Fees for a secondary market deal can be high, ranging from 3 to 5 percent of the total transaction value for smaller deals, depending on their complexity. Advisors often do deals worth less than $10 million, and some handle deals under $100,000. For smaller transactions, a firm may levy a flat advisory fee of $5,000, one advisor says. Fees for deals involving structures other than a direct purchase or sale can vary, depending on the components. In the case of a loan against assets, Allen says NYPPE recently lent at 5.11 percent—or 3 percentage points over one-month Libor (London Interbank Offered Rate)—plus a 1 percent fee.
Finally, because much private equity is governed by limited partnership agreements, sellers must obtain permission from general partners who, in the past, have balked at a partner’s request to pull out of an investment. The momentum of the secondary market has changed things, Allen says. “Today, unlike two years ago, most general partners will permit a secondary transfer of the asset ownership when requested.”
Value Proposition
Secondary equity’s appeal is multifaceted, encompassing favorable risks, returns and discounts, among other factors. For instance, risks in this market are lower than those found in direct private equity investments, hence the “horse halfway around the track” comparisons. By the time a partnership interest appears on the secondary market, the private equity fund has usually completed its fund-raising and may have invested the money in portfolio companies. If it has not, or is running into trouble finding attractive investments, the secondary private equity buyer can offer less for the interest. “The big benefit to secondary market investing is definitely in pricing power,” Mooney says. “An individual can look at an opportunity and say ‘I’d invest at this price.’ But in the primary market, it’s ‘Take it or leave it.’” | From Your Side of the Table | | Essential questions to ask your financial advisor about the secondary private equity market: | 1. How will the investment affect my portfolio diversification in terms of maturities, industry and geography?
2. How has the private equity fund performed? Will this deal provide me better access to other companies or funds run by these managers?
3. What is the discount to net asset value?
4. What factors affect the value of the asset, and how objective is the valuation?
5. What is the expected schedule for returns?
6. What is the cost of the independent valuation and advice, and what is the transaction fee? |
Another advantage of the secondary market is that the wait for initial returns may be shorter than in the primary market. “The weighted average life of an investment in the primary market may be as high as seven to nine years. For secondaries, depending on maturity, we see deals with a three- to five-year life span,” Mooney says. “Most money in the secondary market is drawn down in three to four years, and the remainder is returned in the three to four years after that,” agrees Michael J. Brandmeyer, managing director of Goldman Sachs’ private equity group. Yet the secondary market may now be becoming less attractive. Sellers still offer discounts to fair market value, but they are diminishing. “Two years ago, if you were selling venture capital assets, you would probably average only 20 cents on the dollar; now you should get 70 cents, and some groups are getting 100 cents, if not a premium,” says Kelly DePonte, a partner at Probitas Partners, secondary advisors in San Francisco. Typically, though, a purchase on the secondary market today still will involve a net asset value discount averaging 40 percent.
Brandmeyer expects returns to remain high for a few more years, while the current cycle of primary private equity investments is completed. “The secondary private equity market lags the primary market by three to five years,” he says. “Since the primary market grew so dramatically through 2002, this is a good time for returns in the secondary market.”
Secondary private equity funds offer investors another option for entering the
market. “With secondary funds, you can analyze what you are investing in, get
quarterly statements and perform an analysis of the portfolio of companies,”
says Lawrence Penn, managing director at The Camelot Group International.
There are at least half a dozen secondary funds that will accept small
minimum investments. Among the managers offering these vehicles are New
York-based Lexington Partners, which manages five secondary funds and comanages
six others, and Goldman Sachs, which offers investors access to a series of
vehicles called GS Vintage Funds.
As with direct secondary investments,
larger investors dominate the list of participants in many secondary equity
funds. However, these funds also attract individuals, says Brian Mooney, vice
president and cofounder of Cogent Partners. “There are a lot of secondary fund
groups willing to let in smaller investors, and I don’t think they’d turn away
$1 million.”
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