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Today’s opportunities for buyers of limited partner-led secondaries

January 16, 2024 | 8 min read

Limited partner (LP) led secondaries, transactions in which an LP sells some or all of their commitment in a fund or a portfolio of funds to a third-party secondary buyer, have been a core piece of the secondary market for decades. Though traditionally used as a means to dispose of end-of-term assets, today’s LP-led secondaries represent a robust and diverse marketplace — one that offers asset owners multiple solutions to help achieve a wide range of objectives. As the LP-led market evolves, it’s important for investors to understand the dynamics driving the current LP-led deal activity and the benefits these transactions can offer both buyers and sellers.   

A brief history of the LP-led secondary market

The secondary market dates back to the 1980s when a small handful of institutional investors seeking liquidity sold their private equity fund interests. Initially, these transactions were limited in number with only a few available buyers. However, as the private equity industry grew, so did the need for a deeper and more robust secondary market.  

In the 1990s, dedicated secondary funds emerged, focusing on acquiring portfolios of private equity fund investments on a small scale. Fast forward to today, and the secondary market has not only grown substantially, but secondaries are now crucial to the private equity world as they offer investors flexibility in proactively managing their exposure to the asset class as well as the various weightings within their private equity portfolios. 

As the size and number of secondary deals continue to increase, LP-led transactions continue to evolve and today can provide sellers with flexibility through customized transaction terms to accomplish a broad range of objectives.  

Why the market favored LP-led secondaries in 2023

All LP-led secondaries — from the sale of LP interests in a traditional auction process to highly customized solutions — feature the purchase of established funds, offering secondary buyers some distinct potential benefits, particularly in 2023 and beyond as interest rate and macro uncertainty persist. These include: 

 

Immediate diversification, as larger secondary transactions often include hundreds or even over 1,000 underlying portfolio companies across a range of vintage years, geographies, industries, etc.

The potential for early distributions given the maturity of the assets purchased, resulting in shorter durations and the ability to more quickly de-risk.

Lower (or no) blind pool risk relative to many other strategies, given the majority of transactions occur after the completion of the underlying fund’s initial investment period.

Beginning in mid-2022, many LPs became overallocated to private equity due to the denominator effect and lower levels of distributions. This led LPs to view secondaries as a crucial exit or liquidity lever that could help them address their overallocation challenges and create much needed capacity for new investments. Due to these market dynamics in late 2022 and early 2023, there was a high volume of attractive LP-led secondaries available in the market, slightly outpacing GP-led opportunities over this period.  

Unpacking the shift that occurred in mid-2022 is relatively clear cut. Strong private equity performance through 2021 resulted in a run up in net asset values (NAVs). Then in mid-2022, public market valuations declined meaningfully and relatively quickly — and to a much greater extent than private market valuations. Combined with a slowdown in exit activity in private markets, many LP portfolios became meaningfully overallocated to private equity strategies. For many asset owners, particularly regulated institutions and LPs with larger private equity allocations, this created an environment in which these institutions were compelled to sell a portion of their private equity assets to reach their mandated or desired allocation levels and/or free up capital to make new investments. Practically speaking, the amount of buyside capital has not kept pace with the pressure to sell assets in the market, which has resulted in a shift in market dynamics that favors secondary buyers. Given the relative imbalance of buyside demand and sell-side supply, secondary buyers can now be more selective than in recent years in the assets they acquire.  

On the pricing side, the current market environment often allows buyers to acquire assets at lower prices relative to historical pricing levels. Sellers generally seek to minimize the discounts on the assets they sell in the current environment, which has driven a number of market trends. First, sellers have sought to divest assets of higher quality and lower risk, including funds managed by higher-quality GPs, given such assets can be sold for smaller discounts than assets of lower quality and/or higher risk. Additionally, sellers have shown a willingness to accept deferred purchase prices and to select mosaic sale solutions (in which portions of an LPs portfolio are sold to multiple buyers to secure a higher price than what a single buyer may be prepared to pay for the entire portfolio) as a means for achieving higher purchase prices. In the first half of 2023, for instance, 57% of secondary transactions involved two or more buyers, compared to just 21% in 2021.1  

The chart below illustrates both 2022’s volatility in public markets and average pricing in the private equity secondary market for several years prior to the rebasing. Notably, the average discounts to NAV reached 19% in 2022 and 20% in H1 2023.  

Jeffrey Keay

Managing Director,
Secondary investments

David Lowry

Principal,
Secondary investments

Chris Row

Principal,
Secondary investments

Secondary pricing: opportunity amidst volatility

Source: Greenhill Cogent: Global Secondary Market Review (August 2023), data as of 6/30/2023 and Secondary Market Review (2016-2019). Annual data represents 12-month average for each full year. Secondary pricing represents the average high bid received. 

