Avt secondaries analysis2010

Private Equity Secondary MarketValuation Analysis

Arnaud van TichelenICADE, Faculty Advisor: Rocío Sáenz-DíezLondon, September 2010

PE1PE2

C ARACALLA SCALARP A R T N E R S TM

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© 2010 by Arnaud van Tichelen. All rights reserved. This work is registered with the UK Copyright Service:

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CONTRIBUTORS OF THE STUDY1

ABOUT THE AUTHOR Arnaud van Tichelen recently graduated with distinction from ICADE’s international business administration program (E‐4). During ICADE, Arnaud worked 6 months at UBS within the M&A team and 6 months at Comgest (asset management) as an equity analyst. He currently works in the Investment Banking Division (Consumer products and retail) of UBS in London. He can be contacted at [email protected] 1 Three other investment funds shared their views but requested to remain anonymous. The author is grateful to Professor Rocío Sáenz‐Díez, to Trevor Giles from Caracalla Capital and to Nick Hatch from Scalar Partners for their support in this work but also to the investment professionals who contributed to this study for their precious time and valuable insight.

C ARACALLA

We are proud to have assisted wi th th is study. We bel ieve i t provides an excel lent pr imer to the pr ivate equi ty secondary market along with important market h istory and valuat ion techniques. We hope investors wi l l learn and prof i t f rom th is work.

Trevor S. Giles CMA CFA Managing Director

capital sourcing

corporate f inance

gp / lp secondary for the canadian market

to contact us

vancouver, br i t ish columbia, canada 1.877.354.4422 on the web www.caracal la.ca

Feel free to contact us:

San Francisco Office Salt Lake City Office 580 California Street, 5th Floor 10813 S. River Front Parkway, Suite 300 San Francisco, California 94109 Salt Lake City, Utah 84095 +1 (415) 283‐3280 +1 (877) 872‐3643 [email protected] www.scalarpartners.com/secondaries

We leverage our network and expertise to help limited partners achieve their private equity allocation objectives including: venture and private equity fund I sourcing, screening, due diligence, monitoring and I reporting, fund accounting, and secondary advisory

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ABSTRACT

During the current liquidity crisis, the Private Equity industry has been reshaped and

experienced a significant increase in the level of interest and activity in the secondary

market. However, despite its growth, the market is still inherently inefficient and pricing

tends to vary widely among bidders. Investors need to be aware of the challenges and

dynamics of this fast evolving market and to carefully analyze each potential sourced

opportunity.

This research paper attempts to analyze the characteristics of the Private Equity

secondary market. Furthermore it analyses the valuation in the market and provides an

actual valuation of a real secondary investment opportunity supported by the development

of a secondary valuation model. This analysis is based on more than 25 interviews conducted

with expert participants in secondaries.

Currently, transaction volume for secondaries is near an all-time high which

generates further liquidity and benefits the asset class as a whole. Near-term and long-term

factors are driving a fast growing market which many expect will grow about 16% annually

(CAGR) in the next five years. However opportunities on the market are mirrored by

significant challenges. Although the top-down method is helpful in determining the value of

a potential secondary, empirical data clearly shows that a bottom-up valuation is crucially

important in determining the value of an asset in the secondary market.

Keywords: Private Equity, secondary market, secondaries, liquidity, valuation, selling

limited partnership capital commitments, secondary fund, LP, GP, fundraising, unfunded,

carried interest, waterfall.

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CONTENTS

CONTRIBUTORS OF THE STUDY................................................................................................. II

ABSTRACT ................................................................................................................................... III

CONTENTS ................................................................................................................................... IV

TABLE OF FIGURES ......................................................................................................................... IX

LIST OF TABLES ............................................................................................................................... XI

ABBREVIATIONS AND SYMBOLS .............................................................................................. XII

I. INTRODUCTION ....................................................................................... 15

II. CHARACTERISTICS OF THE PRIVATE EQUITY SECONDARY

MARKET ...................................................................................................... 18

1. DESCRIPTION OF THE MARKET ........................................................................ 18

1.1. Theoretical framework ................................................................................... 18

1.1.1 Private Equity basics .................................................................... 18

1.1.2 An illiquid investment ................................................................. 19

1.2. Volumes of investment in Private Equity ................................................. 19

1.2.1 The size of the primary market ................................................ 19

1.2.2 The size of the secondary market ........................................... 21

1.3. Different reasons to resort to the market ................................................ 23

1.3.1 Reasons that motivate the sellers ........................................... 23

1.3.2 Reasons that motivate the buyers........................................... 26

1.4. The secondary market participants ........................................................... 29

1.4.1 The advisers .................................................................................... 29

1.4.2 The sellers ........................................................................................ 33

1.4.3 The buyers ........................................................................................ 35

1.4.4 Other emerging participants: the private marketplaces 38

1.5. History ................................................................................................................... 40

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1.5.1 The beginning of the market (1982-2002) .......................... 41

1.5.2 The growth of the market (2003-2007) ............................... 42

1.5.3 The credit crunch (July 2007-2009) ...................................... 43

2. THE TRANSACTIONS ON THE MARKET: DESCRIPTION OF THE DIFFERENT

STRUCTURES AND SALE PROCESSES .................................................................. 46

2.1. Different types of transactions ..................................................................... 46

2.1.1 Sale of limited partnership interests ..................................... 46

2.1.2 Direct sale ......................................................................................... 46

2.2. Different sale structures ................................................................................. 47

2.2.1 Straight sale ..................................................................................... 49

2.2.2 Strip Sale ........................................................................................... 50

2.2.3 Stapled Secondary ......................................................................... 50

2.2.4 Structured secondary sale ......................................................... 51

2.2.5 Total return Swaps ....................................................................... 53

2.2.6 Securitisation: CFOs ...................................................................... 54

2.2.7 Securitisation of the unfunded ................................................. 54

2.2.8 Spin-out ............................................................................................. 55

2.2.9 Tail-end ............................................................................................. 55

2.3. The different sale processes .......................................................................... 56

2.3.1 GP option: arrange a sale through the manager ................ 56

2.3.2 Exclusive sale with a secondary buyer ................................. 56

2.3.3 Open auction ................................................................................... 57

2.3.4 Targeted auction ............................................................................ 57

2.4. The execution of the transaction ................................................................. 57

3. LEGAL AND TAX CONSIDERATIONS .................................................................. 58

3.1. Legal considerations in the revision of the LPA .................................... 58

3.1.1 The Consent of the GP .................................................................. 58

3.1.2 Pre-emption rights: Right of First Refusal (ROFR) ........... 59

3.1.3 Legal reporting requirements .................................................. 59

3.1.4 Sale notification requirements ................................................. 59

3.1.5 Payment of costs incurred by the transaction ................... 59

3.2. Legal considerations in the negotiation of the Purchase and Sale

Agreement ............................................................................................................. 59

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3.2.1 The contingent conditions ......................................................... 60

3.2.2 Material Adverse Change clauses ............................................ 60

3.2.3 Clawback provisions .................................................................... 60

3.2.4 Threshold funds ............................................................................. 60

3.2.5 Indemnifications ............................................................................ 61

3.2.6 Joint liability: French legal framework ................................. 61

3.2.7 Stapled transaction clauses ....................................................... 61

3.3. Tax considerations ............................................................................................ 61

3.3.1 Taxation of Private Equity funds ............................................. 61

3.3.2 The United States: the 2% law ................................................. 62

4. THE FUTURE OF THE MARKET .......................................................................... 62

4.1. Empirical demonstration: The primary market drives the secondary

.................................................................................................................................. 62

4.1.1 Secondary market projections model ................................... 63

4.1.2 Historical relationship between the secondary base and the

volume in the secondary market ........................................................... 64

4.1.3 Secondary market transaction volume: 2010-2014E ..... 64

4.2. Future growth catalysts .................................................................................. 66

4.2.1 The “denominator effect” ........................................................... 66

4.2.2 The new requirements of the financial institutions......... 68

4.2.3 An increasing pressure on the investors: fall in the

distributions combined with an increase in the capital calls ..... 69

4.2.4 The improving economic outlook ........................................... 71

4.2.5 The bid offer spread is reduced ............................................... 72

4.2.6 A market that is becoming a more important asset class for

investors ......................................................................................................... 73

