:MSCI. Over one year, three year, five year, 10 year, that's what most folks are compensated against. But what happens if you look at the annual return and you map that annual return and it turns out to be negative? What happens if the slope is negative? By that, I mean, if I were to buy an asset today, Kisan, at a discount, and let's say I paid 80 cents for something that you have more at a dollar. So my day one gain is 1.25. So what is the annualized return on that 1.25? It's massive. But over time, by the time I sell it, I may get back to 1.1, 1.2, whatever the return is. But I know the return isn't as good as it looked day one because of simply the difference between what I pay for it and the GP mark.

33:37Richard Chow:And so from a LP's perspective, I have this really fantastic IRR that I theoretically have gained on day one. But that's not the IRR you get when you monetize the asset. And by the way, Kisan, so what happens if I start monetizing and getting that capital back very early? Do I have the same amount of capital at risk? I don't, because I'm reducing my cost basis over time. So it's not an efficient use of capital, but it's still a good return. But I'm getting money back, which I have to redeploy somewhere else. So what about IRR? I have to contextualize a little bit of that, which is one, is it an efficient use of capital?

34:14Richard Chow:But two, how do I think about the IRR at different points in time of that investment? Because it's not the same. That's where retail investors, if you simply look at the rate of return that the GP or the secondary manager is showing you at a point in time, it's not really reflective of what that long-term return looks like. That's been the biggest challenge for me in terms of capital raise in some of these retail vehicles and what you're thinking about. When you think about a retail investor investing in a BlackRock ETF fund, it's just not comparable in terms of the IR metric and relative return.

34:46Kison Patel:This is my biggest lesson today. I like this.

34:48Richard Chow:I think the lesson being is that the retail investors, you just have to be thoughtful about exposure and also the time horizon in which you're investing. It's not a short-term asset class. We saw that at the beginning of the year with a lot of the redemptions in the private capital BDCs.

35:03Kison Patel:Can you help me think through this question? It's nobody quotes real volume numbers in this market. Why does that data problem exist?

35:10Richard Chow:Because we're always trying to, the secondary market has always been a category of other. That really bothers me. In M &A volume, there are third-party sources you point to, deal logic, whatever you want in terms of international global M &A deal volume.

35:25Kison Patel:I was heard you're talking about just data set of transactions happening for secondaries.

35:29Richard Chow:Exactly. And we don't have that. Because first, the rubric of, we just started the conversation by saying, what is a secondary? And I kind of went into three different versions of secondaries. That other category really is one that's hamstrung us a little bit because a lot of people try to conflate the definition of what a secondary looks like. We're the other category. Everything else that doesn't fit an M &A or IPO or traditional path of exit described is then thrown into the secondary liquidity. That's one where over time, we're doing a better job. But what has not helped is some of the participants in an effort to maybe puff out their chest, look a little bigger than they actually are, just inflate some of those numbers and try to justify how big the market is.

36:12Richard Chow:But we're certainly past that. And we ought to be doing a better job of measuring the deal volume and the actual flow, but which we intermediate and pass through the market at PEEF.

36:22Kison Patel:That's a fair point. So when should a private market investor think about secondary market as a tool?

36:27Richard Chow:They always should. This is not an asset class where you set it and leave it. You invest and then you leave it alone. I mentioned a few factors which change, some of which you can't control with the shape of the house, the path of which you think about strategy. There's some other things that really you can't control, like the macro, whether or not we're in conflict, whether or not interest rates are 500 basis points higher than when you first made that commitment. But we should be thinking about it. I describe private markets investing as the law of unintended consequences, which is make a investment decision day one.

37:01Richard Chow:And by the time you get to year five, it's not that decision is wrong because you obviously made it with best intentions in year one. But things have changed. We should always be thoughtful about some of those unintended consequences. So I'll give you an example where a few years ago, in the mid-2010s, LPs decided that rather than investing in lots of managers with lots of sub-strategies, they should concentrate their investments into 30 and 40 GPs, which they thought were top quartile, top decile managers. But the problem then is that if you have a very large commitment size to those funds, it's really hard to then sell individually those GP commitments because each of the secondary funds that I described to you earlier as buyers, they have their own denominator problem, which is, I can't take a $300 million fund commitment in a fund that's only$5 billion.

37:52Richard Chow:That's a massive exposure, that 1GP. So again, you make the best efforts in terms of kind of maximizing returns for yourself, but there's some unintended consequences in some of those decisions that you make today that are going to impact your subsequent successor who's going to be sitting in that chair five, 10 years later that need to make some of those investment decisions and hard choices when they think about liquidity. So they should be thinking about it more thoughtfully and more incisively on a regular basis.