Understanding opportunities and challenges of customized LP-led offerings

Looking forward, we believe that the market for LP-led secondaries presents an attractive opportunity to add exposures that offer the potential for compelling returns while also providing diversification and the potential for early realizations.  

While discounts have widened in this environment, it is important for buyers to ensure that the prices they pay are calibrated to the true value of the assets acquired, rather than reflecting an artificially high discount based on an overstated NAV. Furthermore, while lower quality managers and portfolio companies may be available at larger discounts, they may also carry disproportionately higher levels of risk. 

In the current market environment, buyers can often secure attractive discounts for high-quality assets and managers, making the current opportunity set particularly compelling. However, some GPs restrict which parties they will approve as a buyer of their funds and with whom they will share information. This dynamic can present an advantage for approved buyers and, conversely, challenges for unapproved buyers. Those buyers with structural advantages including strong GP relationships, access to information, scale, and the resources needed to move quickly, may be best positioned to identify and capture the highest quality deals. In practice, GPs tend to favor buyers that are existing investors and/or have the ability to deploy meaningful primary capital. Meanwhile, sellers vet buyers along a number of dimensions, including the likelihood that they will be approved by GPs to serve as a replacement LP in the fund interests being sold. 

Alongside traditional LP-led sales, which are generally focused on price and executed through more efficient and standardized sales processes, some sellers seek out more customized liquidity solutions in order to achieve transaction objectives that extend beyond price maximization. From a buyer’s perspective, these opportunities may offer the potential to earn differentiated returns by investing in assets that may have a similar profile to traditional LP-led secondaries, but with the benefit of being accessed through a less intermediated and less competitive process. When it comes to these more customized LP-led deals, there are fewer buyers with the track record, scale, relationships, and expertise to successfully navigate the associated complexities, which may include the creation of a new vehicle to hold the underlying assets, together with a bespoke economic agreement between the buyer and seller. These agreements can take the form of joint venture-like structures, preferred equity-like instruments, or a range of other formulations.   

Conclusion

The LP-led secondary market has grown and evolved substantially since its inception in the 1980s. Recent market dynamics, including strong motivations for institutions to sell LP fund interests to resolve overallocation challenges and free up capital to make new investments, have created an attractive opportunity set for buyers that is likely to continue into 2024 with ongoing macro uncertainty and a more volatile public market landscape. Looking ahead, we believe more customized LP-led transactions represent an additional growth vector in the market, but one where fewer buyers have the capabilities and resources to provide these solutions, making alignment with scaled players an important consideration in these more complex deals. 

As a firm, HarbourVest focuses on higher quality over bigger discounts in our investment approach. As a significant primary, direct and secondary investor — and with multiple touch points into private equity managers globally — we have developed a deep, proprietary data set on GPs and private equity assets. Our platform and deep GP relationships provide us a distinct information advantage that allows us to move quickly and with conviction to originate opportunities involving portfolios that have the potential for strong future value creation. 

If you are interested in learning more about HarbourVest’s views on the secondary market and how we can help you craft a liquidity solution, please be in touch.

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Footnotes
  1. Source: Greenhill Cogent: Global Secondary Market Review (August 2023), data as of 6/30/2023.
Disclosure

HarbourVest Partners, LLC is a registered investment adviser under the Investment Advisers Act of 1940. This material is solely for informational purposes and should not be viewed as a current or past recommendation or an offer to sell or the solicitation to buy securities or adopt any investment strategy.  The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication, are not definitive investment advice, and should not be relied upon as such. This material has been developed internally and/or obtained from sources believed to be reliable; however, HarbourVest does not guarantee the accuracy, adequacy or completeness of such information. There is no assurance that any events or projections will occur, and outcomes may be significantly different than the opinions shown here.  This information, including any projections concerning financial market performance, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. The information contained herein must be kept strictly confidential and may not be reproduced or redistributed in any format without the express written approval of HarbourVest.

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Professional Investor Definition

“Professional Investor” under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong) (the “SFO”) and its subsidiary legislation) means:

(a) any recognised exchange company, recognised clearing house, recognised exchange controller or recognised investor compensation company, or any person authorised to provide automated trading services under section 95(2) of the SFO;

(b) any intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong;

(c) any authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(d) any insurer authorized under the Insurance Ordinance (Cap. 41 of the Laws of Hong Kong), or any other person carrying on insurance business and regulated under the law of any place outside Hong Kong;

(e) any scheme which-

(i) is a collective investment scheme authorised under section 104 of the SFO; or

(ii) is similarly constituted under the law of any place outside Hong Kong and, if it is regulated under the law of such place, is permitted to be operated under the law of such place,

or any person by whom any such scheme is operated;

