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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.

Contents

Secondary market participants

As of 2009, it was estimated that there are dozens of dedicated firms and institutional investors that engage in the purchase of private equity interests in the secondary market with upwards of $30 billion of capital available for such transactions.[1] 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.[2][3]

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 Capital Partners, Newbury Partners, Pomona Capital, Saints Capital and W Capital Partners.[2][3]

Additionally major investment banking firms, including Credit Suisse, Deutsche Bank (through RREEF), Goldman Sachs, JPMorgan Chase[4], Lehman Brothers and Morgan Stanley have active secondary investment programs.[3] Other institutional investors typically have appetite for secondary interests. More and more primary investors, whether private equity funds-of-funds or other institutional investors 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).[5]

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, Houlihan Lokey, Lazard and UBS), dedicated boutique firms (Cogent Partners and Fidequity), electronic exchanges (NYPPE and SecondMarket), as well as established fund placement agents (Campbell Lutyens, Probitas Partners and Triago. Since 2008, there have been a significant number of new entrants to this space hoping to capitalize on what is perceived to be a growing market opportunity.

Types of Secondary Transactions

Diagram of a simple secondary market transfer of a limited partnership fund interest. The buyer exchanges a single cash payment to the seller for both the investments in the fund plus any unfunded commitments to the fund.

Secondary transactions can be generally split into two basic categories:

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Sale of Limited Partnership Interests

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:[6]

  • Structured Joint Ventures – Includes a wide variety of negotiated transactions between the buyer and seller that typically is customized to the specific needs of the buyer and seller. Typically, the buyer and seller agree on an economic arrangement that is more complex than a simple transfer of 100% ownership of the limited partnership interest.[6]
  • Securitization – An investor contributes its limited partnership interests into a new vehicle (a Collateralized Fund Obligation vehicle known as a "CFO") which in turn issues notes and generates partial liquidity for the seller. Typically, the investor will also sell a portion of the equity in the leveraged vehicle. Also referred to as a collateralized fund obligation vehicle.[6]
  • Stapled Transactions – (commonly referred to as "stapled secondaries") Occurs when a private equity firm (the GP) is raising a new fund. A secondary buyer purchases an interest in an existing fund from a current investor and makes a new commitment to the new fund being raised by the GP.[6] These transactions are often initiated by private equity firms during the fundraising process.[7] They have become less and less frequent during 2008 as the appetite for primary investments has shrunk.

Sale of Direct Interests

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:

  • Secondary Direct – The sale of a captive portfolio of direct investments to a secondary buyer that will either manage the investments themselves or arrange for a new manager for the investments.[6] One of the most notable example of a corporate seller engaging into a direct portfolios sale is the two consecutive sales of direct portfolios from AEA Technology to Coller Capital and Vision Capital in 2005 and 2006 respectively.
  • Synthetic Secondary / Spinout - Under a synthetic secondary transaction, secondary investors acquire an interest in a new limited partnership that is formed specifically to hold a portfolio of direct investments.[6] Typically the manager of the new fund had historically managed the assets as a captive portfolio. The most notable example of this type of transaction is the spinout of MidOcean Partners from Deutsche Bank in 2003.
  • Tail-End – This category typically refers to the sale of the remaining assets in a private equity fund that is approaching, or has exceeded, its anticipated life.[6] A tail-end transaction allows the manager of the fund to achieve liquidity for the fund's investors.
  • Structured Secondary – This category typically refers to the structured sale of a portfolio of private equity fund interests whereby the seller keeps some/all of the fund interests on its balance sheet but the buyer agrees to fund all future capital calls of the seller's portfolio in exchange for a preferred return secured against future distributions of the seller's portfolio. These type of secondary transactions have becoming increasingly explored since mid 2008 and throughout 2009 as many sellers did not want to take a loss through a straight sale of their portfolio at a steep discount but instead were ready to abandon some of the future upside in exchange for a bridge of the uncalled capital commitments.

