Private Equity Secondary Market: Understanding the Basics

Private equity secondary market refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds.

The market for private company equity sales, also known as the secondary market, is a way for executives and other employees of private companies to liquidate stock in order to gain access to cash in the near term.

The private equity secondary market is expected to reach new heights in 2023, driven by demand for liquidity, economic uncertainty and lower prices.

The private equity secondary market has grown at a rate of over 20% per year over the last two decades. It has reached the critical mass that, many believe, should represent a valuable portfolio management tool for all private equity investors.

However, sellers will face challenges to accept discounts and lower prices, as the market accepts secondary transactions as a mainstream liquidity option.

Key Takeaways

• The private equity secondary market refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds.
• The market for private company equity sales, also known as the secondary market, is a way for executives and other employees of private companies to liquidate stock in order to gain access to cash in the near term.
• The private equity secondary market is expected to reach new heights in 2023, driven by demand for liquidity, economic uncertainty and lower prices.

Understanding Private Equity Secondary Market

Private equity secondary market, also known as the secondaries market, refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds.

It provides investors with the potential to sell holdings before the end of the investment term, providing liquidity in an otherwise illiquid market.

Digitalisation has improved the infrastructure for buying and selling, making the secondary market more institutionalised.

The market for private-equity secondaries has evolved and grown considerably over the past two decades, becoming an essential component in oiling the wheels of the private equity asset class.

The secondary market funds, or secondaries, buy an existing interest or asset from primary fund investors, known as limited partners (LPs).

General partners (GPs) who manage private markets funds may also initiate deals to transfer one or more assets from one vehicle to another.

The secondary market can be divided into two categories: traditional secondaries and GP-led secondaries.

Traditional secondaries involve the transfer of existing fund interests, while GP-led secondaries involve the transfer of assets from one fund to another, often with a new set of investors.

The secondary market has become a thriving industry, with transaction volumes remaining strong in recent years. According to a report by abrdn, the market for private-equity secondaries has grown considerably over the past two decades, providing liquidity to investors in an otherwise illiquid market.

Private equity secondary market is an important component of the private equity market, providing investors with liquidity and flexibility.

It is a critical component of the private capital industry, which includes private equity, venture capital, and other alternative investment funds.

The Players in the Private Equity Secondary Market Guide

The private equity secondary market is a complex ecosystem that involves various entities that play a crucial role in the functioning of the market. These entities include General Partners, Limited Partners, Buyers and Sellers, and Fund Managers.

General Partners

General Partners (GPs) are the investment managers who manage the private equity fund. They are responsible for sourcing, evaluating, and executing investment opportunities. GPs also manage the day-to-day operations of the fund, including investor relations, reporting, and compliance. In the secondary market, GPs may sell their fund interests to other investors or use the secondary market to restructure their portfolio.

Limited Partners

Limited Partners (LPs) are the investors who provide capital to the private equity fund. LPs are typically institutional investors such as pension funds, endowments, and sovereign wealth funds. In the secondary market, LPs may sell their fund interests to other investors to realize liquidity or to rebalance their portfolio.

Buyers and Sellers

Buyers and Sellers in the secondary market are investors who buy and sell fund interests. Buyers may include other LPs, secondary funds, or other institutional investors. Sellers may include LPs who wish to exit their investment or GPs who wish to restructure their portfolio. Buyers and Sellers in the secondary market must navigate a complex market with varying levels of liquidity and pricing.

Fund Managers

Fund Managers are the entities that manage secondary funds. These funds invest in private equity fund interests in the secondary market. Fund Managers may be dedicated secondary funds or may be part of a larger private equity firm. Fund Managers must have a deep understanding of the private equity market and the ability to navigate complex legal and regulatory frameworks.

In conclusion, the private equity secondary market involves a range of players, including GPs, LPs, Buyers and Sellers, and Fund Managers. Each of these players has a unique role to play in the functioning of the market. The secondary market provides liquidity to investors and enables GPs to restructure their portfolios. Understanding the role of each player is crucial for investors looking to participate in the secondary market.