4.3. Ever more structured operations................................................................ 74

III. VALUATION IN THE PRIVATE EQUITY SECONDARY MARKET 76

1. HISTORICAL MARKET VALUATIONS ................................................................. 76

1.1. Transactions: historical valuation .............................................................. 76

1.1.1 General trend .................................................................................. 76

1.1.2 The valuation depends on the type of asset ........................ 78

1.1.3 The valuation depends on the funding ratio ....................... 79

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1.1.4 The valuation depends on the vintage year of the fund . 80

1.2. Listed Private Equity funds ........................................................................... 81

1.2.1 Concept .............................................................................................. 81

1.2.2 Historical trading: a proxy towards the valuation in the

secondary market ........................................................................................ 82

1.2.3 Limits of comparison with the Private Equity secondary

market .............................................................................................................. 83

2. HOW TO THEORETICALLY VALUE THIS ASSET ................................................. 85

2.1. Top-down method............................................................................................. 85

2.1.1 The transaction or trading value/NAV ratio ....................... 85

2.1.2 Comparable transactions method ........................................... 86

2.1.3 The valuation method by the trading multiples ................ 86

2.2. Bottom-up method: the valuation model ................................................. 86

2.2.1 Structure of the bottom-up valuation method of a fund’s

interest............................................................................................................. 87

2.2.2 Valuing the underlying asset ..................................................... 87

2.2.3 Project the unfunded .................................................................... 89

2.2.4 Determine a timing of capital calls/distributions ............. 90

2.2.5 Aggregate the cash flows in the fund’s waterfall............... 90

2.2.6 Discount the cash flows by the cost of capital .................... 93

2.2.7 Sensitivity valuation analysis ................................................... 94

3. REAL WORLD VALUATION: EMPIRICAL CONTRAST OF THE TWO METHODS . 95

3.1. Top-down method: market valuation ....................................................... 95

3.2. Bottom-up method: valuation using the model ..................................... 96

3.2.1 Introduce the fund’s financial data and growth estimates96

3.2.2 The analysis and the valuation of the portfolio companies99

3.2.3 Adding of the cash flows in the waterfall of the fund .... 102

3.2.4 Determination and sensitisation of the price of the limited

partnership interest according to different scenarios ................ 106

3.3. Comparison of the results: explanation of the difference ................108

3.3.1 Comparison of the results ........................................................ 108

3.3.2 The concept of NAV is subjective .......................................... 108

3.3.3 Each asset is different ................................................................ 108

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3.3.4 The lag of the NAV ....................................................................... 109

3.3.5 A buyers’ market .......................................................................... 110

3.3.6 Key valuation method: bottom-up ........................................ 112

IV. CONCLUSIONS ........................................................................................ 114

1. CONCLUSIONS .................................................................................................. 114

1.1. Analysis of the secondary market: an opportunity for the Private

Equity industry ..................................................................................................114

1.2. The future: growth and sophistication ...................................................114

1.3. Valuation in the secondary market: trend and method ...................116

2. FUTURE RESEARCH ......................................................................................... 117

GLOSSARY ................................................................................................................................118

REFERENCES ................................................................................................................................123

1. BOOKS .............................................................................................................. 123

2. REPORTS .......................................................................................................... 123

3. ARTICLES ......................................................................................................... 127

4. DATABASES ...................................................................................................... 129

APPENDIX ................................................................................................................................131

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TABLE OF FIGURES

Figure 1: Structure of the study ............................................................................................... 16

Figure 2: Different Private Equity styles ................................................................................... 18

Figure 3: Raised capital in the primary market ($ billions) ...................................................... 20

Figure 4: Transaction volume in the secondary market ($ billions) ......................................... 21

Figure 5: Geographical distribution of the transactions .......................................................... 22

Figure 6: Volume raised by secondary Private Equity funds ($ billions) .................................. 23

Figure 7: Reasons that motivate the sellers in the market (2007/2008/2009) ....................... 25

Figure 8: Reasons for resorting to the secondary market in the next two years (2010-2011) 26

Figure 9: Secondary funds - Top, median and bottom IRR quartiles (by vintage year) ........... 27

Figure 10: The “J-Curve” ........................................................................................................... 28

Figure 11: Importance of the secondary market to investors’ Private Equity strategies ........ 29

Figure 12: Breakdown by seller type in the secondary market (2008 vs. 2009) ...................... 33

Figure 13: Buyer types (by transaction volume - H1 09).......................................................... 36

Figure 14: Non-traditional buyer types (H1 09) ....................................................................... 38

Figure 15: History of the Private Equity secondary market ..................................................... 40

Figure 16: The beginning of the market (1982-2002) .............................................................. 42

Figure 17: Changes to LPs’ exposure to secondary funds over the years 2008-2009 ............. 44

Figure 18: Proportion of investors who ruled out transactions in 2008 because of pricing

concerns ........................................................................................................................... 45

Figure 19: Two types of secondary transactions: sale of limited partnership interest and

direct sale ......................................................................................................................... 46

Figure 20: Transaction volume breakdown – (Limited partnership interest and Direct sale)

(2007 to 2009) .................................................................................................................. 47

Figure 21: Different sale structures in the secondary market ................................................. 48

Figure 22: Comparison of the characteristics of the different sale structures ........................ 49

Figure 23: Traditional sale structure: straight sale of a limited partnership interest .............. 50

Figure 24: Structure of a stapled secondary sale of a portfolio of limited partnership interests

.......................................................................................................................................... 51

Figure 25: Structured joint-venture sale of a portfolio of limited partnership interests ........ 52

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Figure 26: Total return swaps for a portfolio of limited partnership interests ....................... 53

Figure 27: Securitisation by means of CFOs ............................................................................. 54

Figure 28: Securitisation of the unfunded ............................................................................... 54

Figure 29: Comparison of the characteristics of the different sale processes ........................ 56

Figure 30: Secondary base (in bn$) .......................................................................................... 64

Figure 31: Estimates of the secondary market transaction volume according to the historical

relationship ($ billions) ..................................................................................................... 65

Figure 32: LPs’ anticipated level of Private Equity commitments at the end of 2010 ............. 67

Figure 33: Plans to address the over allocation issue .............................................................. 67

Figure 34: Distributions as a % of NAV ..................................................................................... 70

Figure 35: Anticipated changes in capital calls in the next 12 months .................................... 71

Figure 36: Timing of the tightening of the bid/offer spread .................................................... 73

Figure 37: Anticipated changes to LP’s exposure to secondary funds over 2010-2011 .......... 74

Figure 38: Secondary bids over time (as a % of last fund’s NAV) ............................................ 77

Figure 39: Value of the best bid in comparison with the total exposure to the asset (NAV +

unfunded) ......................................................................................................................... 78

Figure 40: Historical valuation of the best bids received for each fund type (% of the NAV) . 79

Figure 41: Valuation according to the vintage year of the fund (H1 2009) in % of its NAV .... 81

Figure 42: Historical trading of the listed Private Equity funds – Premium / (discount) with its

NAV ................................................................................................................................... 82

Figure 43: Comparison between trading of listed Private Equity funds and bids received in

the secondary market ...................................................................................................... 83

Figure 44: Two valuation methods of the secondary assets .................................................... 85

Figure 45: Structure of the bottom-up valuation method ....................................................... 87

Figure 46: Dry powder in the secondary market in 2010 ($ billions)..................................... 110

Figure 47: Estimate of the dry powder in the secondary market in 2011 ($ billions) ........... 111

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LIST OF TABLES

Table 1: Financial advisers in the secondary market ............................................................... 31

Table 2: Legal advisers on the secondary market .................................................................... 32

Table 3: The ten largest dedicated fund managers at the end of 2009 ................................... 37

Table 4: Distribution of the transaction probabilities during the life of a fund ....................... 63

Table 5: Tier 1 capital and 3% cap of five major US banks....................................................... 69

Table 6: Effect of the funding ratio on the valuation (H1 2009) .............................................. 80

Table 7: Projection multiples of the unfunded according to the quality of the management

team ................................................................................................................................. 90

Table 8: Cash flows of the fund and distributions - Waterfall ................................................. 93

