The Exchanges

Q So at what point in time did the transactions move from LP-led, an LP needing liquidity, to the GPs using it as a technology that was useful for them to, say, wrap up a fun life or what to become with continuation vehicles?

A Beginning in, like, 2012 and 13, there were some early deals, and the language they would use would be, like, zombie funds or GP restructurings. Those were largely tougher assets or tougher manager quality, and that continued largely but in a very small percentage through 2017. For me, there was a watershed moment when one of our best GPs Decided to do a GP-led transaction, and immediately the market Change the name of a restructuring to a recapitalization. A recapitalization has all those positive connotations versus a restructuring, which has the negative connotation. The market shifted wholesale in 2017, 2018, and you can see that with the volume. By 2020, about half the volume was GP-led transactions and half the volume was LP transactions. Juxtapose that versus 2010, it was all LP transactions. And it fundamentally changed the way that the market approached secondaries. The next thing that happened was COVID, and in COVID, managers realized that they would need more time on their portfolios, so we renamed GP leads and started calling them continuation funds. Same mechanics, same structure, same assets, but we just changed the name because that was how they were going to behave. This is when GPs needed a little bit more time. We needed the COVID metrics to Flow through the financials, and nothing was really selling in 2019 or 20. I think the next major milestone is really 2…

AI assessment note: “The market shifted wholesale in 2017, 2018, and you can see that with the volume.”

Q As an active participant in the secondary market, how do you think about the different ways you want to play in the space?

A Maybe I could create a framework of how I think of the secondary players sitting today. In my mind, it's a three-dimensional rubik. On one axis would be deal sizes. For example, RCP, we focus on very small deals. Ten million to fifty million dollars in size. On the very biggest end would be Lexington and Collar. Their transactions are very big. Another axis would be style. We focus solely on North American lower middle market buyout. You have some managers focusing only on venture, some managers focusing only on credit, some managers that have a global footprint. Those are all differentiators in the market today. And then the last dimension of this would be how the managers believe they're creating value. So for our RCP, we feel like because we have a very big primary business, our relationships and information give us an advantage in sourcing deal flow and diligencing that deal flow. Some people feel like their value is that they can do very big transactions that most people can't do. Some people feel like their value is maybe buying more complex transactions that some people do not want to do. Understanding that framework really is the foundation for identifying our market is maturing. Once we land into that idea, then we can approach, how do LPs want to use this market? If I go back in 2010, people thought it was an IRR investment. Get capital back very quickly. Establish a …

AI assessment note: “In my mind, it's a three-dimensional rubik. On one axis would be deal sizes.”

Q How have those lenses changed over the years?

A The two biggest learnings that we had would be first manager quality. When we did our first secondary fund, we did really well. One thing we didn't have a clear grasp on, though, was this construct of manager quality. Specifically, pressure on returns if manager quality was low. So, when we invested our second fund, we were thinking we like the asset quality, And we were a little bit less tuned in on the manager quality. The way I would define manager quality could be, did they have a subsequent fund being raised? When our second fund, which at this point is a 2013 vintage fund, We had a number of managers that weren't able to raise subsequent funds, and the performance of the underlying secondaries that we held suffered as well. That would be something that we tuned into very clearly beginning in 2017, 18. The other piece of it is this idea of when to be a purchaser. A lot of our contemporaries have done very well being tail-end buyers. Managers that buy secondary positions at the end of their life, Typically you're going to see a lot of the value that those folks are getting just through the discounts that they're obtaining. We felt like because we were trying to target a higher quality manager and the market was fairly efficient, we're Chicago people, so we believe in an efficient market. We didn't want to necessarily play in the tail end position, so therefore we reset our …

AI assessment note: “The two biggest learnings that we had would be first manager quality.”

Q What level of underwriting do you do on the underlying businesses?