Key Market Trends

The private equity secondary market has been experiencing significant growth over the last few years. Here are some key trends shaping the market:

GP-Led Transactions

GP-led transactions have been gaining traction in the secondary market. In such transactions, the general partner (GP) of a private equity fund sells the fund’s assets to a new vehicle, which is often backed by a secondary fund. GP-led deals have become a popular way for GPs to provide liquidity to their limited partners (LPs) without having to sell assets at a discount in the open market. According to Campbell Lutyens, GP-led deals represented approximately 40% of the total secondary market volume in 2020.

Venture Capital Influence

Venture capital has been playing an increasingly important role in the secondary market. As more venture-backed companies stay private for longer, secondary buyers are looking for ways to gain exposure to these companies. In addition, venture capital funds are increasingly using the secondary market to provide liquidity to their LPs. According to abrdn, venture capital funds represented approximately 15% of the total secondary market volume in 2021.

Pandemic Impact

The COVID-19 pandemic has had a significant impact on the private equity secondary market. In the early days of the pandemic, the market experienced a slowdown as buyers and sellers paused transactions to assess the impact of the pandemic on portfolio companies. However, the market rebounded quickly as buyers and sellers adapted to the new environment. According to Barclays Private Bank, secondary deal volume grew from $26 billion in 2013 to a record $134 billion in 2021, despite the pandemic.

In summary, the private equity secondary market is evolving rapidly, driven by GP-led transactions, venture capital influence, and the impact of the pandemic. As the market continues to grow, it is likely that we will see more innovative structures and new players entering the market.

Investment and Fundraising

Capital and Investments

Investing in private equity secondaries can provide investors with an opportunity to diversify their portfolio and access a range of alternative investment funds.

According to a report by McKinsey, global private markets fundraising declined by 11% to $1.2 trillion in 2022. However, private equity secondaries remained a popular investment option, with the total secondaries market volume growing to a record $134 billion in 2021, according to Morgan Stanley.

One of the advantages of investing in private equity secondaries is that it can provide investors with access to a range of alternative investment funds, including venture capital funds, funds of funds, and other types of alternative investments. Private equity secondaries can also provide investors with a way to diversify their portfolio and reduce their exposure to risk.

Fundraising Strategies

Fundraising is a critical component of the private equity secondary market. According to a PDF guide by CAIA, global private equity fundraising from 2001-2015 was $1.4 trillion. Despite strong transaction volume increases in the secondary market, the proportion of secondary transactions in relation to the unrealized value of private equity is quite small, accounting for less than 2% for the last 14 years.

Private Equity Secondary Market Guide

To raise funds for private equity secondaries, fundraising strategies can include a range of approaches, such as traditional fundraising methods, including direct outreach to potential investors, as well as using online platforms to reach a wider audience. Additionally, some private equity secondary firms may also use their existing network of investors to raise funds for new investments.

Overall, investing in private equity secondaries can provide investors with an opportunity to access a range of alternative investment funds and diversify their portfolio. Fundraising strategies can include traditional fundraising methods, as well as using online platforms and existing investor networks.

Market Conditions and Volatility

Market Conditions

The private equity secondary market has experienced significant growth over the past two decades. According to abrdn, the market for private-equity secondaries has evolved and grown considerably over the past two decades.

During that time, secondaries have become an essential component in oiling the wheels of the private equity (PE) asset class, by providing liquidity to investors in an otherwise illiquid market.

The market conditions in 2020 and 2021 were favourable for the private equity secondary market. The total secondaries market volume grew to a record $134 billion in 2021, as per Morgan Stanley. This growth was driven by a number of factors, including a rising number of investors seeking to sell their private equity holdings, and an increasing number of buyers seeking to acquire these assets.

Volatility Factors

Despite the favourable market conditions, volatility remains a concern in the private equity secondary market.

As per Barclays Private Bank, secondary deal volume grew from $26 billion in 2013, to a record $134 billion in 2021. Volumes in 2022 remained high at $108 billion, the second biggest year on record, but slowed during the second half amid public market volatility and lower market pricing.

Market volatility can be caused by a number of factors, including economic uncertainty, geopolitical risk, and changes in government policies. In 2020, the COVID-19 pandemic caused significant volatility in financial markets, including the private equity secondary market. However, the market quickly recovered, and by the end of the year, it had reached record levels of activity.

