Our vantage point in the PE secondary market has many benefits. One is that we are able to gauge sentiment, both positive and negative. Every day that we speak to LPs, we hear common misconceptions and past truths that are keeping them away from the secondary market. We feel it is our duty to dispel these myths.
While there are many forces that have led to a groundswell of PE's assets under management in recent years, there is little doubt that the maturing secondary market has been a contributor. Sophisticated LPs have come to understand that they no longer have to be locked into PE funds for their full ten-plus year duration. This understanding provides comfort when committing to fundraisings.
Therefore, the more liquid private equity becomes, the better for all parties in the PE ecosystem. With this in mind, here are the five most common myths we hear about the secondary market – and why they are not true.
Myth 1: No one will be interested in buying tail-end funds
It's clear to see why sellers might choose to focus on the tail-end funds in their portfolio as a clean-up exercise to ease the administrative burden and reduce monitoring costs associated with holding numerous funds. However, buyers see clear advantages to acquiring mature vintages as well. These funds are typically well into their divestment stage and therefore return capital swiftly, which can lift IRR performance by contracting the J-curve. Indeed, this is the primary advantage of buying on the secondary market in the first place. In fact, with the growth of secondaries, there are now some buyers who specialize in the acquisition of tail-end fund stakes. Finally, acquiring tail-end funds is a means of achieving a well-balanced, cash-generative portfolio.
Myth 2: It may jeopardize a relationship with a GP
On the contrary, GPs today are well aware of the integral role that secondaries play for investors in rebalancing and actively managing their portfolios. From a holistic market perspective, secondaries make the entire private equity asset class more attractive to investors, who can take comfort in the knowledge that liquidity is available should they seek it. This is a win-win for GPs and LPs. Trading out of a fund is no longer taboo, and GPs recognize the opportunity to build new, lasting relationships with incoming LPs whom they may not previously have had a connection with. Again, one only needs to look at the evolving nature of the secondary market, with GP-led scenarios becoming increasingly commonplace, to see that secondaries have become an accepted feature of a PE fund's life-cycle.
What sellers need to know is that in today's secondary landscape, it is about properly communicating with GPs that will prove most important in maintaining a healthy relationship (not to mention the overall success of the sale).
Myth 3: Only large bundled portfolios of hundreds of millions of dollars will be able to sell
When reading PE media outlets nowadays, one wouldn't be blamed for thinking that only very large transactions take place in the secondary market. However, blockbuster deals aside, the reality is that the fund stakes don't have to be large in size to command the attention of buyers. The rapid growth of PE secondary along with sizable fundraising for secondary funds and the amount of dry powder on the market means that buyers are looking to deploy that capital. We, at Palico, have consistently seen multi-bidder interests for fund stakes below $20M USD.
Others may automatically pursue a portfolio sale rather than divest fund stakes individually. Certainly, selling as a portfolio can save on legal and administrative costs, but not in all cases. One should also consider the trade-off between expense-minimization and price maximization. Divesting PE assets piece by piece, in multiple auctions with multiple bidders, can maximize pricing for each fund stake, outweighing the costs of additional legal processes. Given the possible trade-off, deciding whether or not to bundle is an important decision to consider early on in the planning phase of a secondary sale.
Myth 4: The secondary market is only used in times of distress
This might be the most abiding – and misleading – myth of the secondary market. Once viewed as "distressed sellers selling distressed assets in distressed funds," investors today turn to the secondary market for numerous reasons. Highly capital-efficient LPs with low-risk exposure may choose to sell a stake in a top-quartile fund to reduce their private equity weighting or to avoid onerous regulatory costs. Rarely are secondary sales defined by distress. One only has to look at pricing dynamics, with in-demand funds commonly changing hands at premiums to NAV, to see this fact.
Myth 5: I will need an advisor to find multiple buyers
This may have held true in the secondary market's nascent years, but the number of options available to sellers is rising every day. Traditional deal mediation is rapidly changing. At Palico, for instance, we have developed a platform that allows investors to list either individual fund stakes and/or portfolios that attract multiple bids from an uncorrelated array of traditional and non-traditional secondary buyers. Sellers have no obligation to transact, giving them the option of whom to move forward with on a sale – and there are no-kill fees charged if the seller ultimately decides not to sell. This makes for a highly cost-effective way for LPs to actively and selectively manage their private equity portfolios.