A A critical piece of our strategy is that we're not buying entire portfolios. We're not buying portfolios of 40 funds or 50 funds. Typically we're buying on an LP interest a single fund, so it might have five or six companies, or maybe two funds, maybe three. As a result, the quantum of number of companies that we have to underwrite or review is much more narrow than if we're buying a thousand different companies. So we have The luxury slash benefit of being able to do effectively like a knockdown LBO model for every single company. To do that, you need two things. You need data, and you need the qualitative information. So on the data side, because we're a primary fund, we're constantly collecting and meeting managers when they're raising capital, when they're issuing data rooms, when they're coming to our offices just to say hello at annual meetings, and everything in between. We're collecting all of that data so we can start collecting metrics like EBITDA, revenue, net debt, purchase price multiples on every single company. And we can use that to build a bottoms up model. I hope everybody's listened to my colleague and partner Alex Abella's podcast because he talks a lot about the data, but that data gives us the advantage to be able to underwrite everything from the bottoms up. The other lever that we pull is relationships with the general partner. We're going to be talking …

AI assessment note: “effectively like a knockdown LBO model for every single company”

Q As you went through your education, how did you think about that in the context of either the business world or where you would go after college?

A I always assumed and thought I would go into something entrepreneurial. Today, if you say, John, are you in an entrepreneurial environment? In finance, I would say, a hundred percent. Absolutely. But, entrepreneurism today takes a different look and shape. Back then, it was just doing something on a smaller basis and not as institutional. When I was in college, my parents didn't push me to do anything. They just said, follow what you like, and I graduated with a history major. Which is a funny degree to have, but the reality is you can spin it into saying it's the foundation for making all investments. As a history major, we take a primary hypothesis, and we use primary and secondary information to validate that hypothesis. Ted, that sounds a lot like, uh, Investment. So, there I was. I was a history major, and I started working in strategy consulting at PricewaterhouseCoopers, largely because I didn't really have a deep level of mentorship to know what I wanted to do. I just took a job, and off I went. My dad's a doctor, so he just said, don't be a doctor. After I left PricewaterhouseCoopers, I did an entrepreneurial startup, and then I went to business school, and I've been at the same job since I graduated business school. 21 years. It's pretty amazing. I think that duration is rooted in that entrepreneurial spirit. I joined RCP when they were raising their first fund. We ha…

AI assessment note: “I always assumed and thought I would go into something entrepreneurial.”

Q All right, John, I want to make sure I get a chance to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family?

A I am either cursed or lucky with a deep love of cars. It started out with my dad. My dad is a car guy, and some of my earliest memories are with him sitting next to him in a car, but all the cars have changed. I have that same bug. I like vintage cars. I like to fix vintage cars. I like to understand them. I like to repair them, and then usually when they're perfect, I often sell them. Just the whole process is really rewarding to me. The other piece is when you work on a car or when you drive a car, you're so present. There's no space for noise of work or no space for noise of family. You just have to be there, and recently I started racing cars as well, and when you're on a track, you can only look at one thing, which is one or two turns ahead of you, And just to have that cathartic experience of a quiet brain is a really special thing.

AI assessment note: “I am either cursed or lucky with a deep love of cars.”

Q In the last stage of history, there's this new insurgence of capital coming. Private wealth started to come. How has that played into the secondary market?

A 40 Act funds or the retail market has influxed into the secondary space. 24 was the year of the retail capital, and it's amazing how much capital has been raised from that avenue. Institutional capital has historically been pretty stable, and maybe the addressable market is fully satiated. So as managers are looking to raise more capital, this is a greenfield TAM, if you will. The structure of a Forti-Act fund or an Evergreen fund is they call the capital at once right off the bat. And as a result, the managers have to invest that capital very quickly, which is why we pushed into the secondary space. When we've seen a lot of the larger portfolios and even a lot of the limited partnership positions trade in 2024, the retail funds have been the main connoisseur of this product. An interesting question is, What happens in the next 10 years? Going back to my history major roots, let's point to the public equities, which was your specialty. I can imagine a space where private equity looks a little bit like the public equity manager market does today, where you have some people that are focused on almost like an index. That would be a pure retail product. Then you will have some folks that are charging a little bit more that will be specialized in what's Let's call that in the public equities world an active managed portfolio. And then you'll have some boutique managers that will be …

AI assessment note: “The structure of a Forti-Act fund... managers have to invest that capital very quickly”

Q What are some of the big questions you have about how the secondary industry needs to optimally grow and improve itself so that what looks like it will be a continued period of growth does play out?

