What is the Secondary Market in Private Equity
Private equity investments are traditionally known for their long holding periods and limited liquidity. Today, the evolution of the Private Equity secondary market provides a range of new tools to effectively mitigate liquidity and portfolio risk through buying and selling Private Equity Fund interests before the fund’s expiration. We at Nexus Expert Research specialize in helping our clients and institutions understand and leverage the expanding Private Equity Secondary Market by analyzing their changing structures.
Understanding the Private Equity Secondary Market
The secondary market in private equity is involved mainly in the trade of existing private equity funds instead of direct investments into companies. As a result, the LPs selling their limited partner shares/contributions to a private equity fund gain some liquidity by not having to wait until the private equity fund liquidates all of the companies it invested in through its portfolios as a means of providing liquidity to the seller.
These types of transactions are known as private equity secondaries and have become a fundamental aspect of managing a modern Private Equity portfolio.
Why the PE Secondary Market Exists
Most private equity funds have a long lifecycle with an expected duration exceeding ten years. Investors may experience changing liquidity requirements, the need for compliance with ever-increasing regulations, and/or strategic goals impacting their investment portfolios throughout the fund’s lifecycle. The PE secondary market provides a solution by enabling investors to exit positions early.
At the same time, private equity investors buying in the secondary market typically acquire more mature investments and thus have a clearer picture regarding the value of these assets, and will virtually eliminate the risk of purchasing from a “blind pile” or “blind fund.”
Selling Private Equity Fund Interests
The sale of interests in private equity funds is one of the primary activities in the secondary market for private equity. Sellers can include pension funds, endowments, family offices, and institutional investors that are looking for liquidity or rebalancing their portfolios.
Secondary transactions may involve either a single fund or an intricate portfolio and require detailed due diligence that considers the quality of the underlying assets, the remaining term of funds, and estimated future cash flows.
Private Equity Secondary Pricing
Pricing of privately-owned equities and their sale as a secondary market transaction are based on many things, such as the performance of the fund; how long it is expected to last; conditions in the capital markets; the perceived risk of the investment; and whether or not the buyer/dealer believes that the seller has received an additional discount or premium over the original investment because of demand for the asset and the quality of the assets being offered.
Accurate pricing is essential in determining an accurate return for both the seller and the buyer when doing business in the secondary market.
Benefits of Private Equity Secondaries
The rise in private equity secondary market activity allows for greater flexibility throughout the entire private equity marketplace. The secondary marketplace allows sellers access to liquidity and enables sellers to manage their risks. For purchasers, accessing the secondary market allows for diversification, accelerated capital deployments, and increased transparency into the portfolio’s performance.
These benefits have spurred the rapid global growth of the PE secondary marketplace.
Risks and Considerations
A private equity secondary market represents a source of potential opportunity for investors, but there are numerous complexities associated with transacting on this market. Uncertainties regarding the valuation of transactions due to a lack of transparency, alongside regulatory issues, affect secondary market private equity transactions. Investors need to complete extensive due diligence prior to completing a transaction in order to match transactions with their respective risk/return profiles.
This type of transaction requires expert knowledge of the secondary market and private equity markets.
Conclusion
The private equity secondary marketplace has emerged as an extremely important segment in the overall private equity ecosystem by providing investors with liquidity, flexibility, and added strategic options. The private equity secondary marketplace provides the ability for existing fund interests to be transferred between parties. The use of private equity secondary transactions can significantly decrease the length of time that capital is “locked up” in a private equity fund and allows for a more dynamic approach to the management of private equity portfolios.
Through our sophisticated market knowledge and analytical capabilities, Nexus Expert Research provides organizations with insights into private equity secondary investment opportunities and pricing, as well as the tools necessary to evaluate value before selling private equity fund interests in an evolving private equity landscape.