Investors in the private equity secondary market must be aware of these volatility factors and take steps to mitigate their risk. This may include diversifying their portfolios, investing in a range of different private equity funds, and carefully monitoring the market for signs of potential volatility.

Private Equity Secondary Market – Valuation and Pricing

Valuation Methods

Valuation is the process of determining the worth of an asset, and in the private equity secondary market, it is crucial to ensure that investors get the best price for their investments.

There are several valuation methods that buyers and sellers use to determine the value of a private equity investment. The most common methods include:

• Net Asset Value (NAV): This is the most commonly used method of valuation in the private equity secondary market. NAV is the value of the assets minus any liabilities of a fund. NAV is calculated by taking the current value of the fund’s assets and subtracting its liabilities. NAV is used as a benchmark for pricing private equity investments.

• Multiples: Multiples are another commonly used valuation method in the private equity secondary market. Multiples are calculated by dividing the enterprise value of a company by its earnings before interest, taxes, depreciation, and amortization (EBITDA). Multiples are used to compare the value of similar companies and to determine the relative value of a private equity investment.

Pricing Strategies

Pricing in the private equity secondary market is a complex process that involves several factors. Buyers and sellers use different pricing strategies to determine the value of a private equity investment. Some of the most common pricing strategies include:

• Market-based pricing: Market-based pricing is a pricing strategy that involves pricing a private equity investment based on the prevailing market conditions. Market-based pricing takes into account factors such as supply and demand, the state of the economy, and the performance of the fund.
• Negotiated pricing: Negotiated pricing is a pricing strategy that involves negotiating the price of a private equity investment between the buyer and the seller. Negotiated pricing is used when the buyer and the seller cannot agree on a market-based price.
• Discounted pricing: Discounted pricing is a pricing strategy that involves pricing a private equity investment at a discount to its NAV. Discounted pricing is used when the seller wants to sell the investment quickly or when the buyer wants to get a bargain.

In conclusion, valuation and pricing are critical factors in the private equity secondary market. Buyers and sellers use different valuation methods and pricing strategies to determine the value of a private equity investment. The most commonly used valuation methods are NAV and multiples, while the most common pricing strategies are market-based pricing, negotiated pricing, and discounted pricing.

Liquidity and Dry Powder

Private equity secondary market has become an attractive option for investors who seek liquidity and partial liquidity. The secondary market offers an opportunity for investors to sell their stakes in private equity funds to interested buyers. This provides investors with the flexibility to monetize their investments and exit a position before the fund’s life cycle ends.

One of the key factors that determine the success of the secondary market is the availability of dry powder. Dry powder refers to the cash reserves that private equity firms have available to deploy when an attractive investment opportunity arises. In the context of the secondary market, dry powder is important because it enables buyers to purchase stakes in private equity funds.

According to a report by Allvue Systems, dry powder in private equity sits around $3.7 trillion as of the end of 2022. Private equity buyout funds are the leading category in terms of dry powder levels with $1.1 billion in committed capital reserves. This indicates that there is a significant amount of capital available for secondary market transactions.

However, the availability of dry powder is not evenly distributed across all top private equity firms. Some PE firms may have more dry powder than others, which could impact their ability to participate in the secondary market. Additionally, the competition for attractive deals in the secondary market is intense, which could drive up prices and make it difficult for firms with limited dry powder to participate.

In conclusion, the availability of dry powder is an important factor in the success of the private equity secondary market. Investors who seek partial liquidity in their private equity investments should consider the availability of dry powder before entering the secondary market. Private equity firms with significant dry powder reserves are better positioned to participate in the secondary market and capitalize on attractive investment opportunities.

Major Market Participants

Private equity secondary market is a growing industry with a number of major participants. Some of the top players in the market include Ardian, Coller Capital, HarbourVest, Evercore, Lexington Partners, Deutsche Bank, Goldman Sachs, and Morgan Stanley. Each of these firms has its own unique approach to the market, but they all share a commitment to providing liquidity to investors in an otherwise illiquid market.

Ardian

Ardian is a leading global private equity firm with a strong presence in the secondary market. The firm has been active in the market since the 1990s and has completed over 400 secondary transactions. Ardian’s secondary team focuses on acquiring portfolios of private equity assets from institutional investors, as well as providing liquidity to limited partners in private equity funds.

