What Are Secondaries in Finance and How Do They Work?

Secondaries in finance refers to the buying and selling of pre-existing investment commitments or assets within private capital markets. These transactions involve interests originally acquired in a primary market, now exchanged between existing investors. Unlike public markets with established exchanges, private market interests typically lack formal trading venues.

Understanding Secondary Market Transactions

A secondary market transaction involves the exchange of previously issued interests or assets between investors. This contrasts with primary market transactions, where capital is initially invested directly into a new fund or company by the original issuer. In the primary market, a company or fund raises capital by selling new shares or interests for the first time, such as a venture capital firm funding a startup.

Secondary transactions occur when an existing shareholder sells their ownership stake to a new investor. The private equity secondary market involves the buying and selling of pre-existing investor commitments to private equity and other alternative investment funds, or the underlying private equity assets.

The secondary market’s purpose is to provide liquidity in an inherently illiquid asset class. Private equity investments are designed for long-term holding periods, locking up capital for extended durations. Secondary transactions allow investors to exit positions earlier than a fund’s typical lifecycle or before a company’s initial public offering (IPO) or acquisition.

Beyond liquidity, secondary markets enable portfolio rebalancing, allowing investors to adjust their allocation by selling certain positions. This is useful for managing over-commitment to private equity or aligning a portfolio with new strategic objectives, such as a pension fund selling holdings to reduce exposure or meet regulatory capital requirements.

For buyers, the secondary market offers opportunities to gain immediate exposure to established portfolios. This can accelerate the return profile, as buyers acquire more mature assets that may generate cash flow sooner than new primary investments. The “J-curve effect,” where private equity funds show negative returns in their early years due to fees and costs, can be mitigated through secondary purchases of more mature assets.

Secondary transactions can offer attractive pricing, with interests purchased at a discount to their Net Asset Value (NAV). Discounts can range from 10% to 30%, influenced by the seller’s urgency or market conditions. Buyers also benefit from reduced “blind pool risk,” acquiring interests in funds or companies with existing performance data and known underlying assets, which allows for more informed due diligence.

The market has experienced substantial growth, with transaction volumes reaching $108 billion in 2022 and surpassing $152 billion in 2024. Projections suggest continued expansion, potentially exceeding $175 billion in 2025. This growth reflects evolving investor needs and the increasing institutionalization of private equity.

Common Secondary Transaction Structures

Secondary transactions are structured in various ways to facilitate the transfer of private market interests. These structures cater to different needs of sellers and buyers, ranging from straightforward sales of fund stakes to more complex, manager-led arrangements. Each type involves distinct mechanics and implications.

LP Interest Transfers

Limited Partnership (LP) interest transfers represent the most common type of secondary transaction. In these deals, an existing Limited Partner sells their stake in a private equity fund to a secondary buyer. The buyer assumes all rights and obligations of the seller, including any remaining unfunded commitments and the right to receive future distributions.

The process involves direct negotiation between the selling LP and potential buyers. The purchase price is expressed as a percentage of the net asset value (NAV) of the fund interests. After agreement, the transaction requires the consent of the fund’s General Partner (GP), who approves or denies transfers to ensure compliance and stability. This consent ensures the new LP meets specific criteria, including “Know Your Customer” (KYC) requirements.

Legal documentation for LP interest transfers includes a purchase and sale agreement, an assignment and assumption agreement, and a consent to transfer from the GP. The seller is released from outstanding unfunded obligations upon transfer, with the buyer taking on these commitments. This structure provides liquidity to LPs needing to exit positions due to portfolio rebalancing, regulatory changes, or cash needs.

Direct Secondaries

Direct secondaries involve the sale of existing direct investments in companies, rather than fund interests. An investor sells an ownership interest directly in an operating company to another investor. These transactions occur when a shareholder, like a founder or institutional investor, seeks liquidity from their direct holding in a private company.

Direct secondaries can involve purchasing a portfolio of direct private equity investments from a corporation or institution. The buyer takes over asset management or engages an external General Partner for oversight. Direct secondaries can be initiated by various types of shareholders in the private company.

These transactions are negotiated bilaterally between the buyer and seller; the company may not be directly involved. Pricing is determined by negotiation, considering the underlying company’s performance and prospects. While less common than LP interest transfers, direct secondaries provide liquidity for direct equity stakes in private companies before a full exit event like an IPO or acquisition.

Structured Secondaries / Continuation Funds

Structured secondaries, particularly continuation funds, are complex transactions initiated by General Partners (GPs). A continuation fund is a new investment vehicle established by a GP to acquire assets from an existing fund nearing its lifecycle end. This allows the GP to retain control over promising assets requiring a longer holding period to maximize value.

In a continuation fund transaction, existing Limited Partners in the original fund can either cash out their interest for a pro-rata amount or roll over their stake into the new continuation fund. This provides liquidity to LPs wishing to exit, while enabling the GP to continue managing assets for those who reinvest. The transaction involves a third-party secondary buyer who injects new capital.

Continuation funds have gained prominence as a strategic tool, especially in challenging exit environments where traditional routes like IPOs or M&A are less favorable. The investment period for a continuation fund is shorter than a traditional private equity fund, as it focuses on more mature assets. These structures require careful alignment of interests between the GP, existing LPs, and new investors, often involving competitive bidding to determine a fair price for transferred investments.

Participants and Underlying Assets

The secondary market for private capital involves diverse participants, both sellers and buyers. Understanding who participates and what assets are traded provides a view of this financial ecosystem.

Participants in the secondary market include sellers and buyers. Sellers are institutional investors like pension funds, university endowments, sovereign wealth funds, and family offices, as well as financial institutions. Their motivations stem from a need for liquidity, a common challenge in illiquid private markets. Sellers may also divest interests to rebalance portfolios, reduce overallocation, meet regulatory requirements, or free up capital. For instance, a pension fund might sell interests to manage asset allocation or address cash flow needs.

On the buying side, participants include dedicated secondary funds, large institutional investors, sovereign wealth funds, and funds of funds. Specialized investment banks and advisory firms act as intermediaries. Buyers are attracted by quicker capital deployment, acquiring existing assets rather than committing to new funds. They also seek diversified portfolios, often at a discount to net asset value, and immediate exposure to mature assets. Mitigating the “J-curve” effect is another draw for buyers.

The underlying assets traded in secondary markets consist of private market investments: debt and equity instruments not publicly traded. Common assets include interests in various private equity funds, such as buyout, growth equity, and venture capital funds. These funds invest in private companies across different growth stages and sectors.

Beyond private equity, the secondary market facilitates transactions in other alternative asset classes. This includes interests in real estate funds, infrastructure funds (focusing on assets like utilities and transportation), and private credit funds (providing direct lending). The market’s evolution has broadened the scope of assets traded, reflecting increasing sophistication and diversity of private capital strategies.