Private equity secondary market

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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.

Secondary market participants

The market for secondary interests is still highly fragmented. Leading secondary investment firms (current dedicated secondary capital in excess of $2 billion) include: AlpInvest Partners, AXA Private Equity, Coller Capital, HarbourVest Partners, Lexington Partners, Pantheon Ventures and Partners Group.

Other major independent secondary firms (excluding banks, $1 - $2 billion of current dedicated capital) include Adams Street Partners, Landmark Partners, LGT, Newbury Partners, Paul Capital 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.

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 and UBS), dedicated boutique firms (Cogent Partners and Fidequity), electronic exchanges (NYPPE also a buyer of secondary interests through Allen Capital Partners), as well as established fund placement agents (Campbell Lutyens, Probitas Partners and Triago).

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:

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:

• 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

• 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.

• 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. These transactions are often initiated by private equity firms during the fundraising process.^[1]

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. 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. 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. A tail-end transaction allows the manager of the fund to achieve liquidity for the fund's investors.

History

Main article: History of private equity and venture capital

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 France^[3] 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 commitmentsto 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.^[6][7] 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, which had previously been a relatively small niche of the private equity industry, prompted new entrants to the market, however 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. Among the most notable publicly disclosed secondary transactions (it is estimated that over two-thirds of secondary market activity is never disclosed publicly):

The following is a timeline of some of the most notable secondary transactions thus far:

2008

• Innovacom Gestion, a Paris based venture capital firm established in 1988, sells a portfolio of direct private equity interests and transfers the management of 10 American and European companies to Saints Capital. ^[9]

• ABN AMRO sells a portfolio of private equity interests in 32 European companies to a consortium comprising Goldman Sachs, Alpinvest and CPP for $1.5 billion.^[10]

• Macquarie Capital Alliance, in June 2008, announced a takeover offer from a consortium of private equity secondary firms including AlpInvest Partners, HarbourVest Partners, Pantheon Ventures, Partners Group, Paul Capital Partners, Portfolio Advisors and Procific (a subsidiary of the Abu Dhabi Investment Authority) in one of the first public to private transactions of a publicly traded private equity company completed by secondary market investors.^[11][12]

• Prelude Trust, a UK-based publicly traded investment company announced the sale of its investment portfolio to Coller Capital. The transaction amounts to $100m of consideration and follow-on funding. The portfolio will continue to be managed by DFJ Esprit.^[13]

• KKR Private Equity Investors disclosed in May 2008 that it had completed the sale of approximately $300 million of selected limited partnership interests in and undrawn commitments to certain KKR-managed funds in order to generate liquidity and repay borrowings.^[14]

• SVG Capital announced the sale of ₤102 million ($203 million) of limited partnership interests in six private equity funds to Lexington Partners and SVG's collateralized fund obligation vehicle, SVG Diamond.^[15]

• California Public Employees Retirement System (Calpers) agrees to the sale of a portfolio of legacy private equity funds. A buyer group comprising HarbourVest Partners, Lexington Partners, Conversus Capital and Pantheon Ventures acquires the most significant portion of the portfolio^[16]

2007

• Coller Capital completes $4.8 billion fundraising and Lexington Partners completes $3.8 billion fundraising for their newest funds, the largest and second largest funds raised to date in the secondary market^{[17] [18]}
• Ohio Bureau of Workers' Compensation reportedly agrees to sell a $400 million portfolio of private equity fund interests to Pomona Capital ^[19]
• MetLife agrees to sell a $400 million portfolio of private equity fund interests to CSFB Strategic Partners^[20]
• Bank of America completes the spin-out of BA Venture Partners to form Scale Venture Partners, which was funded by an undisclosed consortium of secondary investors

2006

• Goldman Sachs Vintage Funds purchases a $1.4 billion private equity portfolio (fund and direct interests) from Mellon Financial Corporation, following the announcement of Mellon's merger with Bank of New York^[21]
• American Capital Strategies sells a $1 billion portfolio of investments to a consortium of secondary buyers including HarbourVest Partners, Lexington Partners and Partners Group^{[22] [23] [24]}
• Bank of America completes the spin-out of BA Capital Europe to form Argan Capital, which was funded by an undisclosed consortium of secondary investors
• JPMorgan Chase completes the sale of a $0.9 billion interest in JPMP Global Fund to a consortium of secondary investors
• Temasek Holdings completes $810 million securitization of a portfolio of 46 private equity funds^[25]
• Vivendi completes the $100 million secondary direct divestment of it corporate venture portfolio to Tempo Capital Partners^[26]
• AEA Technology completes the €100 million secondary sale of a direct portfolio to Vision Capital^[27]

