The private equity secondaries market is rapidly evolving after recent legislation has increased efficiency, liquidity, and transparency in the previously opaque private market. In the past, strict federal regulation, high transaction costs, and asymmetric access contributed to the notoriously illiquid and inefficient private market. Recent events have removed a number of these obstacles, however, setting the stage for an unprecedented flood of both capital and growth in the private equity secondaries market.
In order to currently transfer secondary shares of a privately held company, one must navigate a complex and tangled web of regulation to avoid breaching any holding or volume limitations on the sale of these securities. The private secondaries market is currently regulated under Section 4(a)(1) of the Secondaries Act, which critically exempts resales of secondary securities “by any person other than an issuer, underwriter, or dealer.” While this may seem like an innocuous stipulation, federal courts have adopted an atypically broad interpretation of who qualifies as an “underwriter” in the secondary market. By the court’s definition, anyone who distributes shares from an issuer to the greater investing public is deemed an “underwriter”. This regulation has created great illiquidity in the private market, forcing investors to turn to niche exemptions within Section 4(a)(1) to gain eligibility to exchange shares.
Traditionally, only certain qualified institutional buyers (QIB) were able to exploit rules 144 and 144A to transfer secondary shares, albeit under a slew of restrictions that limited liquidity. Fortunately, however, recent developments have created a new exemption that has broadened the scope of transactions in the private secondaries market. Passed in late 2015, the Fixing America’s Surface Transportation Act, or FAST Act, includes Rule 4(a)(7), which modified the regulation of secondary security transactions. Rule 4(a)(7) expands the right to trade secondaries to all accredited investors while simultaneously alleviating the regulatory burden that these investors must overcome, simplifying what was once an overly complex process. For context, an accredited investor is either an individual who has “earned more than $200,000 as income (or $300,000 together with a spouse) in each of the prior two years” or an entity that maintains net assets in excess of $5 million. In contrast, QIBs mandate individuals to have at least $5 million in investments and entities to manage over $25 million in investments. Evidently, accredited investors have lower barriers to entry, expanding the pool of capital beyond simply the highest net worth individuals and funds. Because of this landmark legislation, the private secondaries market has hit record levels of liquidity.
Activity in private markets is reaching all time highs, as 2019 saw $83 billion worth of transactions in the secondary market, 78 percent higher than the $40 billion that was recorded in 2015. While the onset of the coronavirus tapered deal volume in 2020, transactions are expected to hit an all time once more in 2021, with more than $100 billion worth of deals projected for the first time ever.
In addition to recent regulatory changes, several companies are making strides to both simplify and democratize the secondary market. For example, Carta, a California based startup valued at over $3 billion, is planning on launching a “private share trading platform” that will emerge as an alternative to current stock exchanges and brokerages. While the platform is currently only open to companies valued over $1 billion, the platform already has more than 40 corporations signed up for their services. Henry Ward, the chief executive of Carta, explains his company’s message, stating that “In the current world, you can either be private and illiquid or you can be public and liquid. CartaX is going to help companies be private and liquid.”
Ultimately, friendlier federal legislation coupled with an increased institutional effort to improve efficiency within secondary markets has brought record levels of liquidity to private markets, allowing for the emergence of a new asset class altogether. Nearly all of the largest future investment funds will hold a significant portion of private secondary assets moving forward, as 77 percent of funds have already included these secondaries in their portfolio, with 21 percent seeking to increase their exposure in the near future. Antoine Dean of Forbes projects that by the end of the decade, the amount of private equity assets will more than triple from $9 billion to $30 billion, with annual deal transactions increasing more than fifteen-fold from 2019’s peak of $90 billion to $1.5 trillion. As momentum rapidly moves behind private markets, the next decade is certain to be an eventful one for investors involved in the secondaries market.
1 “Toward a Well-Functioning Private Securities Market.” Parallel Markets. Accessed July 30, 2021. https://parallelmarkets.com/blog/toward-a-well-functioning-private-securities-market/.
2 Drean, Antoine. “The Key to Private Equity’s Growth Is the Booming Secondary Market.” Forbes. Forbes Magazine, June 23, 2021. https://www.forbes.com/sites/antoinedrean/2021/06/21/the-key-to-private-equitys-growth-is-the-booming-secondary-market/?sh=5db7532e2c16.
3 Kruppa, Miles. “Carta Plans Private Share Trading Platform to Rival Nasdaq.” Subscribe to read | Financial Times. Financial Times, May 11, 2020. https://www.ft.com/content/d52b0487-b13c-4bae-bf27-770518ff083d.
4 Osipovich, Alexander. “High-Speed Trader Gts to Create Online Market for Pre-Ipo Shares.” The Wall Street Journal. Dow Jones & Company, April 22, 2020. https://www.wsj.com/articles/high-speed-trader-gts-to-create-online-market-for-pre-ipo-shares-11587555001.
5 Drean, Antoine. “Ten Predictions for Private Equity in 2029.” Forbes. Forbes Magazine, January 11, 2021. https://www.forbes.com/sites/antoinedrean/2020/01/30/ten-predictions-for-private-equity-in-2029/?sh=1dfb91704b23.