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Private equity (PE) firms buy, manage and sell corporate entities. They are also often direct investors in other companies. The market for PE secondaries has increased significantly in recent years, with PE firms content with being secondary investors in private companies. By trading in secondaries, they obtain stakes in private companies at affordable rates and gain access to asset classes without becoming the primary investor. Although PE firms benefit from holding secondaries, there are considerations.
What are PE secondaries?
PE firms do not always wait for IPOs to invest in companies; they also look for other investment options. Secondaries help them invest in private companies by buying stakes. PE secondaries are assets in a private company that the primary investor transfers. The company or individual buying existing investments in a private firm becomes a secondary investor.
PE firms may not get stakes in private companies as primary investors also because stakes may be expensive for primary investors. Secondaries are highly rewarding and are usually offered at discounted rates. PE firms could buy stakes from an existing investor exiting the investment. The PE firm could easily sell secondaries and exit the investment. Limited and general partners are also interested in the PE secondary market. They, too, do not have to wait for a company to grow to generate revenue. Since they are buying stakes in an existing private company, the chances for growth are high.
What to consider before investing in PE secondaries
Company valuation
PE firms must have a complete understanding of the underlying stakes and their current value in the market. When investing in secondaries, you will be dealing with unlisted private companies. Since there is less public information, valuing an unlisted company is a complex process. The secondary investor must obtain the services of an expert valuation team to determine the right price for secondaries. It is crucial to ensure the primary investor sells secondaries at the right market price. There may be a conflict of opinion when primary and secondary investors evaluate secondaries. PE firms could seek third-party support for valuation when trading in secondaries.
The option for liquidity
Most firms invest in private equity secondaries to have the option of liquidity. However, not all PE secondaries are easy to liquidate in the market. Some may be sold faster than others. It is, therefore, crucial to understand the type of assets you are buying and study the liquidity profile of the secondaries before buying them. When assets can be liquidated faster, it is easy to exit the investment in an emergency. Again, PE firms could seek third-party support for analysing the liquidity profile of each secondary investment.
Check supply in the market
Investors must decide on the right time to be in the secondary market. Most primary investors sell secondaries after financial-year valuations (after 31 March). Towards the end of a financial year, supply of secondaries increases. Many primary investors look for secondary investors, to liquidate their assets. If you invest in secondaries at the right time, you could get better rates in the market. PE firms and limited partners could also choose to invest in secondaries towards the end of different financial quarters, and obtain better rates.
Risk/return profiles
Private companies have a better rate of growth, considering current market conditions. There are certain risks associated with buying stakes in private companies. If the secondary investment is not in line with your investment strategy, strategic risks arise. There are other risks associated with PE secondaries. It is essential to assess the return and risk profiles of secondary investments before making a decision.