A I think the secondary buyers always need to have the secondary sellers feel like they're not getting taken advantage of. For us, it's transparency. Even when we're buying a position and we're negotiating with or against a limited partner that's selling, we try to articulate that there is value in the portfolio, and the hope is that the seller recognizes that we have to have a return profile. They can't feel like they're getting their faces ripped off. It just isn't a sustainable business model. And the same is true on GP leads. For us to be transparent with the sellers about why we're landing on values, what the expectations are, what the return profiles are, will allow people to continue to want to sell into this market. I hate using this term, but a win-win. And that's where we really have to land in order to have that sustainability. We can't just be like, Predators trying to feed off distressed animals.

AI assessment note: “secondary buyers always need to have the secondary sellers feel like they're not getting taken advantage of”

Q How do you think about the secondary market as one of the tools that is needed to provide liquidity to a primary market that's a bit stuck?

A The secondary market is the tool to provide that liquidity. We see it manifesting two ways. On the GP led side, We have an incremental transparent perspective on deal flow because we also have a very large co-investment portfolio, and we also have a very large primary portfolio. The amount of failed transactions that occurred in 2022 and 23 primary managers trying to sell their assets was astonishing. Effectively, unless it was a perfect asset, it wasn't going to trade. Or they could go to the secondary market, and so many of the deals that we see in the secondary market, there's a little bit of noise on them. Maybe that's why they're not pricing at a premium like the open market might not get or collect, but that's the fair value. So, GPs using the secondary market as a tool to get liquidity because in one ear, the limited partners are saying, we want maximum value. In the other ear, they're screaming, we want liquidity. So, GPs are recognizing this is a great opportunity for us to do a GP-led and give the liquidity that LPs are screaming for. On the limited partner side of the secondary market, we are with less liquidity coming out. With less realizations occurring, people are over-indexed in private equity, or they have too big of positions in certain managers, so they're using the secondary market to drive value. If we establish a market that feels fair, then people will se…

AI assessment note: “The secondary market is the tool to provide that liquidity. We see it manifesting two ways.”

Q What goes into your assessment of manager quality?

A Our roots are A primary investment manager. If you think about RCP, many would say they're a primary investment shop with a secondary and co-investment funds, and that's what we like. We want to appear like that in the market. It provides a lot of advantages, but having the roots of being a primary manager allows us to assess the construct of team strategy and track record, which we're thinking about in any primary investment, And it also gives us the luxury of knowing these GPs for a very long time. So instead of trying to educate ourselves for the first time on a GP that we're seeing because it's a small market manager, these are folks that we have tracked and followed since their own inception. The manager quality element is relative and absolute, but we have that relative capability because we track the entire landscape of managers, And then absolute is around this team strategy and track record framework. Effectively, if we can start seeing a cadence in their transactions, a cadence in their deals, a rhythm, if you will, then we feel like it's repeatable.

AI assessment note: “absolute is around this team strategy and track record framework.”

Q As you've looked at the various different CVs that come onto your plate as potential transactions, What filters have you used to decide what you want to engage with?

