What Are Secondaries in Private Equity?

Private equity is an asset class where capital is invested directly into private companies or used to complete buyouts of public companies, taking them private. These investments typically involve long holding periods, reflecting the time needed for value creation and eventual exit.

While traditional private equity involves committing capital to new funds, a distinct segment has emerged to address the illiquidity of these investments. This is the private equity secondary market. It involves the buying and selling of existing private equity interests, rather than investments in newly formed funds or companies. The secondary market provides a mechanism for investors to gain liquidity or adjust their portfolios without waiting for a fund’s natural expiration.

Defining Secondary Market Transactions

A secondary market transaction in private equity refers to the transfer of existing capital in private equity funds or direct private assets from one investor to another. Unlike primary investments, where capital is deployed directly into new companies, secondaries involve the trade of existing stakes. This means secondary transactions do not inject fresh capital into a company but rather facilitate a change of ownership for an existing investment.

These transactions provide a solution for liquidity within an asset class that is illiquid. Private equity investments typically have long lock-up periods, during which investors’ capital is tied up. The secondary market allows investors to exit their positions earlier than anticipated, converting illiquid investments into cash. This mechanism has grown significantly, with the total secondaries market volume reaching record highs.

Buyers in the secondary market acquire existing interests, which can include both paid-in capital and any remaining unfunded commitments to the fund. This means the buyer steps into the shoes of the original investor, assuming both their rights to future distributions and their obligations for future capital calls. The pricing in these transactions is often based on reported valuations, typically expressed as a percentage of the net asset value (NAV) of the underlying fund or assets.

Participants and Their Motivations

The private equity secondary market involves two main types of participants: sellers and buyers. Sellers are typically limited partners (LPs), such as pension funds, endowments, family offices, and insurance companies. General partners (GPs), the fund managers, can also initiate sales.

Sellers engage in secondary transactions for various reasons, primarily centered on portfolio management and liquidity. LPs might sell to rebalance their portfolios, especially if private equity allocations become overweighted. The need for liquidity is another common driver, enabling them to fund new ventures, meet unexpected cash requirements, or exit an investment before its full maturity. Other motivations include regulatory changes that compel certain financial institutions to divest private assets, or a desire to clean up “tail-end” funds—older funds with lingering, often smaller, investments.

Buyers in the secondary market are often dedicated secondary funds, large institutional investors, or sovereign wealth funds. Secondary buyers gain immediate exposure to a diversified and often mature portfolio of assets, potentially offering quicker cash flow compared to primary fund investments. This can help mitigate the “J-curve effect,” where private equity funds typically show negative returns in early years before generating positive returns.

Buyers also seek attractive valuations, sometimes acquiring interests at a discount to net asset value, and benefit from reduced “blind pool risk” because they can conduct due diligence on existing, visible assets. Secondaries can offer a means to access funds or general partner relationships that were previously unavailable. The ability to acquire more mature assets with shorter remaining holding periods aligns with their objective of potentially accelerated distributions.

Types of Secondary Transactions

Secondary transactions in private equity manifest in several structural forms. The most common type involves the transfer of Limited Partner (LP) interests. In these transactions, an LP sells its existing commitment in a private equity fund, or a portfolio of such interests, to another investor. The acquiring investor assumes both the rights to future distributions and the remaining unfunded capital commitments of the original LP.

Another category includes direct secondaries. Instead of selling a fund interest, direct secondaries involve the sale of ownership stakes in individual private companies. These transactions allow an investor to sell shares in a privately held company directly to another investor, often without the company’s initiation or sponsorship. This provides liquidity for specific assets, rather than an entire fund position, and can be initiated by founders, early employees, or institutional shareholders.

General Partner (GP)-led secondaries are initiated by the fund manager (GP) to restructure or extend a fund’s life or to provide liquidity to existing investors. A common GP-led structure is the continuation fund, where a GP transfers one or more assets from an existing fund nearing its end-of-life into a newly established vehicle. This allows the GP to continue managing promising assets for a longer period while offering existing LPs the option to cash out or reinvest into the new fund.

Other GP-led structures include tender offers, where the GP offers existing LPs the chance to sell their interests in a fund, and stapled secondaries. In a stapled secondary, a buyer acquires an interest in an existing fund while simultaneously committing capital to a new fund being raised by the same manager. This arrangement can help GPs secure commitments for new funds, especially during challenging fundraising environments, by leveraging the secondary sale.

Executing a Secondary Transaction

Executing a private equity secondary transaction involves a structured sequence of steps. The process typically begins with initiation and preparation, where a seller decides to explore a sale and may engage intermediaries to find potential buyers. This initial phase involves gathering necessary documentation and preparing the asset for market.

Valuation is a step where private equity assets are valued based on their net asset value (NAV) as reported by the fund, with adjustments made through negotiation. Third-party valuation firms are often engaged to provide an independent assessment, ensuring a fair and transparent pricing process. The agreed-upon price is usually expressed as a percentage of this NAV.

Following valuation, the prospective buyer undertakes due diligence. This involves a thorough review of the underlying assets, including financial statements, legal documents, and operational performance. Buyers assess the historical performance, track record of the fund manager, and potential risks associated with the investment. This analysis helps the buyer make an informed decision and understand the value and prospects of the acquired interest.

Negotiation and documentation follow the due diligence phase. The buyer and seller negotiate the terms of the transaction, including the purchase price, representations, warranties, and covenants. The consent of the general partner (GP) of the fund is required for the transfer of an LP interest, and this consent is a key element of the negotiation.

The final stage is closing, where the legal transfer of ownership and funds occurs. The buyer remits the agreed-upon payment, and the seller formally transfers their interest, completing the secondary transaction. The entire process, from initiation to closing, can vary in duration but typically involves several weeks to a few months, depending on the complexity and parties involved.