(f) any registered scheme as defined in section 2(1) of the Mandatory Provident Fund Schemes Ordinance (Cap. 485 of the Laws of Hong Kong), or its constituent fund as defined in section 2 of the Mandatory Provident Fund Schemes (General) Regulation (Cap. 485A of the Laws of Hong Kong), or any person who, in relation to any such registered scheme, is an approved trustee or service provider as defined in section 2(1) of that Ordinance or who is an investment manager of any such registered scheme or constituent fund;

(g) any scheme which-

(i) is a registered scheme as defined in section 2(1) of the Occupational Retirement Schemes Ordinance (Cap. 426 of the Laws of Hong Kong); or

(ii) is an offshore scheme as defined in section 2(1) of that Ordinance and, if it is regulated under the law of the place in which it is domiciled, is permitted to be operated under the law of such place,

or any person who, in relation to any such scheme, is an administrator as defined in section 2(1) of that Ordinance;

(h) any government (other than a municipal government authority), any institution which performs the functions of a central bank, or any multilateral agency;

(i) except for the purposes of Schedule 5 to the SFO, any corporation which is-

(i) a wholly owned subsidiary of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong;

(ii) a holding company which holds all the issued share capital of-

(A) an intermediary, or any other person carrying on the business of the provision of investment services and regulated under the law of any place outside Hong Kong; or

(B) an authorized financial institution, or any bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong; or

(iii) any other wholly owned subsidiary of a holding company referred to in subparagraph (ii); or

(j) any person of a class which is prescribed by rules made under section 397 of the SFO for the purposes of this paragraph as within the meaning of this definition for the purposes of the provisions of the SFO, or to the extent that it is prescribed by rules so made as within the meaning of this definition for the purposes of any provision of the SFO.

The first of such classes of additional “professional investor”, under the Securities and Futures (Professional Investor) Rules (Cap. 571D of the Laws of Hong Kong), are:

(k) any trust corporation (registered under Part VIII of the Trustee Ordinance (Cap. 29 of the Laws of Hong Kong) or the equivalent overseas) having been entrusted under the trust or trusts of which it acts as a trustee with total assets of not less than HK$40 million or its equivalent in any foreign currency at the relevant date (see below) or-

(i) as stated in the most recent audited financial statement prepared-

(A) in respect of the trust corporation; and

(B) within 16 months before the relevant date;

(ii) as ascertained by referring to one or more audited financial statements, each being the most recent audited financial statement, prepared-

(A) in respect of the trust or any of the trust; and

(B) within 16 months before the relevant date; or

(iii) as ascertained by referring to one or more custodian (see below) statements issued to the trust corporation-

(A) in respect of the trust or any of the trusts; and

(B) within 12 months before the relevant date;

(l) any individual, either alone or with any of his associates (the spouse or any child) on a joint account, having a portfolio (see below) of not less than HK$8 million or its equivalent in any foreign currency at the relevant date or-

(i) as stated in a certificate issued by an auditor or a certified public accountant of the individual within 12 months before the relevant date; or

(ii)  as ascertained by referring to one or more custodian statements issued to the individual (either alone or with the associate) within 12 months before the relevant date;

(m) any corporation or partnership having-

(i) a portfolio of not less than HK$8 million or its equivalent in any foreign currency; or

(ii) total assets of not less than HK$40 million or its equivalent in any foreign currency, at the relevant date, or as ascertained by referring to-

(iii) the most recent audited financial statement prepared-

(A) in respect of the corporation or partnership (as the case may be); and

(B) within 16 months before the relevant date; or

(iv) one or more custodian statements issued to the corporation or partnership (as the case may be) within 12 months before the relevant date; and

(n) any corporation the sole business of which is to hold investments and which at the relevant date is wholly owned by any one or more of the following persons-

(i) a trust corporation that falls within the description in paragraph (k);

(ii) an individual who, either alone or with any of his or her associates on a joint account, falls within the description in paragraph (k);

(iii) a corporation that falls within the description in paragraph (m);

(iv) a partnership that falls within the description in paragraph (m).

For the purposes of paragraphs (k) to (n) above:

  • “relevant date” means the date on which the advertisement, invitation or document (made in respect of securities or structured products or interests in any collective investment scheme, which is intended to be disposed of only to professional investors), is issued, or possessed for the purposes of issue;
  • “custodian” means (i) a corporation whose principal business is to act as a securities custodian, or (ii) an authorised financial institution under the Banking Ordinance (Cap. 155 of the Laws of Hong Kong); an overseas bank; a corporation licensed under the SFO; or an overseas financial intermediary, whose business includes acting as a custodian; and
  • “portfolio” means a portfolio comprising any of the following (i) securities; (ii) certificates of deposit issued by an authorised financial institution under the Banking Ordinance (Cap, 155 of the Laws of Hong Kong) or an overseas bank; and (iii) except for trust corporations, cash held by a custodian.