2005

• Dresdner Bank sells a $1.4 billion private equity funds portfolio to AIG
• Lexington Partners and AlpInvest Partners acquired a portfolio of private equity fund interests from Dayton Power & Light, an Ohio-based electric utility^{[28] [29][30]}
• AEA Technology completes the €50 million secondary sale of a direct portfolio to Coller Capital^[31]

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 ^[32]
• Swiss Life sold more than 40 fund and direct investments to Pantheon Ventures

2003

• HarbourVest acquires a $1.3 billion of private equity fund interests in over 50 funds from UBS AG through a joint venture transaction ^[33]
• Deutsche Bank sells a $2 billion investment portfolio to a consortium of secondary investors that would become MidOcean Partners

2001

• Coller Capital acquires 27 companies owned by Lucent Technologies, kick-starting the evolution of the market for "secondary direct" or "synthetic secondary" interests.^[34]

2000

• Lexington Partners and Hamilton Lane acquire $500 million portfolio of private equity funds interests from Chase Capital Partners
• Coller Capital and Lexington Partners complete the purchase of over 250 direct equity investments valued at nearly $1 billion from National Westminster Bank^[35]
• Greenpark Capital founded by former Coller Capital professional Marleen Groen

1999

• The Crossroads Group, which was subsequently acquired by Lehman Brothers, acquired a $340 million portfolio of direct investments in large- to mid-cap companies from Electronic Data Systems (EDS)^[36][37]

1998

• Coller Capital launches the first globally-focused secondaries fund

1997

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

1994

• Lexington Partners founded by former Landmark Partners professionals Brent Nicklas and Richard Lichter (currently Newbury Partners)^[38]
• Coller Capital launches Europe's first secondary fund

1992

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

1991

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

1989

• Coller Capital founded by Jeremy Coller
• Landmark Partners founded by Stanley Alfeld, John A. Griner III and Brent Nicklas

1982

• Venture Capital Fund of America founded by Dayton Carr

See also

• Private equity
• List of private equity firms
• Venture capital
• History of private equity and venture capital

Further reading

• A Secondary Market for Private Equity is Born, The Industry Standard, 28 August 2001

• Cannon, Vincent T. Secondary Markets in Private Equity and the Future of U.S. Capital Markets, Harvard Law School.

• All about private equity investing in Secondaries (AltAssets), Sector Analysis: Case for Sectors. (Articles from 2001-2007)

• Private Equity Secondaries Ennis Knupp

• Ohio Bureau of Worker's Compensation -- Review of Secondary Advisor Selection Process (UBS and Wilshire)

• The evolution of private equity secondary activity in the United States: liquidity for an illiquid asset (Routes to Liquidity, 2004)

• Overlooking Private Equity Partnerships Can Be Costly Mistake Secondary Market Offers Liquidity for Limited Partners (Turnaround Management Association, 2006)

References

Topics on private equity and venture capital Basic investment types Buyout • Venture • Growth • Mezzanine • Secondaries • Equity co-investment History History of private equity and venture capital • Early history of private equity • Private equity in the 1980s • Private equity in the 1990s • Private equity in the 21st century Terms and concepts Buyout Financial sponsor • Management buyout • Divisional buyout Venture Seed money • Startup company • Angel capital • Angel investor • Venture capital financing • Pre-money valuation • Post-money valuation • Venture round • Venture debt Structure Private equity firms and funds • Limited partnership • Limited liability company • Carried interest • Publicly traded private equity • Private Investment in Public Equity (PIPE) Investors Institutional investors • Pension funds • Insurance companies • Endowments • Fund of funds • High net worth individuals • Sovereign wealth funds Related financial terms Initial Public Offering (IPO) • Mergers and acquisitions • Leverage • High-yield debt • Capital structure Private equity and venture capital investors • Private equity firms • Venture capital firms • Portfolio companies