The market provides liquidity to private equity investors, allowing them to sell positions in private equity funds and liquidate equity stakes in private companies. (The latter transactions are known as 'direct' or 'synthetic' secondaries, or, often, simply ‘directs’.)
All secondary markets are a natural consequence of large pools of capital. Investors’ situations and strategies change over time, creating a need for early liquidity. Commercial loans, mortgages and various types of insurance are some of the many areas in which active secondary markets have developed. Indeed, except in the relatively small part of their turnover represented by the issuance of new stocks and shares (IPOs and rights issues), all the world’s stock exchanges are secondary markets.
Private equity is an illiquid asset class, with investors required to commit capital to private equity funds for ten years or more. The development of a secondary market was therefore both necessary and inevitable.
Increased liquidity for the seller is certainly a consequence of all secondary sales, but it is often not the only – or even the principal – motivation. In recent years, secondary sales have been driven by investors’ increasingly active approach to managing their private equity portfolios. This trend will continue and intensify over the next few years, as LPs re-shape their holdings in response to new economic realities and focus more of their commitments on a core of preferred managers.
New regulatory regimes for banks and insurance companies (Basel III and Solvency II, for example) will also prompt significant secondary selling in the next few years.