Mergermarket’s North America funds editor Tom Cane speaks to Matt Swain, head of direct placements and secondaries at Houlihan Lokey, to get his take on the growing secondaries market. While under-capitalized, the secondaries market is seeing unprecedented growth, as more GPs turn to it for creative liquidity solutions, and LP acceptance of this trend increases. Swain was previously global CEO of Triago, which was acquired by Houlihan Lokey in a move that doubled the investment bank’s private placement practice, as Mergermarket previously reported.

Q: How has the secondaries landscape shifted in the last two years?

A: For any GP-led deals you need trophy assets that are highly valued by the LP community, whereas two years ago, there was more flexibility about what could go into a transaction. I think about the term “trophy asset” a little differently from what has become the norm. For me, it’s where you’re getting a true win for new investors coming to the table and where there’s a lot of growth and value still to be unlocked. There must be a new story that requires an additional holding period, and very likely more capital. If you can exit a company in 12-24 months at a big profit just by following the existing trajectory, it doesn’t make sense to do a continuation vehicle. Another major shift from 2021 is that growth prospects alone will not sell a deal. People are much more focused on whether there are solid levels of profit and EBITDA in the companies these deals target.

Q: What’s the outlook for the next two years?

A: The secondaries market is one of the most undercapitalized in corporate finance. I think institutionalization will lead to growth. And I can see 2024 being the biggest year ever. We’re excited about what we have in front of us, and I don’t think we’re alone in that.

Q: Are you focusing on specific areas within secondaries?

A: Many of our peers focus almost exclusively on GP-leds because that’s where the biggest profits are found. We are more holistic and flexible. We aren’t just looking at standard, single-asset continuation vehicles. We’re still doing just as many LP portfolios, we’re looking at tender sales, and we will do fund restructurings.

Q: What trends are you seeing in direct investing?

A: The biggest development in the last six to 12 months is we’re seeing larger transactions. That’s driven by three factors. One, investment banks are increasingly allowing unfunded sponsors to participate in auctions because they recognise the close rate is high. Two, funded sponsors are also turning to direct investing. These could be large middle-market GPs that see value in a company, but the investment doesn’t fit the mandate of their flagship fund, so they want to put it into a side-car vehicle. A direct or single-asset capital raise is the best way to achieve this. Three, strategic investors with lots of capital have started investing in directs.

Q: Where do you see the most attractive opportunities?

A: For now, we see the fastest growth in secondaries. Liquidity is difficult to come by and there is a need for creative capital sources. People are turning to secondaries in unprecedented numbers and there’s a wider acceptance of these transactions among LPs. To position ourselves, we’re hiring great talent, especially for the mid-market. We’re also picky in the types of transactions that we take on. In GP-led secondaries, the hang rate for transactions that do not close is probably 50%, so we have to pick the right assets and the right sponsors to ensure deals close and we win LP loyalty. Trying to do something for inorganic reasons – when the primary motivation is not that the underlying asset needs extra time to unlock value – isn’t the right answer.

Q: Which geographies are most interesting?

A: We’re very much focused on North America and Europe, and less so on Asia. There’s probably a little bit more white space for education on GP-led secondaries and directs in Europe because more GPs have tackled these deals in North America.

Q: What’s been driving consolidation in the advisory space?

A: I’ve said in the recent past that it’s hard to be a real investment bank if you don’t have a true secondaries advisory platform. I think that’s also becoming true with regard to direct advisory platforms. When you pitch a client, you need to be able to put all the options on the table. If one is missing, you can’t deliver the best advice. That said, independent firms can still be successful, although being integrated presents real advantages.

Q: Within Houlihan, how do you work with the M&A team and other parts of the investment bank?

A: It’s extremely collaborative – I think that’s our secret sauce. We lean on our industry bankers and analysts to bring their domain expertise to the table, not just for GPs, but also for LPs and buyers. In a client meeting, we will offer an M&A solution as well as a secondary market solution.