History

History of private equity
and venture capital
Objectivist.jpg

Early History
(Origins of modern private equity)

The 1980s
(LBO boom)

The 1990s
(LBO bust and the VC bubble)

The 2000s
(Dot-com bubble to the Credit crunch)

  

Early history

The Venture Capital Fund of America (today VCFA Group), founded in 1982 by Dayton Carr, was likely the first investment firm [8] 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 France[9] as well as Stanley Alfeld, founder of Landmark Partners, based in Simsbury, CT.[10]

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.[11] As a result, the nascent secondary market became an increasingly active sector within private equity in these years.[12][13] Secondary transaction volume increased from historical levels of 2% or 3% of private equity commitments to 5% of the addressable market.[14][15][16] 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.

2004 to 2007

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.[17] 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.[18] 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.

Since 2008 and the Credit crisis

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.[19] 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.[20]

Private equity fund managers published their December 2008 valuations with substantial write-downs to reflect the falling value of the underlying companies. As a result, the discount to Net Asset Value offered by buyers to sellers of such assets was reduced. However, activity in the secondary market fell dramatically from 2008 levels as market participants continued to struggle to agree on price. Reflecting the gains in the public equity markets since the end of the first quarter, the dynamics in the secondary market continued to evolve. Certain buyers that had been reluctant to invest earlier in the year began to return and non-traditional investors were more active, particularly for unfunded commitments, than they had been in previous years.

Milestones

The following is a timeline of some of the most notable secondary transactions and other milestones:

2009

2008

2007

2006

2005

2004

  • Bank One sells a $1 billion portfolio of private equity fund interests to Landmark Partners
  • The State of Connecticut Retirement and Trust completes the sale of a portfolio of private equity funds interests to Coller Capital, representing one of the first secondary market sales by a US pension fund
  • Abbey National plc completes the sale of £748m ($1.33 billion) of LP interests in 41 private equity funds and 16 interests private European companies, to Coller Capital [47]
  • Swiss Life sold more than 40 fund and direct investments to Pantheon Ventures[48]

2003

  • HarbourVest acquires a $1.3 billion of private equity fund interests in over 50 funds from UBS AG through a joint venture transaction [49]
  • Deutsche Bank sells a $2 billion investment portfolio to a consortium of secondary investors that would become MidOcean Partners

2001

2000

1999

1998

1997

  • Secondary volume estimated to exceed $1 billion for first time

1994

1992

  • Landmark Partners acquires $157 million of LBO fund interests from Westinghouse Credit Corporation

1991

  • Paul Capital founded and acquires $85 million venture portfolio from Hillman Ventures

