How COVID-19 is changing the growth of smaller secondary transactions
When we started Rivver in 2018, the total market value for the transfer of stakes in private investment funds from one investor to another, or secondary transactions as we call them, was $57B. By the start of 2020, the whole industry was expecting a historical year in secondaries, with a total of $100B in transaction value. Fast forward to last winter, as the world first encountered the effects of the novel COVID 19 pandemic, industry experts were not sure what would happen to the flourishing secondaries industry. Seven or eight months after countries began instilling lockdowns and social distancing requirements, we are now finally seeing some of the impacts which COVID-19 is having on the secondary market. Whereas, the secondary and alternative investment industries as a whole have had to adapt in a multitude of ways, the one which interests us the most is the growth of smaller secondary transactions.
Let’s first take a step back and understand the dynamics of secondary transactions. In any given secondary trade, you have the exiting investor - selling their stake a private fund (or the seller), and the buyer (usually a specialized fund, called a secondary fund). Caused in part by a global decrease in the amount of IPOs, private funds are taking longer and longer to provide returns to their investors; leading to secondary transactions becoming a critical tool for both sides. From the seller’s perspective, they now have the option to liquidate their holdings prior to the end of the fund’s life, for situations such as portfolio rebalancing or changes of leadership. On the buy-side, they now have the opportunity to purchase a stake in a fund that typically has already deployed capital; making it easier to underwrite and providing the new investor with a shorter holding period.
In recent years, a large portion of secondary market transactions has been what we can “large portfolio sales”, which combine dozens of funds and hundreds of underlying portfolio companies into one single transaction, oftentimes worth hundreds of millions or billions of Dollars. This was caused by a few factors, such as the inefficiency and cost of secondary trading and new regulatory constraints following the global financial crisis.
As most secondary transactions today are done in a manual way, they require extensive paperwork, manual legal oversight, an array of third-party service providers, and up to 6 weeks of time. Furthermore, new regulatory policies such as the Dodd-Frank Act, have made it more difficult for banks to invest in private funds, forcing them to liquidate most of their private fund holdings to other investors. As a result, investors needed to complete these trades as rapidly as they could, resulting in them giving preference to buyers that were able to purchase entire portfolios. Other large financial institutions, such as pension funds and endowments, also often gave preference to buyers that were able to purchase entire portfolios.
Fast forward to the era of COVID-19, and these bulk secondary transactions are becoming increasingly difficult. The pandemic has impacted every industry in a different way, resulting in some industries, such as travel and hospitality, to financially collapse, others, such as healthcare and technology, to thrive, and others to stay neutral. As many institutional investors have highly diversified private investment portfolios, they inevitably have stakes in companies involved in industries that were highly impacted by COVID-19. As these times are so uncertain, most buyers lack the ability to underwrite and gauge risk for each industry with the great precision that is now needed. This forces large buyers to place bids at steep discounts in an attempt to mediate their underwriting risk; which sellers are having difficulty accepting.
The decrease in bulk transactions has resulted in the total volume of secondary transactions decreasing by 56% in H1 2020. While the decrease in transaction value is alarming for many investors, studies have also shown that the total transaction volume has only decreased by 39%. This is due to the fact that we are already seeing an increase in smaller transactions, with smaller and opportunistic buyers as the counterparties. These smaller buyers are specialized in their particular industries, such as travel or manufacturing, and are able to more effectively underwrite and gauge risk, allowing them to offer a better price than bulk buyers. Smaller buyers also typically use little or no leverage, reducing another COVID-19 inflected risk.
From the sell-side perspective, despite the fact that they are able to receive significantly more capital when transacting with multiple buyers, many institutional investors are still hesitant to do so. This is mainly due to the inefficient legal and operational system relied upon for secondary trades today. Luckily for them, with the advent of new technological tools, investors no longer need to pick between selling their positions at a discount and partaking in an inefficient and costly trading process. At Rivver, we provide a software platform that makes trading a stake in a fund as painless and trading a stock. Our accomplished legal team has built-in all relevant regulatory restrictions into code, enabling you to ensure full compliance in an automated way. Rivver also provides a next-generation digital share register and record-keeping system, allowing you to securely keep track of your investors in real-time.
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