By Myles Milston, co-founder and CEO, Globacap
Private markets are rapidly developing infrastructure that is closing the efficiency gap to public markets, meanwhile, recent IPOs have fallen flat, and private equity firms struggle to exit their positions. Myles Milston, co-founder and CEO of Globacap, discusses how these factors are driving interest in secondary trading in private markets.
Public markets have struggled in 2023. In the first half of this year, the US had its lowest IPO volume and value since 2015, Europe had its lowest amount of listings since 2009, and IPO activity on the UK main market and AIM saw a 31% drop in deal numbers.
As a result, private equity firms are unable to exit their positions. They are facing the worst year in a decade for selling portfolio companies, making it challenging to monetise their investments and return money to investors.
This has led to a spike in interest in secondary trading in private markets. This involves purchasing existing interests or assets from primary private equity fund investors, providing flexibility for limited partners who may want to realise a return on their investments before corporate action takes place.
Secondary trading in private markets has historically involved slow settlement journeys, inefficient and insecure cash custody, and complicated legal title transfers. However, technology has transformed these processes over the past decade, closing the efficiency gap to public markets and making secondaries more accessible than ever before.
IPO drought impacting private equity firms
Public markets are struggling and 2022’s drop in IPO activity has extended to 2023. In the first nine months of this year, global IPO volumes fell 5%, with proceeds down by 32% year on year.
There was much hope for four blockbuster IPOs which looked set to reignite the IPO market but all have fallen flat, dampening confidence in public markets. Klaviyo recently joined Arm, Birkenstock and Instacart in trading below their respective IPO prices.
Their losses compared to their debut highs are even steeper, with Arm down 30% from its peak, Birkenstock 9%, Klaviyo 27% and Instacart 42%.
Further, firms are staying private for longer. From 1980 to 2021, the median age of a technology company going public was eight years. In three of the four calendar years between 2018-2022, the median age was 12 years.
This means private equity firms have to wait even longer to realise investments and return cash to investors.
As a result, exit values have plummeted. The downturn in US private equity exit value is even bigger than what the market endured during the global financial crisis, resulting in an estimated $60 billion shortfall in deal value.
This means less capital gets returned to limited partners and a drop in fund performance which can create difficulties when private equity firms try to raise new funds.
Improving infrastructure in secondary markets
Secondaries enable limited partners to make an early exit, liquidate assets or rebalance their portfolios. They also offer investors a place to buy assets years into their performance cycle, usually at a discount, which means the average holding time of the fund’s underlying assets will typically be shorter.
But they have traditionally suffered from a few key pain points that have held back their potential.
Private market transactions previously required expensive intermediaries with manual processes and would take weeks if not longer to complete. The red tape around ensuring secure, efficient cash custody and legal title transfers has also significantly slowed secondary settlement.
While many large asset owners (LAOs) today are looking to increase their allocations to private markets, they’re hesitant to attempt to navigate them because of concerns about complexity and illiquidity around the asset class.
However, cutting-edge new technology has digitized and automated secondary liquidity in private markets. Private assets, from shares in private companies to units in private equity managers, can now be transacted and settled almost as efficiently and seamlessly as public markets. This significantly reduces the settlement cycle, reducing risk, and therefore allowing many more participants to allocate to private markets in the first place.
Regulated, authorised custodian platforms allow for secure cash holdings, and even settlement can be as simple as ‘point and click’ with the automation of things like stamp duty for transactions on certain securities in certain countries.
It is improvements like these that are signalling to investors that the private secondary market is rapidly becoming a viable route to liquidity.
Secondaries set to grow exponentially
Against the backdrop of a challenging M&A environment, a dry IPO market and improving infrastructure, trading in secondary markets has grown exponentially.
After a record year for secondary transactions in 2021 ($130bn), the market recorded $105bn of volume in 2022, up from $25bn in 2012.
And this growth looks set to continue with large asset managers, including Ares and Franklin Templeton, increasing their exposure to secondary markets. Meanwhile, last month, Goldman Sachs raised $14 billion for a private equity secondary fund.
What was previously a core advantage of being public is quickly becoming matched by private markets as the number of active players in private secondary markets increases.
Furthermore, the lessening ability of venues such as AIM to provide deep and continuous liquidity has reduced their value to many firms. Meanwhile, the growing success of some private market venues shows just how easy it is to trade secondaries by leveraging this new way of working in private markets.
Falling confidence in the IPO market, investors struggling to exit positions and new technology which is improving infrastructure have led to growing interest in secondary markets.
By embracing them, private equity firms can achieve quicker exits, providing returns to limited partners and boosting their performance, while investors can access mature assets at reasonable prices.