38:17Kison Patel:That's actually a really good, fair point example of why it's important to understand it and how to think of it as a tool. Post-GFC, it was sovereign wealth, then pensions, now retail. Are retail investors equipped for these time horizons?

38:31Richard Chow:I think the first four months of the year, clearly there was a path to the answer being no. And by that, I mean, if I step back to some of the headlines that were being passed around, it was the stress around private credit. Most institutional investors would say, there's not a lot to see here. and we think that the problem with private credit is oversold in terms of the headlines that the Wall Street Journal and others are trying to push forward. But that didn't affect retail investors saying, yes, I want my liquidity. And that has created a problem for some of the largest managers where they've had to put up the gates in terms of liquidity.

39:06Richard Chow:So the answer is from the standpoint of how we think about the asset class, no, not right now. But over time, the efficiencies of these vehicles and the redemption mechanisms that were put in place will work through that queue. But it's not set up well today for retail investing. That's where there's a difference between institutional mindset, which is I'm here for a long-term asset class. And I know that I need to ride through a wave of cycle of activity in terms of getting liquidity. Retail investors and the fickleness behind some of their decisions are harder to square with the asset class.

39:43Kison Patel:Can we cover the whole buyer universe? Because I feel like we're coming up with a lot. When I think of the retail, is there another fund structure that's also investing in secondaries marketed for retail investors? And then you obviously have LP interest that gets sold. But then if an LP, is there a certain exposure within a specific company that they wanted to get out of? Can you isolate that and pull it out? Or is it just one investment to the fund that you're parsing out?

40:07Richard Chow:So the largest secondary buyers today have raised capital from institutional investors are investing across the different strategies. And that might look like an LP interest where a large sovereign wealth fund is selling a portfolio for a variety of reasons. That gives you diversified private equity beta. And then they're also investing on a direct basis where they are going to the GPs, identifying some of those crown jewels. And there's a willingness to create alpha, which is they have a strong belief in this industrials company, this software company, this healthcare tech company, whatever it is, where they have strong conviction to create alpha and therefore increase the individual exposure that they're willing to take on that asset, backing the GP through a continuation vehicle.

40:53How they've raised capital comes from a couple of different sources.

40:57Richard Chow:One is the mainstream institutional investors, again, the same LPs who are making investments on a primary basis, but also retail channels because they're also wanting to access the capital that is readily available, which is going to provide them more evergreen carry and management fee streams, which are different than the closed-end vehicles. Make no doubt about it. Their secondary managers are economic animals themselves, and the path to long-term evergreen retail fees is very attractive for them. I'll be completely honest about that one.

41:27Kison Patel:I need to create an infographic to map all this out.

41:30Richard Chow:I tell people that if you can walk back, maybe a survey of private equity, describe, one, where the capital comes from, what some of those progenitors look like and what their incentives are. Then you paint a picture of the GPs in terms of the value that they're creating, but also some of the economic VIG that they're taking as a value for sourcing and then creating value in those companies. is a really interesting map because there's a lot of people and constituents at play, sometimes in conflict, but oftentimes ones where they're very complementary. And that's a good survey to understanding where we are today in private markets.

42:08Richard Chow:But you have to start drawing that out in totality. It can't just be what... I describe it as an elephant where when I was at Audia, we had a co-investment team, we had a primary investment team, and then we had a secondary team. And each banker, in terms of investment bank, would touch those three verticals in a slightly different way, but we were the same elephant in the room. They were touching different parts. And when we think about coordination, you have to basically be much more coordinated with how you access those capital pools because it's the same capital pool. It's a question of how you access investments in different capacities.

42:44Richard Chow:But it is a very large animal and large elephant, but one and the same.

42:49Kison Patel:What about private credit? is that such a big emerging asset class now is that a whole secondaries market for

42:55Richard Chow:private credit too i'm speaking on a panel in the fall and i'm putting together some market data right now pjt has been one of the leaders in credit secondaries for last five six years if i go back 10 years so before the big capital boom in terms of private credit, a lot of private credit was in the form of distressed investing. Private credit managers were investing in special SITS funds, basically making the argument to sovereign wealth funds that they can create equity-like returns with downside protection. And that usually sat in private equity allocations in terms of the cost of capital. But post-GFC, post-banking reform, A lot of capital then was raised to provide private credit for investors, corporates, and replacement of banks.

