Private equity primary investments are transactions made by investors (either directly or via a fund) where a stake in a private company is acquired. This may be as part of a management buy-out transaction or a growth capital funding round. On the secondary market, by contrast, investors trade assets with other investors.

What is a secondary investment fund?

A secondary investment fund, as the name implies, is a kind of private equity firm that specializes on secondary investments. Investors often have particular knowledge in the secondary market and are better suited to handle the complexity of secondary transactions, as well as maintain more mature assets over a shorter timeframe.

Growth in the market

It's important highlighting how valuable secondary market deals are. In 2021, the overall amount of secondary agreements rebounded from a COVID-impacted 2020 to reach a new high of $132 billion, greatly exceeding the previous record of $88 billion established in 2019 (source: PitchBook).

This is part of a larger trend, which has seen private markets expand. According to The Economist, the industry is "three times larger than a decade ago." In the United States, "secondary buy-outs can increasingly exceed the volume of initial public offerings". This is a significant indicator of the market's expansion, and it would have been difficult to anticipate in the 1990s, when the first secondary funds were founded with "tens of millions of dollars of committed capital".

What is a secondary school run by a general practitioner?

Private equity secondary deals are classified into two types: those led by LPs (limited partners) and those headed by GPs (general partners).

An LP is a limited partner in a fund. Essentially, this is an individual or institutional investor that invests by purchasing a portion of a bigger fund. An LP-led transaction occurs when an LP sells their ownership in a fund, together with its full portfolio of assets and liabilities, to a secondary bidder. The basic structure of the fund and its assets remain unchanged, and the secondary buyer merely assumes the role of the selling LP.

In contrast, in a GP-led transaction, a general partner or fund management sells a portion or all of their fund to a secondary investor. Existing LPs in the fund will normally have the option of rolling their holdings over to the new vehicle or cashing out.

These GP-led transactions often take the form of a continuation vehicle. A continuation vehicle, sometimes known as a continuation fund, allows a GP to keep their asset portfolio while certain LPs maintain their investment and others withdraw.

GP-led secondaries may also be single-asset transactions, which is an increasingly common approach that enables GPs to concentrate on their favored individual assets while selling others they no longer wish to own.

While most private equity secondary deals were historically driven by LPs, the number of GP-led transactions has increased significantly in recent years, with the total value of these transactions expected to reach $68 billion by 2021 (source: Lionpoint). This is more than twice the amount from the previous year, and more than half the entire value of secondary fund transactions in 2021.

Why should you consider private equity secondary?

Now that we've described what private equity secondaries are, we can look at why investors are so eager to buy them and why the secondary market has developed so rapidly.

Why should aspiring and existing private equity investors consider participating in secondary markets?

Discounted access to private equity funds.
The first factor we'll discuss here is also possibly the most basic: the price. Secondary investments may provide access to assets, such as whole portfolios or individual firms, at a large discount.

  • The worth of an investment business is known as its net asset value, or NAV.
  • This is computed using a simple formula: the entire value of a company's assets less its liabilities.
  • The per-share value is determined by dividing the net value by the number of shares.

For example:

  • If a business has £100m in assets and £10m in liabilities, its NAV will be £90 million.
  • If the same corporation had a total of one million shares, the value of each share would be £90.
  • NAV varies with the worth of a firm and the cost of its liabilities. As with many investment types, the value of private equity assets may fluctuate dramatically from one day to the next.
  • Sellers who depart private equity firms early have generally had to market their assets at a discount, below NAV.
  • This means that secondary investors may buy assets for less than their nominal value. This implies that the investor may be able to make a larger profit when they ultimately quit.
  • However, as you would assume, this is not always the case, and in periods of exceptionally heavy secondary market activity, secondary purchasers may expect to pay a premium for their acquisition.