Table 9: Top-down valuation of a limited partnership interest ............................................... 95

Table 10: Main characteristics of the fund .............................................................................. 97

Table 11: Financial data and growth hypotheses of a portfolio company .............................. 98

Table 12: Analysis and projection of the operating data of a portfolio company (base case)

........................................................................................................................................ 100

Table 13: Projection of the debt repayment and valuation of the investment ..................... 101

Table 14: Cash flows from the fund’s investments ................................................................ 103

Table 15: Calculation of the costs of the fund ....................................................................... 103

Table 16: Waterfall of the fund .............................................................................................. 104

Table 17: Net cash flows available for LPs ............................................................................. 104

Table 18: Determination of the returns of the secondary investor according to the

acquisition price ............................................................................................................. 105

Table 19: Determination of the price to be paid according to scenarios and returns .......... 106

Table 20: Sensitivity of the returns to the different key variables ........................................ 107

Table 21: Contrast of the valuation according to the different methods .............................. 108

Table 22: Discrepancy in the valuation of the assets (H1 2009) ............................................ 109

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ABBREVIATIONS AND SYMBOLS

ASCRI Asociación Española de entidades de Capital Riesgo (SPAIN)

AVCJ Asian Venture Capital Journal

BVCA British Private Equity & Venture Capital Association (UK)

CAPEX Capital Expenditures: Investment in fixed assets

CFO Collateralized Fund Obligation: debt security of Private Equity fund or

hedge fund assets

DCF Discounted Cash Flow: valuation method consisting in valuing the asset

by discounting its future cash flows

EBIT Earnings Before Interest and Taxes

EBITDA Earnings Before Interest, Taxes, Depreciation and Amortization

EV Enterprise value (equity+ debt)

EVCA European Venture Capital Association

FCF Free Cash Flow

GP General Partner: fund manager

IRR Internal Rate of Return

IRS Internal Revenue Services: tax authority in the USA

KYC Know Your Customer: due diligence requirement that financial

institutions must perform to identify their client and ascertain relevant

information to doing financial business with them

LBO Leveraged Buy Out

LP Limited Partner: Co-owner of a limited partnership

LPA Limited Partnership Agreement: constitution agreement of a Private

Equity fund

MAC Material Adverse Change: legal provision that allows the acquirer to

withdraw from the transaction if the target suffers a substantial change

MBO Management Buy Out

NAV Net Asset Value

NOPAT Net Operating Profit After Taxes

NPV Net Present Value

NVCA National Venture Capital Association (USA)

PEF Private Equity Fund

PSA Purchase and Sale Agreement

QMS Qualified Matching Service: approved management services for

secondary transactions by the tax authorities

ROFR Right Of First Refusal

SPA Share Purchase Agreement

SPV Special Purpose Vehicle

VC Venture Capital: Private Equity investment style in the early stages of

the development of the companies

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PART I:

INTRODUCTION

I. Introduction - 15 -

I. INTRODUCTION

During the current liquidity crisis, it may be valuable for a limited partner to dispose

of an interest in a Private Equity fund, but how? The secondary market can provide this

desired liquidity which is critically important to limited partners. Many key issues are taken

into account when disposing of an interest, but as Cicero said: “belli nervus pecunia”, money

is the sinews of war, the value of the asset sold, is the key consideration in a transaction in

the secondary market. But how are these assets valued? Why are there such large disparities

between the different bids received for the same assets?

The secondary market is growing constantly and is now a major participant in the Private

Equity industry. From a very private confidential market to a broad liquidity provider for the

investment community, the market has changed dramatically. In 2009, funds raised for the

purchase of Private Equity fund interests accounted for roughly 20% of all Private Equity

funds closed during the year. Over the last decade, the market has become more and more

complex and become the reflection of new opportunities. However, although the market is

being established it remains inefficient.

Motivations for entering the secondary market are increasingly different and complex. What

volumes are traded in the market? Who are the participants? Transactions are becoming

more complex. What are the different sales structures and their characteristics? Beyond

structuring of transactions, why can there be so much price disparity between the bids on

the same asset? Is there a way to accurately value these assets? How could we measure the

fair value of an interest in a fund?

Secondary market literature is limited and due to this lack of information, many investors

and agents still do not understand all of its characteristics, nuances and complexities. No

study giving a comprehensive and thorough overview of the market and its main issues has

been published prior to this paper. This study attempts to answer a lack of information and

to be a guide through the characteristics and valuation of the Private Equity secondary

market.

Structure of the study

The content of this study is organized around the following structure:

The first part (section II) explains the main features of the market. Its basic

characteristics, size, participants, motivations to enter the market and historical

development are detailed (II.1). Also analyzed are the different sales structures and

I. Introduction - 16 -

processes (II.2) as well as tax and legal considerations in such transactions (II.3) in order to

better analyze and project future trends of the market (II.4).

The second part (section III) focuses on the valuation of the assets on the secondary

market. After analyzing the existing market valuations (III.1), the different valuation methods

are explained based on theoretical knowledge and direct experience of secondary market

participants (III.2). Once the theoretical approach of valuing these assets is understood, a

real world valuation is demonstrated. An interest in a Private Equity fund is valued following

two valuation methods: bottom-up and top-down (through the valuation model developed

in partnership with several market participants) in order to demonstrate the optimal

valuation method of assets in the secondary market (III.3).

The last part (section IV) lists the main conclusions of the study and its investigations.

Main considerations on the market, its future and the valuation of these assets are

highlighted in order to summarize the key contributions of the study.

To support the present study, appendices are attached containing databases of market

participants, marketing documents of the present study, summaries of meetings and calls

with sponsors of this study, analysis of historical data in the market and a projection model

of secondary transaction volume.

Figure 1: Structure of the study

Source: Author’s own

PART II:

CHARACTERISTICS OF THE PRIVATE

EQUITY SECONDARY MARKET

II. Characteristics of the Private Equity secondary market - 18 -

II. CHARACTERISTICS OF THE PRIVATE EQUITY SECONDARY MARKET

1. Description of the market

1.1. Theoretical framework

1.1.1 Private Equity basics2

Private Equity funds are limited partnerships, the purpose of which consists of taking

short-term interests in unlisted companies. The objective sought is that with the help of the

capital investment and fund management team, the investee company increases in value

and the fund exits obtaining a profit.

Private Equity funds (PEF) can be invested in a many different ways according to their

investment strategy (investment style, the type of assets in which it invests or targets).

Figure 2: Different Private Equity styles

Source: adapted from JP Morgan Asset Management; «Secondary Private Equity Discussions»; 2009.

A Private Equity Fund (PEF) is a collective investment scheme through which assets are

administered by an investment firm (the Private Equity firm). The assets are divided into

interests conferring to their holders, the Limited Partners or LPs, a property right thereon3.

The LPs’ commitments are managed by the Private Equity firm acting as the General Partner

or GP which also invest in their own funds, typically providing 1% to 5% of the overall capital.

In making an investment in a PEF, LPs sign a Limited Partnership Agreement or LPA with the

GP. This document, drawn up by the GP and its advisers, governs the relationship between

2 Gómez-Acebo & Pombo abogados y ASCRI; «Capital riesgo (Private Equity) aspectos regulatorios, mercantiles,

financieros, fiscales y laborales»; 2006 3 CNMV, «Reglamento de los fondos de capital riesgo», www.cnmv.is/legislacion/capital_risk/REGLAFON.DOC

(Last accessed: 6 November 2009)


the LPs and GPs. It describes the rights and obligations of the parties and sets forth the

fund’s operating mandate and limitations.

The amount that LPs invest is called committed capital. The LP commits in writing to provide

capital funding within the agreed time limit (in general ten days4) upon notification of the

manager’s capital call. In general, the investor will provide capital over a period of time and

the portion committed by the investor but not yet paid is called the unfunded commitment.

The LPA sets forth details on how the fund is to be managed including the management fee5

which is measured as a percentage of the committed capital or the assets under

management depending whether the fund is in the investment period or liquidation period

(it is generally applied to the committed capital during the investment period and to the

assets under management during the liquidation phase). The management fees are usually

2% but they can differ slightly (between 1% and 3%) according to the manager’s reputation

and fund size.