1989

1982

  • Venture Capital Fund of America founded by Dayton Carr

See also

References

Notes

  1. ^ Private Equity Secondary Funds: Are They Players or Opportunistic Investors? Knowledge@Wharton, August 5, 2009
  2. ^ a b The Private Equity Analyst Guide to the Secondary Market. Private Equity Analyst, 2004
  3. ^ a b c Source: Private Equity Intelligence
  4. ^ JPMorgan Chase acquired a publicly listed vehicle from Bear Stearns, renamed J.P. Morgan Private Equity Limited (LSEJPEL), that makes secondary purchases. Bear Stearns Private Equity Limited Changes Name to J.P. Morgan Private Equity Limited. September 8, 2008
  5. ^ Secondary real estate market quietly ramps up. Reuters, Sep 20, 2007
  6. ^ a b c d e f g The Private Equity Secondaries Market, A complete guide to its structure, operation and performance The Private Equity Secondaries Market, 2008
  7. ^ "Escaping PE Purgatory Through A Secondary Sale." Buyouts, July 7, 2007
  8. ^ Contrarian : Second Helping (Dealmaker, 2007)
  9. ^ "Secondary sales of private equity interests." AltAssets, February 18, 2002
  10. ^ The Private Equity Analyst: PE Wire (Private Equity Analyst), February 24, 2003.
  11. ^ Cortese, Amy. "Business; Private Traders See Gold in Venture Capital Ruins." New York Times, April 15, 2001.
  12. ^ *"Secondaries Getting Primary Attention." Buyouts, July 22, 2002
  13. ^ "Secondaries Pros Discuss Market's Evolution." Secondaries Pros Discuss Market's Evolution - Cont'd. Buyouts, December 16, 2002
  14. ^ Vaughn, Hope and Barrett, Ross. "Secondary Private Equity Funds: The Perfect Storm: An Opportunity in Adversity". Columbia Strategy, 2003.
  15. ^ Rossa, Jennifer and White, Chad. Dow Jones Private Equity Analyst Guide to the Secondary Market (2007 Edition).
  16. ^ A Secondary Market for Private Equity is Born, The Industry Standard, 28 August 2001
  17. ^ "Buyouts Still Dominate Surging Secondaries Market: Some Say Market Is Overcapitalized Fund-of-Join The Game." Buyouts, May 24, 2004
  18. ^ Private Equity Market Environment: Spring 2004, Probitas Partners
  19. ^ Cash panic sweeping VC industry: The capital calls problem VentureBeat, November 7, 2008
  20. ^ MAC uncertainty grips sellers in secondary market. Private Equity Online, November 3, 2008
  21. ^ "3i agrees VC asset sale with Coller, HarbourVest consortium." PEI Asia News, September 13, 2009.
  22. ^ "Goldman group snags ABN AMRO unit." Pensions&Investments, August 12, 2008.
  23. ^ Discount offered to offload ABN Amro's Secondaries
  24. ^ "Macquarie Capital will spend $836m to go private". The Australian, June 17, 2008
  25. ^ "Macquarie Capital soars on buyout plan". The Sydney Morning Herald, June 16, 2008
  26. ^ CalPERs private equity stakes under microscope. Reuters 'Dealzone' November 20, 2008.
  27. ^ Craig, Catherine. Five buy record $3bn Calpers portfolio. Financial News, February 5, 2008.
  28. ^ Tracy, Tennille. Calpers, and where private-equity funds go to die. Wall Street Journal's Deal Journal blog, November 5, 2007.
  29. ^ Press Release: Coller International Partners V closes at $4.5 billion dollars'
  30. ^ Lexington Capital Partners VI
  31. ^ OBWC Portfolio Sale Nears End
  32. ^ Ohio Bureau of Worker's Compensation -- Review of Secondary Advisor Selection Process (UBS and Wilshire)
  33. ^ Secondaries join the mainstream
  34. ^ Dow Jones Financial News: Goldman picks up Mellon portfolio
  35. ^ "American Capital Raises $1 Billion Equity Fund; Expands Its Asset Management Business; Will Host 9 am Conference Call". PR Newswire. American Capital Strategies. 2006-10-04. http://www2.prnewswire.com/cgi-bin/stories.pl?ACCT=104&STORY=/www/story/10-04-2006/0004444957&EDATE=.  
  36. ^ American Capital raises $1bn fund. (AltAssets)
  37. ^ ACS spins off stakes into $1B fund (TheDeal.com)
  38. ^ Singapore’s Temasek Hits Hard Going (Asia Sentinel, 2007)
  39. ^ THE PRIVATE EQUITY SECONDARIES MARKET: A complete guide to its structure, operation and performance. (PEI Media)
  40. ^ Press Release: AEA Technology: Proposed sale of the Portfolio Companies and the Rail Business to Vision Capital. (AEA corporate)
  41. ^ Liquid Realty Acquires GBP 435 Million Real Estate Secondary Portfolio. Business Wire, May 3, 2006
  42. ^ AlpInvest and Lexington Partners buy $1.2bn secondary portfolio from DPL (AltAssets)
  43. ^ M&A legal guru urges more diligence
  44. ^ DPL to sell PE stakes for $850M (TheDeal.com)
  45. ^ Press Release: AEA Technology: Sale of Portfolio Companies. (AEA corporate)
  46. ^ Lexington Partners Buys Merrill Lynch Portfolio. Private Equity Analyst, April 2005 (p.10)
  47. ^ Press Release: Abbey sells private equity portfolio to Coller Capital
  48. ^ Pantheon acquires Swiss Life private equity portfolio. AltAssets, 2004
  49. ^ HarbourVest transactions
  50. ^ Press Release: Lucent Technologies and Coller Capital form independent venture firm to manage Lucent's New Ventures Group portfolio
  51. ^ Press Release:The Royal Bank of Scotland: asset sale
  52. ^ Lehman Brothers acquired The Crossroads Group in 2005
  53. ^ Cawley, Rusty "Crossroads uses EDS portfolio to launch fund." Dallas Business Journal, September 24, 1999
  54. ^ "Newbury Partners Promises To Keep A Secret." Buyouts, August 20, 2007

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