43:47Richard Chow:Now, the problem also is very similar to what I described earlier, which is you sign an LPA, you agree to a set of terms, investment period, and then harvest period, expect normal interest rate environments to then persist through that period of time. And no one in 2018 would have anticipated interest rates being 500 basis points higher they would not have anticipated COVID putting a big problem in the spanner into the works in terms of liquidity for a lot of corporate private equity sponsors. So that impact on private equity has equally had an impact on private credit. So we're facing really the same problem.

44:25Richard Chow:And what the opportunity set has really been for asset managers, secondary managers, is to find the right cost of capital to match the asset class. Because you can't apply equity returns to a private credit portfolio that's focused on senior rec lending. You can't make a 10 % returning asset class look like a 15 % rate of return. I just can't through discount and low return. So you have to find the right pool of cost of capital for folks. And what's been interesting is that they have found that capital. They found it in the form of a lot of the pension funds who found themselves under-allocated to private credit.

45:01Richard Chow:And now are looking for the opportunity to invest in pools of assets, which are already in the ground, performing and also generating the yield. That's really interesting if you're a Asian insurance company or a Middle East Southern wealth fund.

45:16Kison Patel:I just got a few more questions I wanted to get in. These are some fun ones we saved if we had time. So this question was, you valued SpaceX at$15 billion with a 2013 IPO. Wrong on both. What did that teach you?

45:29Richard Chow:Yeah, that's why I'm on the advisory side. I'm not on the investor side these days. Two things I learned. As a secondary investor, it's really hard to see past two years. That's a fault in the system where the natural reflex for secondary buyers is anything past two years, the crystal ball really gets really fuzzy. So I'm only going to underwrite to things that are knowable and seeable in the next receivable two to three, maybe 24 to 36 months. There's a missed opportunity there in terms of really seeing where there are compounding assets, which, again, if I were to just take one of those mistakes away, I should not have been focused clearly on just discount to last round.

46:09I should be thinking about the true upside

46:11Richard Chow:that could be generated out of that really unique asset.

46:14Kison Patel:And I think the second part of this is

46:15Richard Chow:information is really one that you have to take with a grain of salt. We had the somewhat fair amount of information that we were getting from the market through triangulation with other investors in SpaceX, but you really didn't know what the incentive was for that company to go public or not go public. You had to interpolate some of that. And oftentimes, secondary buyers think that just through diligence, you can get all the questions answered and you can basically

46:47Richard Chow:manage for all the investment risks that you can play forward. But in this case, the investment risk was really this massive upside that you couldn't really anticipate, that you really couldn't underwrite in diligence through kind of available means. Those things are hard. I would say it's been obviously a clear winner and compounder for a lot of investors that have been able to benefit. I still look at it.

47:08Kison Patel:I didn't think about investing either, so...

47:11Richard Chow:I was asked recently whether or not I wanted to participate in the IPO and I took a pass. So I missed it twice, Nissan.

47:18Kison Patel:Twice. I don't know. I buy the dip, so I'll wait for that. Exactly. So a complex cap table on a target minority stakes, legacy LP positions, how does secondary exposure factor into diligence?

47:32Richard Chow:There's a confluence of things happening here. So in a cap table, and this is like a growth company where maybe you have a series A, B, C, and D investor. Each of those companies, each of those GPs invested at different cost basis. They probably also invested in different time periods in those funds. And some of those funds may be way out of their investment period, Series A investors. Whereas the Series C investors, they have one or two years to go, so they have no real push for liquidity. But the Series A investors really do, and they need to provide liquidity back. Therein lies the complex puzzle that you're trying to draw out, which is, this might be a really high-performing company.

48:13Richard Chow:This might be an open AI, or it could be an Android, where you have no one single investor, which is the control investor, but you have lots of different people with different maybe conflicting viewpoints in terms of when liquidity needs to happen. So that's where I think from a puzzle-solving perspective, we get really excited because who do we work with? There are many different points where we can say, maybe I will work with the company. Maybe I should be thinking about helping them raise more capital, but also clean up their cap table. So again, traditional M &A advisory assignment where you'd say, I would like to position my firm as your future IPO underwriter, But first, before you get there in three years, I want to be able to help you think about your capital base.