The LPA also defines the fund’s distribution structure (also called waterfall). The carried

interest is defined in this part. Carried interest represents the fund manager’s share in

capital gains resulting from operations carried out by the fund once the investment of the

LPs has been returned and a minimum return to the investors called the hurdle rate (about

8%) has been provided for. In Private Equity Funds, the carried interest is usually about

20%6.

1.1.2 An illiquid investment

An investment in a PEF is fundamentally illiquid given that LPs commit to fulfilling

their obligation to invest the agreed amount decided in the LPA over a period which is

usually ranges from 10-12 years.

The secondary market is developed in response to this lack of liquidity in this asset class. In

this market existing investments are traded as well as the unfunded part of the commitment

in combination (the most usual) or separately.

1.2. Volumes of investment in Private Equity

1.2.1 The size of the primary market

Primary markets are those in which assets or financial instruments between investors

and companies or banks are issued for the first time.

4 Akin Gump Strauss Hauer & Feld; «Role of the secondaries market and LP trends»; 2009

5 See section III. 2.2.4- ii. The fund management costs

6 See section III, 2.2.4- iii. The waterfall


Figure 3: Raised capital in the primary market ($ billions)

Source: Author’s own using data7 from: Private Equity Analyst (1996-1999); Thomson Reuters, AVCJ, EVCA, Asia

Private Equity, NVCA (2000-2008); Preqin (2009).

As the graph above demonstrates, investments in Private Equity increased annually until the

technology bubble burst in 2000. After a short period of decline in new capital raised (mainly

due to Venture Capital funds) the market rebounded from 2002 to 2007 following a period

of macroeconomic expansion. In 2007, after reaching historic highs, the trend reversed due

to the financial crisis and the volume of new capital raised fell dramatically.

In 2009, investments in Private Equity continued to fall and due to a difficult economic

recovery it is forecast that annual volume in the next two years will remain constant8.

According to Preqin, the first quarter of 2010 shows a constant trend with $50 billion raised,

representing an increase of 5% in comparison with capital raised in the first quarter of 20099.

From 2005 to 2008 the Private Equity asset class raised nearly $1.5 trillion. Driven by

attractive returns and the enthusiasm of investors, the Private Equity industry has grown

significantly in recent years from approximately $950 billion in 2003 to $2.5 trillion in 200810.

7 The data used are from a historical analysis of the information published by different market participants. See

appendix 8.3. The selected data are the most accurate and are from recognised and trustworthy sources 8 Bain & Company, Inc; «Global Private Equity Report 2010»; 2010

9 Preqin; «Q1 2010 Private equity Fundraising Update»; 2010 (via Twitter 1 April 2010)

10 Including the NAV of the portfolio and the unfunded. Preqin; «Private Equity secondary market: Short-Term

Boom, Long-Term Growth»; 2009

50

81

117133

250

140

70 80

120

255

370

455

375

246

0

50

100

150

200

250

300

350

400

450

500

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009


1.2.2 The size of the secondary market

i. Transaction volume in the secondary market

Figure 4: Transaction volume in the secondary market ($ billions)

Source: Author’s own using data11

from: Dow Jones; «Guide to secondary Market Buyers»; 2009 (Sale price +

Unfunded; transactions of traditional participants: funds of funds and secondary funds); UBS Private Funds

Group; «Adams Street Secondary Networking Event»; 2010 (2009).

The data of this market are estimates given that since it is not an organised market

there is no system capable of capturing the exact volume of transactions in the market.

Furthermore, the data that are published represent large-scale transactions in which

secondary dedicated funds or fund of funds were involved. The smaller more numerous

transactions of LPs’ interests are not usually published and therefore their impact is very

difficult to measure.

For a long period of time, the secondary market was nearly invisible given its low volume.

Since 2003 it has become a major market, as can be inferred from the recent media interest

(press, conferences, etc.).

11

The data used are from a historical analysis of the information published by different participants. See

appendix 8.1. The selected data are the most accurate and are from recognized and trustworthy sources

0.6 0.71.5

2.43.1

2.3 2.1

6.9

8.47.5

10.3

13.4

16.1

9.1

0

2

4

6

8

10

12

14

16

18

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

CAGR 2002-08

41%

II. Characteristics of the Private Equity secondary market

In 2008, transaction volume in the secondary market was over $16 billion. Despite the

magnitude of this amount, this large vo

Private Equity industry12. Compared with other asset classes, this is a very low proportion of

secondary transactions. This implies that many investors keep their interests until

with little opportunity to change their strategy and sell their investment during this period.

In 2009, according to the present survey shown in appendix (8.1), secondary

(advisers and buyers) estimated the secondary transaction volume at an average of $7.5

billion, which represents a 50%

Figure 5: Geographical distribution of the transactions

Source: Author’s own using data from UBS Private Funds Group; «Private Equity Secondary Market review»;

2009.

The majority of transactions are carried out in the United States and Europe

participants are present and transactions more significant.

One of the secondary market’s growth drivers is the volume raised in the primary market.

Historically, a positive direct relationship between the primary and secondary markets

seems to have existed.

ii.

The volume raised by dedicated secondary funds has also grown

last five years. Since 2003, funds ded

raised commitments totalling $75 billion.

12

Secondary transactions in 2008 (Dow Jon

billion/ $25 trillion = 0.64%

21%2%

76%

1%

2007

cs of the Private Equity secondary market


magnitude of this amount, this large volume represents less than 1% of the total size of the

. Compared with other asset classes, this is a very low proportion of

secondary transactions. This implies that many investors keep their interests until

to change their strategy and sell their investment during this period.

In 2009, according to the present survey shown in appendix (8.1), secondary


50% decrease over 2008 volume.

: Geographical distribution of the transactions


majority of transactions are carried out in the United States and Europe

are present and transactions more significant.


sitive direct relationship between the primary and secondary markets

ii. Volume raised by dedicated secondary funds

The volume raised by dedicated secondary funds has also grown

last five years. Since 2003, funds dedicated to the Private Equity secondary market have

raised commitments totalling $75 billion.

in 2008 (Dow Jones Guide)/Assets managed by Private Equity in 2008 (Preqin)= $16

Europe

Asia

USA

Other

50%

6%

43%

1%

2008

- 22 -


lume represents less than 1% of the total size of the

. Compared with other asset classes, this is a very low proportion of

secondary transactions. This implies that many investors keep their interests until maturity

to change their strategy and sell their investment during this period.

In 2009, according to the present survey shown in appendix (8.1), secondary participants



majority of transactions are carried out in the United States and Europe where the main


sitive direct relationship between the primary and secondary markets

Volume raised by dedicated secondary funds

The volume raised by dedicated secondary funds has also grown significantly in the

icated to the Private Equity secondary market have

te Equity in 2008 (Preqin)= $161

Europe

Asia

USA

Other


Figure 6: Volume raised by secondary Private Equity funds ($ billions)

Source: Author’s own based on data from13

: Dow Jones; «Guide to secondary market buyers»; 2009 (1996-

2008); Preqin; «Private Equity Spotlight January 2010»; 2010 (2009).

In 2009 it was the only segment of Private Equity that grew in comparison with 2008 and

represents 7.5% of the total funds raised14.

According to Campbell Lutyens15 and Probitas Partners16, it is forecast that in 2010

secondary funds will raise some $27 billion if they manage to achieve their fundraising

targets.

1.3. Different reasons to resort to the market

What characterises the market today is the multiplicity of reasons that different

participants have for entering the market17.

1.3.1 Reasons that motivate the sellers

� Inability to finance unfunded commitments: This reason is often cited when an

over-commitment strategy is employed. In good times the investors commit more

13

The data used are from a historical analysis of the information published by different participants. See

appendix 8.2. The selected data are the most accurate and are from recognised and trustworthy sources 14

Secondary funds / total funds raised = 246/18.5= 7.5% 15

See appendix 7.13, which includes a summary of the call to Campbell Lutyens (10 March 2010) 16

Probitas Partners; «Adams Street Secondary Networking Event»; 2010 17

Kelly DePonte, Probitas Partners; «Routes to liquidity»; 2009

1.10.7

2.7 2.0 2.4

6.4

4.0

7.47.8 7.2

13.012.3

8.9

18.5

0

2

4

6

8

10

12

14

16

18

20

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009


money than they have to invest in this asset class and then finance capital calls with

distributions from mature funds. But during downturns when the distributions are

reduced they are unable to fund capital calls. They need to sell their interests that

entail large unfunded commitments (i.e. most recent funds).

