Understanding the Private Equity Secondary Market (2024)

The private equity secondary market refers to the buying and selling of commitments to private equity commitments during a fund’s lifetime. To avoid confusion, when making reference to both private equity secondaries and direct investments into private equity funds, these direct investments are often known as “primary” private equity.

The private equity secondary market has grown steadily since the turn of the century as the benefits have become hard to ignore. These include access to liquidity, a faster return profile and the ability to mitigate Blind Pool risk - see below for more on each of these.

Types of secondary transaction

“LP secondary” transactions

This is the most common secondary transaction. It involves an existing Limited Partner that sells its assets to a secondary buyer. The buyer without prior investment in the fund then replaces the Limited Partner with all their rights and obligations.

“GP-led” transactions

The most popular type of GP-led transaction is the ‘continuation vehicle transaction’, taking place when a General Partner needs to extend the investment period of a fund that has reached the end of its life. Portfolio companies (or a single asset) are moved to a new fund vehicle that enables additional follow-on capacity and, hence, extended hold periods. Existing Limited Partners have the option to either ‘roll-over’ or cash out the interest to a secondary buyer. This is also known as “fund recapitalisation”.

Direct secondary transactions

This is the trade of directly-held ownership interest in a company from Limited Partners to an existing investor. A direct secondary transaction is an opportunity to sell stock before the entire portfolio of companies has been sold.

Benefits of secondaries

Liquidity access

For sellers, secondaries can offer a valuable mechanism to better manage otherwise illiquid private equity portfolios. Selling stakes creates a stream of cash that is ready to be deployed into potentially new investment priorities - or satisfy an urgent need for capital.

Faster returns (J-Curve mitigation)

For buyers, investing in a private equity fund secondary as opposed to a primary investment in a fund cuts down the time until cash is returned to Limited Partners. This will - of course - be reflected in the purchase price: the shorter the period until it starts returning capital, the more expensive (and vice versa).

Mitigating Blind Pool Risk

“Blind Pool Risk” refers to the fact that Limited Partners commit capital to a portfolio that is yet to be constructed, creating a “blind pool” of capital. In the case of secondaries - especially those purchased late in a fund’s lifetime - investors are putting their money into companies that are already known, allowing them to analyse the performance so far and calculate the future value potential of the underlying companies.

For more on how to access the private equity secondary market, visit the Moonfare Secondary Marketplace. Though liquidity is not guaranteed, Moonfare’s semi-annual digital secondary market is a structured auction that allows investors seeking early liquidity a chance to sell their Moonfare allocations to other members.

What is a secondaries fund?

It is important to make a distinction between the market for private equity fund secondaries (as described above) and a secondaries fund. In the case of a secondaries fund, the fund manager creates a portfolio of private equity fund secondaries, either by buying out other investors or investing capital into funds after they launch.

Investing in a secondaries fund has a number of key benefits:

• Diversification. Investors in secondaries funds receive access to hundreds of underlying portfolio investments, managed by a General Partner with particular expertise and experience in the field.
• Lower fees. Investors in secondaries funds typically pay lower fees than “primary” funds. The logic here is that the General Partner role is more as a portfolio manager as opposed to actively adding value to the underlying companies.
• Early liquidity profile. A secondaries fund invests in underlying funds of various vintages, a strategy designed to offset commitments and distributions against each other. The result is early liquidity and a far shallower J-Curve.

Authors