A guide to understanding and investing in private equity secondaries

What is the secondary private equity opportunity and how can you leverage it to own shares in unicorn companies? Kelvin Lee of Alta, a digital securities exchange for alternative investments, breaks it down for us

The private markets have witnessed remarkable growth in secondaries, also known as secondary funds that purchase existing interests or assets from primary private equity fund investors. Annual volume of secondaries surged from $20 billion in 2008 to over $100 billion in 2021 and 2022, as reported by the leading private markets investment management firm Hamilton Lane. In 2012, secondary market volume was just 5 percent of the total private market distributions. By 2022, it had doubled to 10 percent, indicating the rising significance of secondaries in providing liquidity to investors.

But how is this changing the investing landscape? About a decade ago, we had no access or opportunity to invest in a private tech giant like WhatsApp until Meta, then Facebook, went public in 2012.

Fast forward to today, we have access to investment opportunities in fast-growing social communications platforms, like Discord, and high-profile unicorns, such as TikTok’s parent company ByteDance, OpenAI and SpaceX, largely thanks to the secondary market platforms like the one Alta has developed.

NEW YORK, NEW YORK - JUNE 14: Traders work on the floor of the New York Stock Exchange (NYSE) on June 14, 2023 in New York City. Markets fell over 200 points following news that the Federal Reserve announced Wednesday that it was keeping its interest rate at around 5% - the first time it has not raised the rate in over a year. (Photo by Spencer Platt/Getty Images)

Above Today's investing landscape offers broader access to investments in high-profile private companies like Discord, ByteDance, and SpaceX through secondary market platforms (Photo: Getty Images)

Besides accessibility, many areas of the private market tend to be illiquid by design, which can allow long-term investments to realise their full economic potential. This can also create challenges for investors who need flexibility. The secondary market offers a solution by providing a platform for selling existing investments to other buyers, alleviating liquidity issues in private equity investments.

A prime illustration of this synergy is the listing of Income Insurance, a household name in the insurance sector that has become synonymous with Singapore’s integrity and prosperity, on our securities exchange. Recently, a share liquidity programme launched by Alta and investment firm PhillipCapital enabled over 15,000 Income Insurance shareholders globally to sell their shares. The programme would see the shares listed on Alta’s securities exchange, which is regulated by the Monetary Authority of Singapore, and made available to institutional and accredited investors to trade and own them.

As one of Singapore’s leading insurers and a publicly non-listed company, the listing of a company the size of Income Insurance was a tipping point for more unlisted companies to tap into the private market for liquidity, validating the viability of private exchanges to facilitate exits for early investors and shareholders.

In this article, I hope to help shed light on the growing secondary private equity opportunity for the individual investor—from how and why the market has been growing to the benefits of owning secondaries.

Above Unlike in primary markets, where the company directly benefits from the capital raised, transactions in the secondary market involve the trade of shares between investors (Photo: Getty Images)

Primary versus secondary transactions

Primary transactions involve companies raising funds by issuing new shares to investors. The secondary transaction emerges when these investors seek to exit their investment, akin to the stock market where investors trade existing shares; one investor typically sells their shares to another.

Differences between secondary public markets and private markets

Trading secondary shares in public markets involves buying and selling shares of publicly listed companies on stock exchanges. These transactions are highly liquid, with prices determined by supply and demand in real time. Public market trading is regulated and transparent, ensuring fairness for all participants.

In contrast, trading secondary shares in private markets involves transactions of shares of privately held companies. Private market transactions are less liquid and more opaque compared to public markets. Pricing is often negotiated between buyers and sellers, and there may be less transparency in valuation.

New-age digital exchanges are helping to bridge this gap by leveraging technology to enhance liquidity and transparency in private market transactions. These platforms provide tools for price discovery, trade matching and transaction settlement, making secondary share trading more efficient and accessible to a broader range of investors.

A young woman is doing cryptocurrency business trading on her computer at home at nigh.

Above Modern digital exchanges are utilising technology to improve liquidity and transparency in private market transactions (Photo: Getty Images)

Types of secondary transactions

Secondary transactions are of two types: direct secondaries and fund secondaries. Direct secondaries involve investors selling shares of a company directly to another investor.

Fund secondaries can be further categorised into limited partner (LP) secondary transactions and general partner (GP) led secondary transactions. LP secondary transactions involve an existing LP selling its stake in a fund to another investor, while GP-led secondary transactions involve a fund’s GP initiating a sale of one or more of its portfolio companies to a newly formed continuation vehicle with a new set of LPs.

Main factors driving growth

As more individuals and institutions participate in investing, secondary markets naturally expand. Factors such as financial literacy initiatives, easier access to investment platforms, and technological advancements in trading platforms have broadened the investor base.

Growing allocations to venture capital, extended time horizons for startup exits, increased investor demand for liquidity and the proliferation of new secondary deal structures are some factors resulting in a large and expanding venture secondary market.

Modern companies, especially those in tech, are remaining private longer for various reasons. In 1980, the median age of a company at its IPO was six years. In 2021, the median age was 11. In fact, from 1980 to 2000, there were more than 6,500 IPOs while there have been fewer than 3,000 from 2001 to 2022. That’s because private companies that face lower ongoing costs avoid the expenses associated with going public and prefer alternative exit strategies like secondary sales or mergers and acquisitions.

Read more: Should you get a co-founder?

Above One of the reasons for the interest towards private equity stems is the pursuit of higher returns in an environment where interest rates are low (Photo: Getty Images)

The advantages of secondaries fuelled the appetite for private equity

The interest in private equity is largely fueled by the extended private status of companies and the ongoing search for yield in a low interest-rate environment. While overall appetite for private equity may be the major demand driver, there are advantages secondary deals confer that add to this demand. Secondary private equity deals offer potential discounts on the last round valuations—typically from 5 percent to as much as 40 percent—providing potentially better returns, shorter exit horizons, and the removal of early-stage risks. They also allow for more diversified investment portfolios and thorough due diligence.

When it comes to investing, thorough due diligence is crucial for prospective secondary investors. Although there are significant benefits such as early-stage risk being reduced, investors should always keep in mind potential informational gaps and glean as much information from the primary investor as possible before committing. Understanding these aspects is essential for making informed investment decisions.

This article was adapted from A guide to secondaries: The gateway to unicorns.

Kelvin Lee is the co-founder and CEO of Alta. He is responsible for driving growth and strategic initiatives across the business. As Southeast Asia’s largest licensed digital securities exchange for alternative investments, Alta believes that access to capital markets is pivotal in all economies and building the critical infrastructure can pave the way for entrepreneurship, job creation, financial inclusion, and economic resilience, fostering a brighter future for emerging markets and economies.

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Topics

Investing Investment Finance Private Equity Unicorn Companies Shares Trading Venture Capital Opinion

Tatler Asia

Private equity secondaries: What are they and how do you invest in them?

Primary versus secondary transactions

Differences between secondary public markets and private markets

Types of secondary transactions

Main factors driving growth

The advantages of secondaries fuelled the appetite for private equity