� Urgent need for liquidity (distressed sellers).

� To comply with the new regulatory accountancy risk management and capital

requirements (Basel II).

� Change in the overall strategy: sale of non-core assets.

� Corporate transaction: mergers and acquisitions, restructuring, change in the

management team.

� Denominator effect18: due to the fall in publicly traded security valuations the

weighting of other assets increases in the portfolio. This imposes a re-balancing of

the different assets classes in order to comply with the allocation threshold of assets

in the portfolio policy.

� Change in the investment strategy: geographical area, sector, vintage year,

change in the management team, asset class…

� Reorganisation of the portfolio and exit from problematic funds.

� To lock-in performance.

� To focus on relationship with some GPs: having interests in few funds allows to

follow a limited number of GPs and therefore to reduce the management and

administrative costs.

� To avoid distributing remaining assets of a fund to the LPs: a manager prefers to

sell assets in the secondary market to return cash to his LPs rather than distribute the

fund’s remaining assets19.

18

For more details on the denominator effect, see 4.2.1. The denominator effect. 19

Charles Soulignac, CEO Fondinvest Capital; «Secondary Market in private equity - an asset class in

expansion»; 12 March 2002. www.AltAssets.com (last accessed: 3 February 2010)


Figure 7: Reasons that motivate the sellers in the market (2007/2008/2009)

Source: Author’s own using data from

In the figure above two major reasons why sellers resort to the secondary market stand out:

active portfolio management and the need for liquidity. Since 2009, due to the credit crunch,

the main reason for selling has become the need to find liquidity.

14%

56%

17%

13%

2007

40%

8% 4%

2009


that motivate the sellers in the market (2007/2008/2009)

Source: Author’s own using data from Dow Jones; «Guide to Secondary Market Intermediaries»; 2009

two major reasons why sellers resort to the secondary market stand out:


the main reason for selling has become the need to find liquidity.

56%

27%

54%

11%8%

2008

48%

2009

Sellers are distressed/

inexperienced

Portfolio management tool

Regulatory changes

Other

- 25 -

Dow Jones; «Guide to Secondary Market Intermediaries»; 2009.

two major reasons why sellers resort to the secondary market stand out:


Sellers are distressed/

Portfolio management tool


Figure 8: Reasons for resorting to the secondary market in the next two years (2010-2011)

Source: Author’s own using data from Coller Capital; «Global Private Equity Barometer Winter 2009-10»; 2009.

According to a survey by Coller Capital carried out in the winter of 2009, the main reasons

why sellers are going to use the secondary market in 2010-2011 will be lack of liquidity and

portfolio management (to rebalance their allocation to Private Equity or refocus resources).

1.3.2 Reasons that motivate the buyers

� To generate large returns by exploiting market inefficiencies20:

The secondary market is characterised by price and information inefficiencies. Moreover, the

imbalance between the supply and demand for assets may create a buyers’ market.

These returns are reflected in the average IRR of the secondary funds created between 2000

and 2005 which are between 20% and 30% higher than the average of the primary funds21.

20

Goldman Sachs PEG ; «Private Equity liquidity : a perspective on the secondary market »; May 2008 21

Preqin; «Private Equity Secondary Market: Short-Term Boom, Long-Term Growth»; 2009

0% 20% 40% 60% 80% 100%

Increase liquidity

Re-balance portfolio within the PE

asset class

Re-focus resources on the best-

performing GPs

Re-direct resources to other asset

classes or uses

"Lock in" returns

Winter 2009-10 Summer 2007


Figure 9: Secondary funds - Top, median and bottom IRR quartiles (by vintage year)

Source: Preqin; «2009 secondary review»; 2009.

According to a survey by Probitas Partners published in November 2009, more than 50% of

investors believe returns of the best secondary fund managers (those of the top quartile) in

vintage year 2010 will reach an IRR of 20% or more during the life of the fund22.

� To optimise the risk-return trade-off of a portfolio:

In some cases the transaction allows investment with preferred conditions in the funds,

providing greater seniority in the capital structure and therefore less risk alongside preferred

returns.

� To invest in an identifiable portfolio of assets:

In the primary market, the investor invests in a blind pool and trusts the judgement of the

GP to buy high-performing assets. When buying in the secondary market, the investor knows

the assets in which the fund is invested and can estimate its growth and future value.

� To gain access to future funds of a certain GP:

The acquisition of a fund’s interest seeks to develop a relationship with a GP in order to

obtain access to future funds that will be raised.

� To diversify the portfolio:

It allows diversifying the portfolio, adding a different vintage year or buying funds from an

outstanding vintage year.

� To minimise the impact of the J-curve on the portfolio:

22

Probitas Partners ; «Private Equity Market Review and Institutional Investor Survey»; 2009


At the beginning of the investment, a PEF requires capital to invest (“investment period”)

and in this phase the fund typically shows negative returns. The fund’s return rate reaches a

turning point from the moment in which the fund distributions appear. The effect of this

impact on portfolio returns is called the “J-curve effect”23.

Figure 10: The “J-Curve”

Source: JP Morgan Asset Management; «Secondary Private Equity Discussions»; 2009.

Upon adding more mature assets to a portfolio the J-curve effect is reduced. Some GPs

therefore resort to the secondary market to buy interests in mature funds in order to reduce

this impact.

According to Capital Dynamics, a Private Equity fund takes 5 years to achieve a NAV of 80%

of the committed capital. Buying an interest in a mature fund allows for acceleration of

initial returns and improves liquidity of the portfolio since secondary funds usually generate

earlier distributions24.

However, the main motives that drive the market are those of the sellers. Indeed, in

quantitative terms, the majority of transactions were led by large financial institutions

(banks, insurance companies) that decided Private Equity is not their core business and sold

their interests in the secondary market in order to reemploy this capital to other activities.

That trend is called “active portfolio management”.

For all these reasons, the secondary market increasingly forms part of investors’ strategy.

23

Private Equity Magasine ; «J Curve: la vraie bonne raison d’acheter»; 2009 24

Capital Dynamics; «Perspectives»; 2009


Figure 11: Importance of the secondary market to investors’ Private Equity strategies

Source: Author’s own based on data from Preqin; «Private Equity Secondary Market: Short

term growth»; 2009.

According to a survey by Fidequity, more than 80% of investors in the Private Equity

secondary market seek to increase their exposure to this asset class

Furthermore, the GPs’ attitude toward secondary transactions carried out in their funds

generally positive. A study carrie

have experienced a secondary transaction in their funds, only 25% of them have expressed

concerns regarding these sales.

1.4. The secondary market

The three main participants active

1.4.1 The advisers

In a secondary market transaction, the seller must employ the services of legal and

financial experts in order to maximise the transaction value and correctly

inherent risks. Furthermore, the buyer must employ the services of a legal adviser to analyse

the existing LPA of the fund in which it invests and to draft the Purchase

(PSA).

i.

In July 2010, according to

appendix 1.1), there were nearly 50 financial advisers

25

Fidequity; «Global Private Equity Limited Partner Survey26

Preqin; «Private Equity Secondary Market: Short27

See appendix 7.13, which includes a summary of the call to Campbell Lutyens (10 March 2010)

10%

22%


: Importance of the secondary market to investors’ Private Equity strategies

Source: Author’s own based on data from Preqin; «Private Equity Secondary Market: Short

Fidequity, more than 80% of investors in the Private Equity

secondary market seek to increase their exposure to this asset class25.

the GPs’ attitude toward secondary transactions carried out in their funds

. A study carried out by Preqin26 showed that whereas nearly 63% of GPs


concerns regarding these sales.

The secondary market participants

active in the secondary market are advisers, sellers and buyers.