Institutional Investor / Accredited Investor Definition

An institutional investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(a) the Singapore Government;

(b) a statutory board as may be prescribed by regulations made under section 341 of the SFA, as prescribed in the Second Schedule of the Securities and Futures (Classes of Investors) Regulations 2018;

(c) an entity that is wholly and beneficially owned, whether directly or indirectly, by a central government of a country and whose principal activity is —

(i) to manage its own funds;

(ii) to manage the funds of the central government of that country (which may include the reserves of that central government and any pension or provident fund of that country); or

(iii) to manage the funds (which may include the reserves of that central government and any pension or provident fund of that country) of another entity that is wholly and beneficially owned, whether directly or indirectly, by the central government of that country;

(d) any entity —

(i) that is wholly and beneficially owned, whether directly or indirectly, by the central government of a country; and

(ii) whose funds are managed by an entity mentioned in sub‑paragraph (c);

(e) a bank that is licensed under the Banking Act 1970;

(f) a merchant bank that is licensed under the Banking Act 1970;

(g) a finance company that is licensed under the Finance Companies Act 1967;

(h) a company or co‑operative society that is licensed under the Insurance Act 1966 to carry on insurance business in Singapore;

(i) a company licensed under the Trust Companies Act 2005;

(j) a holder of a capital markets services licence;

(k) an approved exchange;

(l) a recognised market operator;

(m) an approved clearing house;

(n) a recognised clearing house;

(o) a licensed trade repository;

(p) a licensed foreign trade repository;

(q) an approved holding company;

(r) a Depository as defined in section 81SF of the SFA;

(s) a pension fund, or collective investment scheme, whether constituted in Singapore or elsewhere;

(t) a person (other than an individual) who carries on the business of dealing in bonds with accredited investors or expert investors;

(u) a designated market‑maker as defined in paragraph 1 of the Second Schedule to the Securities and Futures (Licensing and Conduct of Business) Regulations;

(v) a headquarters company or Finance and Treasury Centre which carries on a class of business involving fund management, where such business has been approved as a qualifying service in relation to that headquarters company or Finance and Treasury Centre under section 43D(2)(a) or 43E(2)(a) of the Income Tax Act 1947;

(w) a person who undertakes fund management activity (whether in Singapore or elsewhere) on behalf of not more than 30 qualified investors;

(x) a Service Company (as defined in regulation 2 of the Insurance (Lloyd’s Asia Scheme) Regulations) which carries on business as an agent of a member of Lloyd’s;

(y) a corporation the entire share capital of which is owned by an institutional investor or by persons all of whom are institutional investors;

(z) a partnership (other than a limited liability partnership within the meaning of the Limited Liability Partnerships Act 2005) in which each partner is an institutional investor.

An accredited investor as defined in Section 4A of the SFA and Securities and Futures (Classes of Investors) Regulations 2018 is:

(i)  an individual —

(A) whose net personal assets exceed in value $2 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(B) whose financial assets (net of any related liabilities) exceed in value $1 million (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount, where “financial asset” means —

(BA) a deposit as defined in section 4B of the Banking Act 1970;

(BB) an investment product as defined in section 2(1) of the Financial Advisers Act 2001; or

(BC) any other asset as may be prescribed by regulations made under section 341; or

(C) whose income in the preceding 12 months is not less than $300,000 (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe in place of the first amount;

(ii)  a corporation with net assets exceeding $10 million in value (or its equivalent in a foreign currency) or such other amount as the Authority may prescribe, in place of the first amount, as determined by —

(A) the most recent audited balance sheet of the corporation; or

(B) where the corporation is not required to prepare audited accounts regularly, a balance sheet of the corporation certified by the corporation as giving a true and fair view of the state of affairs of the corporation as of the date of the balance sheet, which date must be within the preceding 12 months;

(iii) A trustee of a trust which all the beneficiaries are accredited investors; or

(iv) A trustee of a trust which the subject matter exceeds S$10 million; or

(v) An entity (other than a corporation) with net assets exceeding S$10 million (or its equivalent in a foreign currency) in value. “Entity” includes an unincorporated association, a partnership and the government of any state, but does not include a trust; or

(vi) A partnership (other than a limited liability partnership) in which every partner is an accredited investor; or

(vii) A corporation which the entire share capital is owned by one or more persons, all of whom are accredited investors.

Continuation solutions encompass a host of transaction types in which a GP secures interim liquidity and/or additional primary capital for their LPs in a strongly performing asset, or set of assets, that the GP will continue to own and control. Specifically, they include continuation funds, new funds created by GPs for the purpose of acquiring the asset(s) that continue to be managed by the same GP and capitalized by one or several secondary buyers, or equity recapitalizations involving a direct equity or structured equity investment into a portfolio company. These transactions can also include a parallel investment from the GP’s latest fund into that same pool of assets (a “cross-fund trade”).