Private Equity Secondary Market
Private Equity Investors Turn to Secondaries Market
Generally, the secondary market for private equity is a market for the buying and selling of capital commitments to private equity funds by limited partners. The secondaries market has seen a large boom recently as many private equity investors are selling their investment commitments at considerably lower prices than the estimated value. The financial crisis and low performance of many private equity funds has led to this major push to 'dump' private equity investments even at a short term loss because the investors believe that it could get worse or cannot afford to remain committed to the fund as long as they are obligated. As the private equity secondary market becomes more and more popular, it's important to have an understanding of what the secondaries market for private equity is.By definition, private equity investment is different from the public investment markets where anyone can purchase shares of publicly traded companies. The private equity secondaries market is a way for private equity investors to exchange pre-existing investor commitments, similar to public exchange markets. A big difference though is that the private equity secondaries market is involves trading illiquid assets of long-term commitments to private equity funds.
The emphasis of these commitments is long-term because limited partners typically commit to private equity funds for at least 5 years and as long as 10 years for some fund. The reason is mostly that private equity funds seek to maximize profits of portfolio companies by restructuring and reducing the areas that cut into profits. To be successful, private equity firms prefer a longer time period to make the changes and for good reason.
By having a longer time frame to carry out the adjustments, private equity firms are able to find what is best for the company's success rather than worrying over producing near-immediate returns to investors. This is also a concern of private equity for limited partners because they attach themselves to the fund for such a long time period, during which various problems could occur within the investment or beyond (such as the current financial crisis) which causes the investor to want to cash out early.
This is where the secondary market for private equity proves useful to investors who want to exit their longterm investment. Especially in times of turmoil, private equity investors may want out and in this event activities in the secondaries market surge. A great example of this is the aftermath of the Dot-Com crash where many private equity investors, especially those in venture capital funds, scrambled to sell off their investments that were rapidly sinking in value. During the time period of the Dot-Com bubble's burst and the subsequent retreat by limited partners, the volume of transactions in the secondaries market rose from an estimated 2-3% to 5%. This led to a massive influx of undervalued investments, a large amount from tech-focused venture capital funds, and after a couple years the private equity secondaries market was more reasonably priced to the actual value. This may change again, however, as many nervous or hurt private equity investors are selling off investment commitments seemingly at a much lower price than the actual value, similar to the aftermath of the Dot-Com collapse.
Types of Transactions on the Private Equity Secondaries Market
- Sale of Limited Partnership Interests: The most common transaction on the private equity secondaries market is the sale of limited partnership interests. Nearly all private equity funds (mezzanine fund, venture capital fund, angel investor fund etc) can be sold on the secondaries market and many investors use this to sell capital commitments to funds to other investors hoping to benefit from what they think is a undervalued investment. There are several variations on the basic sale of a limited partnership interest: a structured joint venture is a typically more complicated exchange where the buyer and seller negotiate terms that suit both parties. Securitization is an option for investors that want some liquid assets by investing its limited partner interests into a new vehicle, often a collatoralized fund obligation which issues notes or other liquid assets to the investor in return. A stapled transaction is a negotiated agreement when a general partner is raising another fund which ties the limited partner's current fund investment to the new fund.
- Sale of Direct Interests: This is different from the sale of limited partnership interests because it trades a direct investment in operating companies rather than in an investment fund. A secondary direct transaction is the sale of a captive portfolio of direct investments that must be either actively managed by the buyer or the buyer is supposed to arrange for a manager. Synthetic secondary transaction occurs when a secondary investor purchases a limited partnership holding a portfolio of direct investments. A tail-end transaction deals with the interest in a private equity investment that is nearing or has passed its expected life.
Partial source: Wikipedia
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