The advisers


financial experts in order to maximise the transaction value and correctly

rmore, the buyer must employ the services of a legal adviser to analyse

the existing LPA of the fund in which it invests and to draft the Purchase and Sale

i. The financial advisers27

In July 2010, according to current analysis of existing financial advisers (see list in

appendix 1.1), there were nearly 50 financial advisers serving the market. According to

Global Private Equity Limited Partner Survey-Q3 2009»; Q3 2009

Private Equity Secondary Market: Short-term boom, long-term growth»; 2009


68%

Not a core part of the

strategy

Core part of strategy

Of growing importance to

strategy

- 29 -

: Importance of the secondary market to investors’ Private Equity strategies

Source: Author’s own based on data from Preqin; «Private Equity Secondary Market: Short-term boom, long-

Fidequity, more than 80% of investors in the Private Equity

the GPs’ attitude toward secondary transactions carried out in their funds is

that whereas nearly 63% of GPs


ndary market are advisers, sellers and buyers.


financial experts in order to maximise the transaction value and correctly understand the

rmore, the buyer must employ the services of a legal adviser to analyse

and Sale Agreement

ancial advisers (see list in

the market. According to

; 2009



Preqin, 47% of currently active financial advisers have entered the market since 200328. This

is a growing sector and it is forecast that new advisers will enter the market in coming years

to exploit new market opportunities, but also to compensate for declines in the main

fundraising activity of many placement agents. However, one must distinguish specialist

advisory firms in the secondary market from brokerage firms which have no advisory

capabilities in structuring and valuation of complex transactions. The three largest advisory

firms in the secondary market that advise on the largest transactions are UBS PFG, Cogent

Partners and Campbell Lutyens. The advisers mainly act on behalf of the seller and they

advise them in numerous ways29.

• Knowledge of the market: the adviser knows the current state of the market and the

preferences of large buyers.

• To structure transactions: the adviser knows the different options for structuring

transaction and their advantages and drawbacks. He can advise on the most appropriate

and then structure it.

• Price orientation: evaluating a price range for the asset, evaluating the fund’s underlying

assets and detailing the valuation method. The adviser knows the current valuations of

the market and has a team capable of modelling the asset price.

• Detailed knowledge of the buyers in the secondary market: adds value in the marketing

strategy, knows the potential buyers and can contact them.

• To manage the process: advises in the selection of the most suitable sale process

(auction, private sale…), provides suitable information, manages the queries, coordinates

legal advisers, receives bids, reviews them and assesses which is the best.

• To close the process: manages the transfer of funds and closes the transaction.

Seeking the service of an adviser is highly advisable when carrying out a secondary market

transaction because it typically achieves the best returns (in the acquisition or sale) and

provides for the efficient management of many complex issues (portfolio analysis, valuation,

legal, terms, etc.)30.

Advisers usually charge a commission that depends on the characteristics of each

transaction (size, unfunded part, complexity) and according to the base used to calculate the

commission (NAV + unfunded; transaction price + unfunded; transaction price). The data

28

Preqin; «The 2009 Preqin Private Equity Secondaries Review»; 2009 29

Dow Jones; «Guide to secondary market intermediaries»; 2009 30

“As a general rule the most successful man in life is the man who has the best information.” – Benjamin

Disraeli


gathered for this analysis indicates commissions are usually between 1% and 3.5% of the

sale amount defined as the NAV + unfunded31.

Table 1: Financial advisers in the secondary market32

Financial advisers (alphabetical order)

Almeida Capital Cogent Partners Patronus Capital

Alpha Associates AG Continental Capital Partners plurisvaluation

Altitude Capital Advisory Credit Suisse Group Preqin

Ariane Capital Partners Fidequity Probitas Partners

Augusta & Co Global Finance Rainmakers Partners

Autumn Capital Partners Greenhill & Co. Richmond Park Partners

Axon Partners Griffin Private Equity Group Rotschild

Axonia Partners Houlihan Lokey Roux Capital

Azla Advisors Lancea Partners Scalar Partners

Bluetower Capital Lazard Secondcap

Boyd & Co Matrix Group Setter Capital

Breslin AG Mercury Capital Advisors Somerset Capital

Campbell Lutyens MHT Partners Secondary Advisors The Camelot Group International

Capital Dynamics Mummert & Company Triago

Capstone Partners Nakatomi Capital UBS Private funds Group

Carta Diem Palomar Corporate Finance

Champlain advisors Park Hill Group


ii. The legal advisers

In a secondary transaction, the legal adviser mainly manages the review of the fund’s

LPA and the drafting of the PSA.

Before a sale the LP must ensure the transaction can be carried out according to the LPA;

that there are no clauses that prevent it, but also according to current tax laws.

Furthermore, the buyer’s legal adviser must analyse the LPA of the fund in which his client

wishes to invest in order to understand how exactly it operates, its management clauses and

compensation and the admission consent.

31

See appendix 7, which summarises the calls to Secondmarket (1 December 2009); Breslin AG (2 December

2009); Pantheon Ventures (9 December 2009); Campbell Lutyens (10 December 2009); UBS PFG (2 February

2010) 32

See list of financial advisers in the secondary market in appendix 1.1. This table contains advisers and

intermediaries


He also advises his client in the drafting of the PSA, in which important clauses such as

contingent conditions, clawback conditions, material adverse change clauses (MAC) or

compensation clauses will have to be negotiated.

All these considerations are crucial to the acquisition/sale process in the secondary market

and may be unfamiliar to the counterparties requiring experts be engaged to analyse these

details to ensure transaction success.

Table 2: Legal advisers on the secondary market33

Legal advisers (alphabetical order)

Covington & Burling Howard Rice SJberwin

Debevoise & Plimpton Kaye Scholer Weil, Gotshal &Manges

Fried Frank Kirkland & Ellis Wilmer Cutler Pickering Hale and Dorr

Goodwin Procter OR'Melveny & Myers


Few legal firms have a practice dedicated to secondary transactions, however in the case of

direct transactions (acquisition of a direct interest in a portfolio company), legal firms that

advise on mergers and acquisitions transactions are usually hired.

33

See list of legal advisers in the secondary market in appendix 1.2. Only legal firms with a dedicated practice

are included.


1.4.2 The sellers

There are two types of sellers in the market: investors in funds (LPs) and the

managers themselves (GPs).

Figure 12: Breakdown by seller type in the secondary market (2008 vs. 2009)

Source: Author’s own based on data from UBS Private Funds Group; «Adams Street Secondary Networking

Event»; 2010. Breakdown is based on number of transactions brought to market. Asset managers include

Private Equity GPs, fund of funds and hedge funds.

Investors in funds (limited partners) usually represent close to 75% of the number of

transactions and managers (General Partners) the remaining 25% according to data

published by UBS34.

i. The LPs (investors in funds)

Traditionally, financial institutions (banks, pension funds, insurance companies) have

represented between a third to a half of the secondary transactions. Furthermore,

endowments, listed vehicles, foundations, family offices and wealthy individuals act as

sellers in the market35.

34

UBS Private Funds Group; «Adams Street Secondary Networking Event»; 2010. Based on the number of

transactions in the market. 35

Real Deals; «Secondaries roundtable 2009»; 2009

31.1%

42.3%

27.0%

25.8%

18.9%5.2%

10.8%11.3%

6.8% 12.4%

5.4% 3.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

H1 07 to H1 08 H1 08 to H1 09

Corporate

Endowment

Family office /

Foundation

Pension funds (Public

and private)

Asset manager

Financial institutions


• Banks36: These entities tend to enter and exit the Private Equity market in cycles.

Many of the banks have invested in this asset class to be able to finance leveraged

buyouts (LBOs) and to advise on mergers and acquisitions. In periods of crisis, banks

are incapable of playing their financing role, which compels them to reduce their

exposure to this asset class that has never been a core business. Currently they are

the most important sellers in the secondary market. Recent transactions include the

sale of a $1.9bn Private Equity portfolio of Bank of America to Axa PE in April 2010

and the $1.1bn sale of Citi’s fund-of-funds, mezzanine fund, feeder fund and co-

investment fund interests to Lexington in July 2010. Bank of America was said at the

end of July 2010 to be in talks with Lexington Partners and the sovereign wealth fund

China Investment Corp (CIC) to sell $1.2bn (€930mn) in commitments made to funds

managed by Warburg Pincus according to several people familiar with the

transaction.

