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The Post-COVID Secondary Market Fair Value Downsize

Purchasing an existing business is a less risky alternative to starting a new business from scratch. In fact, many start-up companies fail within the first several years. On the other hand, selling a company can take several months to even years, depending on factors such as business maturity, the industry, the market, and the context. Usually, stock deals tend to move much more quickly than asset deals for a number of reasons. Buyers can rely on the protection of securities laws so diligence tends to be less involved. Fewer third party consents are required. There are fewer tax issues to debate.

Private equity fund stakes follow the same market rules. The Secondary market in Europe formed by Jeremy Coller, the first fund created was about 60 million euros in the1990s, 2.1billion euros raised between 1991 and 1995. In 2019 a single transaction is bigger than that, the size of the market is 85 million euros. The market is still very small compared to the private equity industry. The AUM in PE is 5.2 trillion, dry powder is 177 billion. The secondary is 50 times smaller than what is currently in the industry. Unfortunately, secondary activities have made a pause since the pandemic beginning. At the end of March, many deals have been closed.

The main point is that activity is derived by family offices and pension funds buyers rather than the largest private equity players. Active deal flow is generally priced at discount linked to intrinsic value, what the buyer is willing to accept, and generally to allow for portfolio management and offer liquidity solutions. At the moment, here are record levels of dry powder that are available while many secondary market deals are made waiting for the rebound whenever it takes place.

Deal structures are privileging preferred equity solutions to effectively give the provider the right early cash flow and returns being kept as a unionized rate. The only potential sting in the way or roadblock is ensuring that LPs actually consent to those deals. Actually, this is not a market for short time vendors. That’s why the volumes on the LP side are very limited. This is driving to lower volumes the LPs at the lower scale. With distribution continuing, the liquidity shortage might drive some activity but it’s only for the LPs where there is a real need for selling out. Therefore, volumes will remain discrete and significant drops will be expected in the valuation of PE interests.