Secondary PE Investing

Secondary investing is the business of buying limited partnership interests from investors in funds (or funds of funds) prior to their maturity. In other words, instead of investing as a limited partner in the original fund, you simply buy out a limited partner's interest in an existing fund. Typically, the limited partner will be a motivated seller who needs to raise capital and can no longer tolerate the illiquidity of his position.

Note that in most cases the general partner will control the sale. When an investor acquires a limited partnership interest in a PE fund, the limited partnership (LP) agreements typically provide that partners may not transfer their interests or commitments. To effect a transfer thus requires the approval of the general partner, who, as noted, will normally take control of the process. However, in the case of very large sales of LP interests, an auction may take place.

Although families can buy secondary interests directly, it's a far better practice to invest in a fund dedicated to buying secondary interests. This is a highly specialized sector of the PE market, and few families—or institutions, for that matter—will have the ability to gain access to interesting secondary opportunities, negotiate acceptable pricing, and deal with the general partners who control the game.

Among the advantages of secondary investing is that the money goes out faster because the fund interests are more mature, there is little or no J-curve effect, and returns occur earlier. Employed on an opportunistic basis, secondary investing can be significantly additive to a diversified PE program.