• Pension funds: They are large asset owners that invest capital obtained through the

accumulated savings of a group of people in order to make payments to their

stakeholders once they have reached retirement age. Preqin details in a report that

on average these investors seek to allocate 6.2% of their assets to the Private Equity

asset class37. According to a study by the National Association of Pension Funds in the

United Kingdom, pension funds in the United Kingdom have reduced their

percentage allocation to Private Equity from 2.5% on average in June 2008 to 1% in

June 200938. For example, Calpers, the pension fund of the public employees of the

state of California ($237.1 billion AUM) sold more than $2 billion of interests in

Private Equity funds in 2008.

• Insurance companies: These companies offer insurance policies to the public by

direct sale or through other sources such as the employees’ benefit plan. They

manage large sums of money and invest a portion in Private Equity. According to a

study by Preqin, they seek to allocate 3.7% of their assets to the Private Equity39

asset class.

• Listed funds of funds40: These are listed investment vehicles. A true “closed box” (it

has no income apart from the distributions of the fund in which it is invested) until it

issues additional securities. These vehicles employ an over-commitment strategy and

are highly leveraged. In the midst of the financial market crisis, they suffered greatly

36

See appendix 7.4, which summarises the email from Preqin (2 December 2009) 37

Preqin; «2009 Global Private Equity Review»; 2009 38

Web page: http://www.AltAssets.com/private-equity-news/by-pe-sector/buy-out/article/nz17417.html 39

Preqin; «Survey by insurance companies investing in Private Equity»; October 2009 40

See appendix 7.4, which summarises the email from Preqin (2 December 2009)


from reduction in fund distributions and severely reduced access to credit leading to

increased use of the secondary market.

• Endowments41: These funds seek to cover a part or all the needs of the institutions

to which they belong with the returns on their investment portfolios. According to a

study by Preqin these funds on average seek to allocate 11.8% of their assets to the

Private Equity asset class42. Another “closed box”, these funds have no income and

employ an over-commitment strategy. Accordingly they have had the same problem

as listed funds because of the reduction in fund distributions. The largest are those of

American universities, such as Harvard ($26billion) which has had to access the

secondary market to comply with its liquidity needs.

• Foundations and family offices: Foundations are non-profit organisations that

dedicate their assets to pursuing general aims and family offices are companies that

advise wealthy families. On average, these institutions seek to allocate 11.1% of their

assets to the Private Equity asset class43.

ii. The GPs (fund managers)

The General Partners or fund managers may also be sellers in the market whether it

may be selling a fund interest, a direct interest in a portfolio company, or a part of or all the

portfolio of the fund(s) they manage.

1.4.3 The buyers

Buyers are traditional or non-traditional depending on whether these investors have

capabilities to invest in the secondary market. Traditional buyers are funds dedicated to the

secondary market and funds of funds that invest part of their capital in secondary assets.

The non-traditional are diverse institutional investors: foundations, insurance companies,

endowments, pension funds, family-offices or GPs (fund managers).

According to a survey conducted by Probitas Partners published in November 2009, 50% of

those surveyed (institutional investors) actively purchase direct positions in funds and 10.8%

actively purchase direct positions in companies in the secondary market44.

41

See appendix 7.4, which summarises the email from Preqin (2 December 2009) 42

Preqin; «Survey by Endowments investing in Private Equity»; October 2009 43

Preqin; «2009 Global Private Equity Review»; 2009 44

Probitas Partners ; «Private Equity Market Review and Institutional Investor Survey»; 2009


Figure 13: Buyer types (by transaction volume

Source: Author’s own based on data from Cogent Partners; «Secondary Pricing analysis Summer 2009»; 2009.

According to a study by Cogent Partners, during the first half of 2009, 57% of the investors

by volume were traditional45.

i.

According to present analysis of secondary buyers (see in appendix 2), there

are 140 buyers with secondary asset acquisition programmes.

• Fund-of-funds: Investment vehicles designed to invest in other funds. In order to

diversify their portfolio and accele

their capital in the secondary market. The

assets (defined in their LPA) has greatly increased over time and is usually about 20%

• Dedicated secondary funds

appendix (2.1 and 2.2), indicates a total of 77 companies that have funds dedicated to

investing in the secondary market. These

dedicated to the secondary market

managers are from the United States (56%) and from Europe (36%)

At the end of 2009 the ten largest fund managers dedicated to the secondary

were as follows:

45

Cogent Partners; «Secondary Pricing analysis Summer 200946

According to the author’s own survey.

however, there is no requirement to invest47

See appendix 2.1 and 2.2 48

Preqin; «The 2009 Preqin Private Equity Secondaries Review»; 2009


: Buyer types (by transaction volume - H1 09)



i. Traditional buyers

to present analysis of secondary buyers (see in appendix 2), there

140 buyers with secondary asset acquisition programmes.

nvestment vehicles designed to invest in other funds. In order to

diversify their portfolio and accelerate returns, these funds usually invest a p

in the secondary market. The amount these funds can allocate to secondary

assets (defined in their LPA) has greatly increased over time and is usually about 20%

Dedicated secondary funds: Analysis of buyers in the market, the list of which is in


investing in the secondary market. These firms manage a total of close to $130 billion

dary market47. According to a study by Preqin, the majority of the

managers are from the United States (56%) and from Europe (36%)48.

At the end of 2009 the ten largest fund managers dedicated to the secondary

Secondary Pricing analysis Summer 2009»; 2009

According to the author’s own survey. This percentage is that which they can invest in

there is no requirement to invest in secondary assets, it is a possibility


- 36 -



to present analysis of secondary buyers (see in appendix 2), there currently

nvestment vehicles designed to invest in other funds. In order to

rate returns, these funds usually invest a portion of

se funds can allocate to secondary

assets (defined in their LPA) has greatly increased over time and is usually about 20%46.

nalysis of buyers in the market, the list of which is in


manage a total of close to $130 billion

. According to a study by Preqin, the majority of the

At the end of 2009 the ten largest fund managers dedicated to the secondary market

in secondary assets;


Table 3: The ten largest dedicated fund managers at the end of 2009

Rank Name of the Manager

Secondary funds

managed ($ Billions)

1 Lexington Partners 15.9

2

Goldman Sachs Private Equity

Group 12

3 HarbourVest Partners 10

4 Coller Capital 8.4

5 Credit Suisse Strategic Partners 8.2

6 Landmark Partners 6.7

7 Partners Group 6

8 AlpInvest Partners 5.3

9 AXA Private Equity 5

10 Pantheon Ventures 4.6

TOTAL 82.1


These ten firms manage 64.4% of the dedicated secondary funds.

ii. Non-traditional buyers

According to a study by Cogent Partners, during the first half of 2009 43% of the

investors by volume were non-traditional49.

Non-traditional buyers are considered to be investors that resort opportunistically to the

secondary market. In general, these buyers invest in this asset class in order to diversify their

portfolio or to take advantage of specific opportunities. They usually buy interests in funds

(LP Interest) through straight and opportunistic sales. However, some have investment

programmes dedicated to the secondary market.

49

Cogent Partners; «Secondary Pricing analysis Summer 2009»; 2009


Figure 14: Non-traditional buyer types (H1 09)


1.4.4 Other emerging participants: the private marketplaces

Besides those three groups of main participants, we highlight the ever-growing

presence of private marketplaces. These firms act as intermediaries that bring together

sellers and buyers. On these electronic platforms, interests in funds and direct interests in

private companies can be exchanged. Since they are private these marketplaces are

restricted to Qualified Institutional Buyers (QIBs) by market regulation authorities50. A list of

the main marketplaces for exchanging interests in Private Equity funds is in appendix (1.3).

i. A source of liquidity for limited partners

In these marketplaces, LP interests are transacted between a limited partner (seller)

and a secondary investor. The largest in the segment of LP interest transactions (Private

Equity; Venture Capital, funds of funds and hedge funds) are the firms Secondmarket (c. $2

billion of interests for sale) and Investorflow. According to Mr Bollerman of Secondmarket

(Head of limited partnership interest group) this market segment’s growth is “exceptionally

important”51.