Coller Capital

Coller Capital is one of the largest and most experienced buyers of private equity secondary interests. The firm was founded in 1990 and has since completed over 1,000 transactions. Coller Capital’s secondary business focuses on acquiring portfolios of private equity assets from institutional investors, as well as providing liquidity to limited partners in private equity funds.

HarbourVest

HarbourVest is a global private equity firm with a strong presence in the secondary market. The firm has been active in the market since the 1980s and has completed over 1,000 secondary transactions. HarbourVest’s secondary team focuses on acquiring portfolios of private equity assets from institutional investors, as well as providing liquidity to limited partners in private equity funds.

Evercore

Evercore is a global investment banking advisory firm with a strong presence in the secondary market. The firm’s secondary business focuses on advising clients on the sale and purchase of private equity assets. Evercore has completed a number of high-profile secondary transactions, including the sale of a $1 billion portfolio of private equity assets to HarbourVest.

Lexington Partners

Lexington Partners is one of the largest and most experienced buyers of private equity secondary interests. The firm was founded in 1994 and has since completed over 2,500 transactions. Lexington Partners’ secondary business focuses on acquiring portfolios of private equity assets from institutional investors, as well as providing liquidity to limited partners in private equity funds.

Deutsche Bank

Deutsche Bank is a global investment bank with a strong presence in the secondary market. The firm’s secondary business focuses on advising clients on the sale and purchase of private equity assets. Deutsche Bank has completed a number of high-profile secondary transactions, including the sale of a $1.5 billion portfolio of private equity assets to Ardian.

Goldman Sachs

Goldman Sachs is a global investment bank with a strong presence in the secondary market. The firm’s secondary business focuses on advising clients on the sale and purchase of private equity assets. Goldman Sachs has completed a number of high-profile secondary transactions, including the sale of a $1.5 billion portfolio of private equity assets to Lexington Capital Partners.

Morgan Stanley

Morgan Stanley is a global investment bank with a strong presence in the secondary market. The firm’s secondary business focuses on advising clients on the sale and purchase of private equity assets. Morgan Stanley has completed a number of high-profile secondary transactions, including the sale of a $1 billion portfolio of private equity assets to Goldman Sachs Vintage Fund.

Overall, these firms are major players in the private equity secondary market, providing liquidity to investors and helping to drive the growth of this important industry.

Alternative Investment and Diversification

Private equity secondaries offer an alternative investment opportunity for investors seeking diversification in their portfolio. Unlike traditional investments in stocks and bonds, private equity secondaries provide exposure to a different asset class, which can help mitigate risk and enhance returns.

Investors can access diversified private equity exposure across strategies, vintages, geographies, sectors, and fund managers. This diversification can help manage risk by spreading investments across multiple assets. Additionally, investors have visibility on portfolio quality, which allows them to assess the quality and valuations of the underlying assets and how future value might be created and exits achieved from the portfolios.

Alternative investments are becoming increasingly popular among institutional and individual investors. Private equity secondaries offer a unique opportunity to invest in a growing market, which has seen compound growth rates of 23% per year from 2013 to 2021, according to Barclays [1].

Moreover, private equity secondaries can provide a way to avoid the “J-curve” effect on returns that is often associated with private equity investments.

Private Equity Secondary Market Guide

The J-curve effect refers to the historical tendency of private equity funds to deliver negative returns in early years and investment gains in later years as their portfolios mature. By purchasing secondary interests later in the fund’s term, investors may be able to avoid the negative returns and benefit from the matured portfolio.

In conclusion, alternative investments such as private equity secondaries can provide investors with diversification opportunities and access to a growing market. Private equity secondaries offer exposure to a different asset class and can help manage risk by spreading investments across multiple assets. Additionally, investors have visibility on portfolio quality, which allows them to assess the quality and valuations of the underlying assets and how future value might be created and exits achieved from the portfolios.

