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Private equity secondary market |
In finance, the private equity secondary market (also often called private equity secondaries or secondaries) refers to the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds. Sellers of private equity investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds. By its nature, the private equity asset class is illiquid, intended to be a long-term investment for buy-and-hold investors. For the vast majority of private equity investments, there is no listed public market; however there is a robust and maturing secondary market available for sellers of private equity assets.
Driven by strong demand for private equity exposure, a significant amount of capital has been committed to dedicated secondary market funds from investors looking to increase and diversify their private equity exposure.
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The market for secondary interests is still highly fragmented. Leading secondary investment firms with current dedicated secondary capital in excess of circa $3 billion include: AlpInvest Partners, AXA Private Equity, Coller Capital, HarbourVest Partners, Lexington Partners, Pantheon Ventures, Partners Group and Paul Capital.
Other major independent secondary firms with circa $1 - $3 billion of current dedicated capital to secondaries include Adams Street Partners, Greenpark Capital, Landmark Partners, LGT, Newbury Partners and Pomona Capital.
Additionally major investment banking firms, including Credit Suisse, Deutsche Bank, Goldman Sachs, Lehman Brothers and Morgan Stanley have active secondary investment programs and other institutional investors typically have appetite for secondary interests. More and more private equity funds-of-funds also allocate some of their primary program to secondaries.
Within the secondary arena, certain smaller specialized firms, including Industry Ventures, Lake Street Capital, Saints Capital, Vision Capital and W Capital, focus on purchasing portfolios of direct investments in operating companies (referred to as secondary directs. Other niches within the secondary market include purchases of interests in fund-of-funds and secondary funds (Montauk Triguard) and purchases of interests in real estate funds (Liquid Realty and Madison Harbor Capital).
While intermediation in the secondary market is still not as pervasive as in corporate mergers and acquisitions, leading advisors to secondary market sellers include investments banks (Credit Suisse, Lazard, Merrill Lynch and UBS), dedicated boutique firms (Cogent Partners and Fidequity), electronic exchanges (NYPPE), as well as established fund placement agents (Campbell Lutyens, Probitas Partners and Triago).
Secondary transactions can be generally split into two basic categories:
The most common secondary transaction, this category includes the sale of an investor's interest in a private equity fund or portfolio of interests in various funds through the transfer of the investor's limited partnership interest in the fund(s). Nearly all type of private equity funds (e.g., including buyout, growth equity, venture capital, mezzanine, distressed and real estate) can be sold in the secondary market. The transfer of the limited partnership interest typically will allow the investor to receive some liquidity for the funded investments as well as a release from any remaining unfunded obligations to the fund. In addition to traditional cash sales, sales of limited partnership interests are being consummated through a number of structured transactions:
Secondary Directs or Synthetic secondaries, this category refers to the sale of portfolios of direct investments in operating companies, rather than limited partnership interests in investment funds. These portfolios historically have originated from either corporate development programs or large financial institutions. Typically this category can be subdivided as follows:
The Venture Capital Fund of America (today VCFA Group), founded in 1982 by Dayton Carr, was likely the first investment firm 2 to begin purchasing private equity interests in existing venture capital, leveraged buyout and mezzanine funds, as well as direct secondary interests in private companies. Early pioneers in the secondary market include Jeremy Coller, the founder of UK-based Coller Capital, Arnaud Isnard, who worked with Carr at VCFA and would later form ARCIS, a secondary firm based in France3 as well as Stanley Alfeld, founder of Landmark Partners, based in Simsbury, CT.4
In the years immediately following the dot-com crash, many investors sought an early exit from their outstanding commitments to the private equity asset class, particularly venture capital.5 As a result, the nascent secondary market became an increasingly active sector within private equity in these years. Secondary transaction volume increased from historical levels of 2% or 3% of private equity commitments to 5% of the addressable market.67 Many of the largest financial institutions (e.g., Deutsche Bank, Abbey National, UBS AG) sold portfolios of direct investments and “pay-to-play” funds portfolios that were typically used as a means to gain entry to lucrative leveraged finance and mergers and acquisitions assignments but had created hundreds of millions of dollars of losses.
The surge in activity in the secondary market, between 2004 and 2007, prompted new entrants to the market. It was during this time that the market evolved from what had previously been a relatively small niche into a functioning and important area of the private equity industry. Prior to 2004, the market was still characterized by limited liquidity and distressed prices with private equity funds trading at significant discounts to fair value. Beginning in 2004 and extending through 2007, the secondary market transformed into a more efficient market in which assets for the first time traded at or above their estimated fair values and liquidity increased dramatically. During these years, the secondary market transitioned from a niche sub-category in which the majority of sellers were distressed to an active market with ample supply of assets and numerous market participants.8 By 2006 active portfolio management had become far more common in the increasingly developed secondary market and an increasing number of investors had begun to pursue secondary sales to rebalance their private equity portfolios. The continued evolution of the private equity secondary market reflected the maturation and evolution of the larger private equity industry.
The secondary market for private equity interests has entered a new phase in 2008 with the onset and acceleration of the credit crunch. Pricing in the market fell steadily throughout 2008 as the supply of interests began to greatly outstrip demand and the outlook for leveraged buyout and other private equity investments worsened. Financial institutions, including Citigroup and ABN AMRO as well as affiliates of AIG and Macquarie were prominent sellers.
With the crash in global markets from in the fall of 2008, more sellers entered the market including publicly traded private equity vehicles, endowments, foundations and pension funds. Many sellers were facing significant overcommittments to their private equity programs and in certain cases significant unfunded commitments to new private equity funds were prompting liquidity concerns.9 With the dramatic increase in the number of distressed sellers entering the market at the same time, the pricing level in the secondary market dropped rapidly. In these transactions, sellers were willing to accept major discounts to current valuations (typically in reference to the previous quarterly net asset value published by the underlying private equity fund manager) as they faced the prospect of further asset write-downs in their existing portfolios or as they had to achieve liquidity under a limited amount of time.
At the same time the outlook for buyers became more uncertain and a number of prominent secondary players were slow to purchase assets. In certain cases, buyers that had agreed to secondary purchases began to exercise Material Adverse Change (MAC) clauses in their contracts to walk away from deals that they had agreed to only weeks before.10
Looking forward, it is believed that a majority of Private Equity fund managers will publish their September and December NAV with subtancial write-downs to reflect the falling value of the underlying companies and of the public comparables. As a result the discount to Net Asset Value offered by buyers of private equity Interests to sellers of such assets will likely be reduced.
The following is a timeline of some of the most notable secondary transactions and other milestones:
2008
2007
2006
2005
2004
2003
2001
2000
1999
1998
1997
1994
1992
1991
1989
1982
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