22nd September 2021
Robert de Corainville
Managing Partner, 17Capital
17Capital’s Robert de Corainville discusses the growing prevalence of private equity firms accessing non-dilutive financing to enable succession planning and generational change.

Originally featured in Private Equity News.


Paving the way for the next generation

An increasing number of successful firms are reaching the point where they are now having to embrace the changing of the guard.

The private equity industry has experienced significant growth during the last two decades and there is no sign of it slowing down. The industry’s global assets under management stands at nearly $5tn , with the number of active firms more than doubling in the past ten years alone . As the industry has matured, so too have the founders and senior figures of many of its leading firms – an increasing number of successful franchises are reaching the point where they are now having to embrace the reality of a changing of the guard.

Succession can be one of the most testing times in the life of any private equity investment firm and, clearly, it is vital such change goes smoothly. Planning is key and it is essential to have the right tools to manage the transition. An interesting new tool has emerged in recent years to help fund transitions – portfolio finance.

There can be various motivations behind founders proactively addressing succession: for example, to monetise decades of hard work and take a step back from the front line; to expand the next generation’s economic participation in the growth of the business; or to provide investors with reassurance around the long-term continuity of the firm. These are all understandable, potentially even laudable, reasons for making a change, but they create challenges.

A key challenge is created by the structure of the industry itself. When a GP invests successfully it creates a divergence between the value of the earlier generation’s ownership stake and the accessible wealth of the younger generation. This can be difficult to navigate because GP commitments and carried interest of individual employees are generally tied up for extended periods within various fund structures. Third-party capital is often vital to bridge this liquidity gap.

Until now, one of the more popular solutions for GPs seeking succession-driven capital has been to sell a minority equity stake in the firm’s management company. However, these transactions come with several significant drawbacks, such as permanent ownership dilution, potential team misalignment, and sceptical reception from investors. However, portfolio finance is increasingly being recognised as a viable alternative to this.

Historically, preferred equity and NAV-based credit portfolio financing have most commonly been employed to fund growth initiatives or accelerate liquidity.


But this non-dilutive, highly flexible capital can also be used for a range of strategic purposes within private equity management companies – the structures are self-liquidating and, in certain instances, can address key tax and estate planning considerations.

When applied to generational change, it delivers private equity management teams the capital to implement a transition without sacrificing the powerful long-term incentive of equity ownership. Crucially, it also retains alignment of interests between the GP and its LPs.

Portfolio financing is usually extended against management’s holdings in their firm, whether in the form of management fee income, GP commitments, carried interest, or a combination of these. The structures will often include a primary component to capitalise the balance sheet and support expansion of existing and new strategies, as well as secondary proceeds to achieve liquidity objectives. The GP team preserves full operational autonomy, with the financing partner assuming a passive role.

The trend is only increasing. Precedent minority stake transactions and the growing roster of publicly listed private equity firms have created observable valuation benchmarks to help GPs navigate internal discussions around firm ownership. This is sparking an increasing appetite for non-dilutive financing as a way of smoothing the path towards generational change.

By way of example, 17Capital recently provided finance to a top-tier US private equity firm that was seeking to generate liquidity for its senior partners while retaining full employee ownership, thereby maintaining alignment with the firm’s next generation of leadership and its investors.

We expect widespread adoption of non-dilutive financing structures at the management company level, particularly among successful mid-market GPs. Succession planning will likely prove to be a common strategic driver, as ambitious management teams seek to retain equity ownership and drive continued growth with an agile capital structure that maintains the best alignment with LPs. And hopefully, with the current vast array of firms remaining in safe hands, the growth of the industry will continue for years to come.


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