[1] Barclays. “Spotlight on secondary private markets.” (2023) https://privatebank.barclays.com/insights/2023/march/spotlight-on-secondary-private-markets/

Market Challenges and Opportunities

Challenges

The private equity secondary market is not without its challenges. One of the primary challenges is the illiquid nature of the market. Private equity investments are typically long-term, and it can be difficult for investors to exit their positions before the end of the investment term. This illiquidity can make it challenging for investors to rebalance their portfolios or generate cash flow when needed.

Another challenge is the J-curve effect. This effect refers to the fact that private equity investments tend to have negative returns in the early years of the investment, as the fund incurs fees and expenses and invests in new companies. Over time, as the portfolio companies mature and generate cash flow, returns improve. However, this means that investors may need to hold their investments for several years before seeing positive returns.

Opportunities

Despite these challenges, the private equity secondary market also presents a number of opportunities for investors. One of the key advantages of the secondary market is the ability to access a wider range of investment opportunities. By purchasing existing private equity positions, investors can gain exposure to a diverse range of companies and industries.

In addition, the secondary market can provide liquidity for investors who need to exit their positions before the end of the investment term. This can be particularly valuable for institutional investors who may need to rebalance their portfolios or generate cash flow for other purposes.

Another opportunity presented by the secondary market is the ability to invest in mature companies with a proven track record of success. These companies may be less risky than early-stage companies and may provide more predictable returns.

Overall, while the private equity secondary market does present some challenges, it also provides a number of opportunities for investors looking to diversify their portfolios and access a wider range of investment opportunities.

Future Outlook

The private equity secondary market has been surging in recent years, and this trend is expected to continue in the future. According to a report by Private Equity Wire, global volumes for the secondary market hit an H1 record of $57bn in 2022. This was due to a combination of factors, including increased buyout, carveout and M&A activity, as well as more quality portfolios for sale in the secondary markets.

Looking ahead, it is expected that the secondary market will continue to grow and evolve. One area of growth is likely to be in GP-led deals, which have become increasingly popular in recent years. These deals involve the general partner of a private equity fund selling a portfolio company to a new investor, often with the participation of the existing limited partners.

Another area of growth is likely to be in the use of technology to facilitate secondary market transactions.

This includes the use of blockchain technology to create secure and transparent transactions, as well as the use of artificial intelligence to identify potential buyers and sellers.

Despite the expected growth in the secondary market, there are also some potential challenges to be aware of.

One challenge is the potential for a downturn in the global economy, which could lead to a decrease in demand for private equity investments.

Another challenge is the increasing complexity of secondary market transactions, which can make them more difficult to execute and value accurately.

Overall, the future outlook for the private equity secondary market is positive, with continued growth and evolution expected in the years to come.

While there are some potential challenges to be aware of, the increasing popularity of GP-led deals and the use of technology are likely to drive continued growth and innovation in this important segment of the private equity market.

Frequently Asked Questions

What is the difference between primary and secondary investments in private equity?

Primary investments involve investing in a private equity fund during its initial fundraising stage. In contrast, secondary investments involve buying and selling existing private equity fund investments.

What is the private equity secondary market and how does it work?

The private equity secondary market refers to the buying and selling of existing private equity fund investments. This market allows investors to sell their existing private equity fund investments to other investors who are willing to purchase them. This can provide liquidity to investors who may otherwise have to wait for the fund’s maturity to access their capital.

How do private equity secondaries firms operate in the market?

Private equity secondaries firms typically purchase existing private equity fund investments from investors and then manage those investments until they are sold to another investor. These firms may also provide liquidity solutions to investors who need to exit their investments early.

What are the largest private equity secondary market funds in the UK?

As of 2023, some of the largest private equity secondary funds in the UK include Coller Capital, HarbourVest Partners, and Partners Group.

What is the private equity secondaries market outlook for the next 12 months?

The private equity secondaries market is expected to remain strong over the next 12 months, with continued demand for liquidity solutions and opportunities for attractive returns. However, market conditions may shift due to factors such as changes in interest rates or economic uncertainty.

How does the private equity secondary market impact LPs and GPs?

The private equity secondary market can impact LPs (limited partners) and GPs (general partners) in several ways. LPs may benefit from increased liquidity options, while GPs may be able to access additional capital for their funds. However, the secondary market can also impact the valuations of existing investments and may require additional reporting and due diligence for LPs and GPs involved in secondary transactions.

Private Equity Secondary Market