A The secondary market has evolved in the same way that styles and strategies have. We want to make sure that this is a high-quality asset and that it's de-risked. More specifically, we want to make sure that there's a good reason for the GP-led transaction to occur. It's not just to get liquidity, which we feel would be misaligned. Have they held on to it for a long enough period that it's time to sell? Has it appreciated enough? Do they need more capital to do further add-on acquisitions, or do they need more time on a hold period because maybe the management team is new? We want to make sure that the GP-led transaction we're buying, the go-forward strategy is a continuation of the historical strategy so it's been largely de-risked.

AI assessment note: “We want to make sure that this is a high-quality asset and that it's de-risked.”

Q As you look at the types of companies that are coming through, how have you shifted your preferences to the types of underlying companies in your space that you like?

A When leverage was less expensive, the capital intensive businesses were a little bit more easily digested. Buy and builds. Where today, the construct of a buy and build is a little bit more difficult because leverage is so expensive. When we think about our portfolio and how it's evolved, it hasn't course corrected, it hasn't changed wholesale, but it feels like Many of the deals that we're doing today are less capital intensive businesses that have been able to grow organically and also have a high level of free cash flow yielding off of them. With the market, are we in a recession? Are we going into a recession? Are we in a trade war? Are we going into a trade war? I don't know. And I don't think anybody knows, but the market prices that with that in mind. When we're looking at a transaction today, we have to take the worst case scenario position versus the best case scenario position, because if we take the worst case scenario position and we're wrong, we're right. And if we take the best case scenario position and we're wrong, we're very wrong. As a result, I think a lot of the construction that you would think to have around volatile market, which we're in today, is being inserted into all of our assumptions.

AI assessment note: “Many of the deals that we're doing today are less capital intensive businesses”

Q I'm curious this juxtaposition of the Forti-Act channel clearly growing at the same time You have now potentially real bellwether announcements of secondary sales at Yale and Harvard. Where do you see that shake out? It's the institutional market maybe is saturated or oversaturated. At the same time that there's this new channel of money coming in.

A I think fundamentally your question is around growth of our space, and let's say in 2025 expected secondary volume is a hundred and ninety billion dollars, plus or minus. That represents a percentage of the total amount of NAV that is in alternatives in general. Historically that Ratio, which has been the total volume over the total amount of NAV has been about one to one and a half percent. Let's imagine a scenario where the total volume goes to two and a half percent or three percent or four percent. You can very quickly see our market doubling or tripling or quadrupling. I think that's going to drive a lot of the volume that we're seeing in the secondary market along with the idea that liquidity in our market over the past couple years has changed in terms of duration. When we first started, the average assumption on a company being held in a portfolio was four and a half to five and a half years. I think today that same assumption is probably six years plus. And you've seen it with some institutional reporting coming out where the amount of liquidity that limited partners are getting on a yearly basis has come from a number of 15 to 20% of their total commitments every year returning back to 10%, or maybe even lower. So as liquidity continues to pressure the market, that will continue to drive volume. Do we have space for all of these new entrants in secondaries? Do we have…

AI assessment note: “Do we have space for all of these new entrants in secondaries? ... Yeah”

Q I'd love to dive into the GP-led slash CV market. What's your broad sense of resolving the various alignment challenges that it poses?

A As a primary investor and as a secondary investor, we wear a two-horned hat, if you will. My partners that are more focused on the primary side feel like the alignment in terms of the valuation is something that they think a lot about, and for us on the secondary side, alignment in terms of the next phase of this investment is something we think a lot about. In 2021, that was a much more poignant topic. GPs could go into the market and possibly sell these transactions. Were GPs getting top dollar? It always felt like as a buyer they were, but always felt like as a seller they weren't. It's sort of like the old thing, both sides are unhappy that maybe that's the middle point. But beginning in 2022, where liquidity really dried up in the market, limited partners recognized the value of the secondary market to drive liquidity in their portfolios. So, rather than saying, we don't feel like we're getting top dollar, I think a lot of limited partners moved into the construct of saying, we're happy for the liquidity.

AI assessment note: “limited partners moved into the construct of saying, we're happy for the liquidity.”