48:56Because by SEC reg, you can't have more than 250 shareholders. So are there shareholders that we can help you generate liquidity for and clean up that

49:05Richard Chow:cap table? And indirectly help those investors, those Series A, B, and C investors, generate liquidity, DPI back to their investors. And in addition, maybe bring in some new investors that look more like an Asian sovereign wealth fund. who have maybe a slightly different lower cost of capital, but one where they have not participated in the series A, B, and C round because they are not built to make$5 million investments. But are they able to make$500 million investments? And if the answer is yes, we can put those two parties together and have a discussion. So that's really about some confluence of what you described in terms of, is it a secondary direct?

49:44Richard Chow:Is it some instrument of liquidity on an LP perspective in terms of increasing DPI? Is it something that looks more akin to traditional M &A advisory where you're helping them fix a problem? It's all of that.

49:58Kison Patel:It's a different view than I ever thought about optimizing the cap table, like from that view of understanding all these investors and where they play and how you can make room for bigger, better.

50:08Richard Chow:Bigger, better, and longer in terms of time horizon. So those Series A investors may really need liquidity yesterday. But you have a sovereign wealth fund that doesn't have the duration to their fund. It's evergreen by design.

50:21Kison Patel:What's the most common mistake you see the buy side make when they're first engaging in the secondary market?

50:28Richard Chow:The biggest mistake to me is the diligence process, if I were to think about it. So it's one where if you're keenly focused on the next two-year risk, you're missing the opportunity for future growth, number one. And number two, you're not anticipating some of the other challenges that come into play if you just remain short-sighted. And by that, I mean the company may not be motivated by having someone come in and saying, we're only in it for a two-year stint. We're out the very next day. The GP may say, I love your capital. I love your diligence process. But I'm really looking for a primary investor that's going to support my program going forward.

51:05Richard Chow:I'm using this continuation vehicle to generate additional capacity and additional relationship capital through other vehicles and other instruments that I'm investing in. So it's hard for me to describe other than saying there's a commodity in terms of secondary capital as well. And the way to win the hearts and minds of some of the GPs is the fact that you have primary capital and staple and other things that you can do for the GP and just simply say, I'm writing the biggest and highest check. So that's where there's a missed opportunity when you think about secondary deals. It's not just about transaction.

51:40Richard Chow:You have to think about, again, who the GP is and what are their objectives.

51:44Kison Patel:It's a big thing, looking at the whole picture. Absolutely. Absolutely. Hey, Richard, this has been a great conversation. I appreciate you taking the time. You taught me so much. I've never talked about secondaries in this length and depth. So my head is spinning from all this that I picked up. I'm going to have to extract a lot of notes from this.

52:02Richard Chow:No, it's a pleasure, Kisan. And like I mentioned, on the private credit chain, a lot is happening, obviously, on the back of the BDCs and some discussion that we've seen around private credit and some of the stressors in the market. So I'd love to come back and have you interview me in a long discussion of what some factors that lead to underwriting kind of credit secondaries and what's happening in terms of the market opportunity there for sure.

52:24Kison Patel:That'd be fun. Another great setup for a two who can click in deeper and get more technical.

52:29Richard Chow:Absolutely. But it's been a pleasure. Thanks for all the great questions.

52:32Kison Patel:If you're still listening to this podcast, my fellow M &A scientists, brothers and sisters, I would love to hear feedback. This was actually a recommendation from a friend who gave me a topic idea and introduced me to Richard. And that's how he got connected. So I'd love to hear what she thought about this conversation. Connect with me on LinkedIn. I got my privacy filters down right now. I'm getting a bunch of spam. So if you do connect with me on LinkedIn, make sure you put a note in there that you actually listen to the podcast. And I'll make sure I look for and connect and love to get the feedback, other topic ideas we haven't covered.

53:03Until next time, here's to the deal.

53:17Kison Patel:Thank you for taking the time to explore the world of M &A with our podcast. We love hearing feedback. Tag us on a LinkedIn post, add a review on Apple Podcasts. We'd love to hear from you. If you need help standing up an M &A function or optimizing one that you already have, we're here to help. And if we can't help you, we probably know someone that can. You can reach out to me by email, Kisan, K-I-S-O-N, at mascience.com. Or you can text me directly at 312-857-3711. If you just want to keep learning at your own pace, visit mascience.com for a lot more content and resources. That's where you can also subscribe to our newsletter.

54:02Kison Patel:Again, that's mascience.com. Here's to the deal.

54:16Kison Patel:views and opinions expressed on mna science reflect only those individuals and do not reflect the views of any company or entity mentioned or affiliated with any individual this podcast is purely educational and is not intended to serve as a basis for any investment or financial decisions.