A stapled commitment is a cash flow, not goodwill: discount it at the return the buyer's capital must earn and take it off the price.
A stapled primary costs the secondary buyer the net present value of the new fund's cash flows, discounted at the return the buyer requires on its secondaries capital. On an illustrative 50 commitment to a fund expected to return 1.60x net, that is 7.18 points of NAV at a 15 per cent hurdle, so an interest worth 90.23 on its own can only be bought at 83.04 once the staple comes with it.
Worked in full in The Private Equity Secondaries Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A staple is the condition a general partner attaches to a secondary sale: the buyer gets the LP interest, or a better price on it, if it also commits to the manager's next fund. Buyers often treat the commitment as neutral, or even as a bonus, because the new fund is expected to make money. Expected profit is not the test. The test is whether that money earns the buyer's hurdle, and a primary commitment rarely earns a secondaries hurdle.
| Input | Value |
|---|---|
| Reported NAV of the interest | 100 |
| Headline price (a 12 per cent discount) | 88 |
| Distributions, years 1 to 4 | 24, 36, 38, 30 |
| Buyer's required return | 15% |
| Stapled commitment to the new fund | 50 |
| Calls, years 1 to 5, % of commitment | 25, 25, 20, 15, 15 |
| Expected net multiple of the new fund | 1.60x |
| Distributions of the new fund, years 4 to 10 | 80.0 |
The distributions of the new fund follow an ordinary shape: 3, 7, 13, 18, 22, 20 and 17 per cent of the 80.0 returned, from year 4 to year 10. Calls and distributions overlap in years 4 and 5, so the net cash flows are what matter.
Maximum price = PV at 15% of the distributions
= 24 ÷ 1.15 + 36 ÷ 1.152 + 38 ÷ 1.153 + 30 ÷ 1.154 = 90.23
In Excel: =NPV(15%, B3:B6) with the four distributions in B3:B6. At the headline 88 the IRR is =IRR(B2:B6) = 16.2 per cent.
On its own the deal clears the hurdle with 2.23 points of NAV to spare. This is the deal the buyer thinks it is pricing.
The stapled commitment of 50 is called at 12.5, 12.5, 10.0, 7.5 and 7.5 over five years and returns 80.0 from year 4 onwards, a profit of 30.0. Netting calls and distributions year by year and discounting at the buyer's 15 per cent:
Staple value = NPV at 15% of the new fund's net cash flows
Net flows, years 1 to 10: −12.5, −12.5, −10.0, −5.1, −1.9, +10.4, +14.4, +17.6, +16.0, +13.6
NPV at 15% = −7.18. The fund's own IRR on these flows is 9.8 per cent.
A fund that returns 1.60x and 9.8 per cent a year is a perfectly respectable primary. It is a poor use of capital that was raised to earn 15. Every unit of the commitment that sits in it is a unit not earning the secondaries return, and the 7.18 is that shortfall, measured today.
Maximum package price = PV of the secondary − cost of the staple
= 90.23 − 7.18 = 83.04, a discount of 16.96 per cent instead of 12.
Check: the combined cash flows at a price of 83.04 have an IRR of exactly 15.00 per cent. At the headline 88 the package earns 13.4.
In other words, the staple turns a deal that cleared by 2.23 points into one that misses by about five. If the GP offers 88 with the staple, the buyer should ask for 83 or decline the commitment. Every 10 of commitment at these terms costs about 1.44 points of NAV on the secondary price.
| Staple | New fund 1.40x | 1.60x | 1.80x | 2.00x |
|---|---|---|---|---|
| Commitment of 25 | 84.90 | 86.64 | 88.37 | 90.10 |
| Commitment of 50 | 79.58 | 83.04 | 86.51 | 89.98 |
| Commitment of 100 | 68.93 | 75.86 | 82.79 | 89.73 |
| New fund's own IRR | 6.9% | 9.8% | 12.4% | 14.8% |
Two readings. First, the staple is close to free only when the new fund is expected to earn the secondaries hurdle itself: on this call and distribution profile that takes a 2.01x net multiple, an outcome few primary underwriters would put in a base case. Second, the cost scales with the commitment, so a staple sized at the NAV bought (100 for 100) more than doubles the discount the buyer needs, from 9.77 points without a staple to 24.14 at 1.60x.
The answer depends entirely on the discount rate, which is why it is argued over. At 10 per cent the same staple costs only 0.37; at 12 per cent, 3.52. A buyer that runs a primary programme alongside its secondaries book and would have committed to this manager anyway can reasonably value the staple at its primary hurdle, and for that buyer it is nearly free. A dedicated secondaries fund that has to place the commitment in its own vehicle should use the return its investors were promised. The rate is a question about whose capital is being used, not about the GP.
Duration makes it worse. The secondary is out in four years; the staple ties up capital for ten. A secondaries fund with a ten-year life can find the staple's last distributions arriving after its own term, which means a second sale or an extension the fund's investors did not sign up for.
The common mistake is to value the staple undiscounted: 50 in, 80.0 out, a profit of 30.0, so the commitment "adds value". That is true at any rate below 9.8 per cent and false at 15. The second mistake is to look only at the secondary's headline discount, which the GP may have improved by a point or two to sweeten the staple. A point of extra discount on 100 of NAV against a 7.18 cost is not a concession, it is the buyer paying for the commitment.
Price the staple as a cash flow, not as goodwill. Discount the new fund's calls and distributions at the rate the buyer's own investors require, subtract the result from the value of the secondary, and bid that. The deal model in the free workbooks for this book prices an interest from its distributions in the same way. For the effect of an unfunded commitment inside the interest itself, see how unfunded commitments change a secondary price.
A secondary sale in which the general partner makes the transfer, or a better price, conditional on the buyer committing to its next fund. In the illustrative case a buyer purchasing 100 of NAV is asked to commit 50 to a fund expected to return 1.60x net, which at a 15 per cent required return costs 7.18 points of NAV.
When the new fund is expected to earn at least the rate the buyer requires on the capital it uses. On a five-year call and seven-year distribution profile, a 15 per cent hurdle needs a 2.01x net multiple. At 1.60x the new fund earns 9.8 per cent, and the staple has a negative value.
The return the buyer's own investors require on the capital the commitment uses. A dedicated secondaries fund should use its secondaries hurdle; a buyer with a primary programme that would back the manager anyway can use its primary rate. The same 50 staple costs 7.18 at 15 per cent, 3.52 at 12 and 0.37 at 10.
This article is one calculation from The Private Equity Secondaries Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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