CVs are generally more concentrated than the average traditional LP secondary. This is because managers are typically selecting a key asset for a single-asset continuation fund or a handful of larger assets for a multiasset continuation fund. Due to the larger-than-usual exposures, investors should consider the level of diligence required to underwrite these transactions. Many secondary buyers have revealed that the diligence they perform on CV transactions, particularly for single-asset deals, is closer to that of a co-investment or direct investment underwriting than to a traditional LP-deal underwriting.
Far more so than with traditional LP secondaries, participants in CVs are taking a deep dive into information for portfolio companies, taking into account the experience of the GP deal team and company management, historical and projected financial performance, capital structure and leverage, specifics on the value-creation plan and budget, and overall industry trends. Given these differences, investment approaches must be tailored to meet the more rigorous diligence required.
These three areas are just a few of the many considerations that come with evaluating CV transactions. Some other issues that an investor may need to explore include the following:
- Are the GP's deal team and portfolio company management staying in place for the next holding period? How aligned are management and any co-investors?
- How different is the new value-creation plan for the asset from the plan during the previous holding period? What is the rationale behind any changes?
- Is the amount of unfunded capital being requested by the GP appropriate given what is known about the go-forward plan for the asset?
- Are the terms of the new vehicle appropriate given what is known about the projected returns of the asset and relative to the terms of the vehicle the asset comes from?
The key takeaway is that although CV transactions are a novel and exciting component of the secondary market, they come with a number of new diligence items for investors to consider to ensure successful participation in these transactions.
Mitch Clemente is a principal and Pete Veravanich is a managing director at Pathway Capital Management. Both. authors are based in Irvine. Calif. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.