What Is Secondary Private Equity & How Does It Work?

Private equity involves investment in companies not publicly traded on stock exchanges, aiming to grow businesses or improve operations over a multi-year horizon. Primary private equity deals involve direct capital infusions into companies or new commitments to investment funds. The secondary private equity market offers an avenue for existing investors to sell their private equity holdings, injecting liquidity into an asset class known for its long-term, illiquid nature. This market has grown significantly, with transaction volumes reaching new records, demonstrating its evolving role in the broader financial landscape.

Defining Secondary Private Equity

Secondary private equity refers to the buying and selling of existing private equity assets. This fundamentally distinguishes it from primary private equity, where capital is committed to new funds or directly invested into private companies for the first time. In the secondary market, transactions involve the transfer of previously committed capital or existing ownership stakes.

The secondary market’s purpose is to provide liquidity within the inherently illiquid private equity asset class. Private equity investments typically involve long holding periods, often 5 to 10 years, making premature exits challenging. The secondary market allows investors to sell interests before assets mature or funds wind down. This mechanism helps address “blind pool risk” associated with primary investments, as secondary buyers gain exposure to seasoned funds with observable characteristics and cash flows.

Existing assets can include limited partnership interests in private equity funds or direct equity stakes in private companies. Sellers receive cash for their interests, while buyers acquire seasoned portfolios, potentially benefiting from shorter investment durations and faster returns. The secondary market facilitates portfolio rebalancing and liquidity management for sellers, while offering buyers a diversified entry point into private markets with reduced uncertainty.

Types of Secondary Private Equity Transactions

Secondary private equity transactions encompass several structures.

LP Interest Transfers

The most common type involves Limited Partner (LP) interest transfers, also known as fund secondaries. An existing LP sells its stake in a private equity fund, or a portfolio of funds, to a new buyer. The buyer assumes all rights and obligations of the seller, including any remaining unfunded capital commitments.

Direct Secondaries

Direct secondaries involve an investor selling a direct equity stake in a private company rather than a fund interest. This bypasses the fund structure, allowing for the sale of specific company ownership interests. Such transactions can involve a single company or a portfolio of direct investments, providing liquidity to founders, early investors, or employees. Direct secondary purchases offer an opportunity to realize gains before a full company exit or public listing.

GP-led Secondaries

GP-led secondaries, initiated by the General Partner (GP) of a fund, represent a growing market segment. These involve transferring portfolio companies from an older fund to a new “continuation fund” managed by the same GP. This structure allows the GP to retain control and continue managing assets, while providing existing LPs an option to cash out or roll their investment into the new vehicle. GP-led transactions offer a flexible exit alternative and account for a substantial portion of secondary market volume.

Key Participants in Secondary Transactions

Various parties play distinct roles in secondary private equity transactions.

Sellers

Sellers typically include institutional investors such as pension funds, endowments, sovereign wealth funds, and family offices. They seek liquidity to meet financial obligations, rebalance portfolios, or manage risk. For instance, a decline in public markets can lead to over-allocation to private assets, prompting LPs to sell interests. Sellers may also divest interests in older funds to streamline portfolios or exit underperforming investments.

Buyers

Buyers are primarily specialized secondary funds, large institutional investors with dedicated secondary programs, and other private equity firms. Their motivations include gaining immediate exposure to mature private equity portfolios, reducing blind pool risk, and acquiring interests at attractive valuations. Secondary buyers assume the seller’s rights and obligations, including any unfunded commitments.

Intermediaries and Advisors

Intermediaries and advisors, such as investment banks and advisory firms, play a crucial role in connecting buyers and sellers. These firms facilitate transactions by providing valuation services, structuring deals, and ensuring regulatory compliance. Their expertise helps navigate the complexities of these transactions, which involve due diligence and negotiation.

The Secondary Transaction Process

The process of executing a secondary private equity transaction typically involves several structured stages.

Opportunity Identification

Sellers may initiate a process through an auction, where multiple buyers bid for assets, or engage in bilateral negotiations. Initial interest is followed by information gathering, allowing potential buyers to assess the offering.

Due Diligence

A thorough due diligence is a key phase. Buyers conduct research and analysis on underlying assets, fund performance, and legal documentation. This includes reviewing financial statements, assessing market conditions, and evaluating earnings reports. For LP interest sales, buyers examine limited partnership agreements and side letters to understand legal terms and obligations. This investigation helps buyers form an accurate valuation and understand potential risks.

Valuation

Valuation is a complex step, as private equity assets lack public market pricing. Assets are valued based on their Net Asset Value (NAV), representing the fund’s total assets minus liabilities. Secondary transactions often occur at a discount or sometimes a premium to the reported NAV, influenced by market conditions, fund performance, and seller urgency. Discounts can range from 10% to 30% of NAV.

Negotiation and Closing

Following due diligence and valuation, parties negotiate terms, including purchase price, payment schedule, and indemnities. This leads to drafting and executing legal documentation, such as a Sale and Purchase Agreement and an Assignment Agreement, formalizing the transfer of ownership and associated rights. The transaction closes with the final legal transfer of interest and payment of the agreed-upon price.