In the USA these marketplaces are deemed Qualified Matching Services (QMS) if they

comply with IRS (Internal Revenue Service) requirements. QMS status gives general partners

the ability to provide additional liquidity to their LPs for trades of their fund interests.

50


See appendix 7.2, which summarizes the call to Secondmarket (1 December 2009)

Pension fund

36%

Insurance

company

17%

Family Office

16%

Endowment

11%

Foundation

11%

GP

9%


Partnerships that utilize QMS can trade an additional 8% of the total amount of the fund

besides the normal 2% each fiscal year without losing the limited partnership status and

associated fiscal advantages52.

ii. A source of liquidity for the fund managers (GPs)

These marketplaces are also a source of liquidity for fund managers (GPs) of Venture

Capital funds (VC) and Leveraged Buyout funds (LBOs) which can sell their fund interests or

direct company interests thus providing an additional exit strategy. The largest marketplaces

for private company stocks are Secondmarket, NYPPEX, Portal Alliances LLC and SharesPost.

These marketplaces typically charge an intermediation fee by of about 3% of the sale price

(adding other costs if this commission does not cover the fixed costs of the platform)53.

According to Daniel Green of Greenpark Capital, one of the key considerations when using

these platforms is confidentiality of information. In confidentiality clauses of many LPAs the

exchange of interests on this type of platform may not be allowed54. Furthermore regulation

on trading in these private marketplaces and the financial viability of the process will govern

the success of these new market participants.

52

See part 3.3.2: Fiscal considerations 53

See appendix 7.2, which summarises the call to Secondmarket (1 December 2009) 54

AltAssets’ web page: www.AltAssets.com; interview with Daniel Green; (Last accessed: 20/10/2009)


1.5. History

According to Wouter Moerel, a partner at AlpInvest Partners, the secondary market

has grown since its beginning due to two main factors55:

� The growth of the primary Private Equity market as the base of the secondary

market.

� The systemic shocks which compel investors in Private Equity (LPs) to sell their

investments for various reasons (liquidity, asset allocation, etc.)

Figure 15: History of the Private Equity secondary market

Source: Author’s own using data from: Dow Jones; UBS (Secondary volume 2009); Private Equity Analyst;

Preqin; Chicago Board Option Exchange.

In light of these two reasons and considering historical volume and volatility in the market

(index VIX) we can highlight three major phases of the secondary market.

55

Wharton Knowledge; «Private Equity Secondary Funds: Are They Players or Opportunistic Investors?»; 9

August 2009. http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009)


1.5.1 The beginning of the market (1982-2002)

Dayton Carr is considered to be the father of the Private Equity secondary market. He

began in the 1970s managing a Venture Capital fund for the president of IBM, Thomas J.

Watson Jr.. At the end of 1979 American President Carter named Thomas Watson Jr. as

Soviet ambassador. At that time Dayton Carr carried out the first known secondary

transaction by buying the fund that he managed and began to sell the interests. “I realized

that entering in a posterior phase, when financial difficulties begin to soften, and with a

discount, could generate returns of about 60%” stated Dayton Carr56.

In 1982, he founded Venture Capital Fund of America (today VCFA Group), the first

investment firm formed to acquire Private Equity interests in the secondary market. In 1984

the VCFA Group created the first dedicated secondary fund in the USA with investor

commitments of $6 million. Later other pioneers such as Stanley Anfeld, founder of

Landmark Partners (1989), and Jeremy Coller, founder of Coller Capital (1990), helped to

develop the market. According to Mr. Wilson, Managing Director at HarbourVest, Private

Equity at that time was “A desert- you could not trade out.”57.

In the beginning it was a niche market and there was no established secondary market.

There only existed the need to exchange interests in the largest and most popular funds58.

There were some isolated transactions and mainly involved one interest in a fund and

generally between the initial investors. In 1998 Coller Capital launched the first global

secondaries fund.

In the year 2000 Coller Capital and Lexington Partners together led the first secondary

transaction with a value larger than $1 billion by buying the Private Equity portfolio of

NatWest following the bank’s takeover by Royal Bank of Scotland. In 2001 the direct

secondary market expanded with the first significant direct (or synthetic) secondary

transaction led by Coller Capital which bought a portfolio of 27 technology companies from

Lucent Technologies59.

56

Arun Natarajan; Web page: http://www.ventureintelligence.in/blog/2008/01/father-of-pe-secondaires.html;

(last accessed; 31 December 2009) 57

BVCA, Arshi Thind; «BVCA Research note: The Private Equity Secondary Market»; 2009 58

Sam Scherwin, Dan Burstein; «Inside the Growing Secondary Market for Venture Capital Assets»; 2007 59

Coller Capital’s web page; http://www.collercapital.com/assets/html/about_coller/coller_secondaries.html;

(last accessed: 5 January 2010)


Figure 16: The beginning of the market (1982-2002)


From the beginning of the market until 2002 the main market driver was growth of the

primary market and only $15 billion was exchanged in the secondary market. It was still a

“cottage industry” 60.

1.5.2 The growth of the market (2003-2007)

At the beginning of this period the market expanded as a result of the systemic

shocks from 2000 to 2001 in which the technology bubble burst and attacks on the twin

towers took place. Investors began to seek an early exit of their unpaid commitments to

Private Equity and in particular to Venture Capital.

During this period many of the large financial institutions (Deutsche Bank, UBS AG, Abbey

National, Bank One, Merrill Lynch, Dresdner Bank, JP Morgan, Bank of America) began selling

large portfolios of interests in Private Equity funds and interests in “pay-to-play” funds used

as a mean to obtain lucrative leveraged finance or merger and acquisition mandates but that

generated losses in the banks’ accounts.

Moreover, growth in the primary market due a period of economic expansion was the main

growth driver of the secondary market. New investors in this asset class were accessing the

secondary market to create portfolios and relationships with GPs61.

During this period the secondary market evolved becoming more efficient and replacing a

market characterised by limited liquidity and highly discounted prices. For the first time in

the history of the Private Equity secondary market assets were exchanged at their net asset

60

Coller Capital’s web page; http://www.collercapital.com/assets/html/about_coller/coller_secondaries.html;

(last accessed: 5 January 2010) 61

Greenpark Capital; «With debt market tightening, what is the likely impact on the primary PE / secondaries

market?»; 2007


value (NAV) or even at a premium (called “secondary bubble” due to the intense

competition for quality assets62) and liquidity greatly increased. Reflecting the increased

issuance in the primary market the secondary market became a portfolio management tool.

This period witnessed a niche market evolve into an active market with broad supply and the

appearance of many specialist participants (buyers or advisers).

1.5.3 The credit crunch (July 2007-2009)

i. The crisis: growth driver in the secondary

Marleen Groen of Greenpark Capital classifies the secondary market as a

“countercyclical”63 market. Since 2007 when the American real estate market collapsed a

new market environment has emerged. The financial crisis that was unleashed and the

infamous “credit crunch” with its disastrous consequences in the real economy have been

catalysts to growth of the secondary market.

The increasing cost of financing of highly leveraged portfolio companies has put the future of

double digit Private Equity returns in doubt. When the financing tap is turned off, the cost of

financing increases and the value of investments64 falls. Opportunities to exit and refinance

investments are severely diminished. At the same time that operational risk is increasing the

financial risk (above all for the LBOs) of Private Equity investments rises; sometimes

dramatically. Funds that invested in 2006-2007 (the maximum in the market) purchased at

high valuation levels and now face many difficulties due to a high level of leverage. Guy Hand

who heads Terra Firma Capital Partners, a large Private Equity investment firm in London,

said during a conference in November 2008 that returns on the trillion dollars invested at

the height of the Private Equity boom in 2006-2007 will be “negative, very negative”65. Many

investors began to reduce their exposure to this asset class by seeking another risk/return

trade-off and this benefited the secondary market. Furthermore, active portfolio

management, the denominator effect, and the lack of liquidity helped push the secondary

market upwards.

Moreover, listed Private Equity funds have suffered from the reduction fund distributions

and financing restrictions. Without access to new financing they have had to sell assets by

resorting to the secondary market66.

62

Greenpark Capital; «With debt market tightening, what is the likely impact on the primary PE / secondaries

market?»; 2007 63

Catherine Craig, Private Equity news; «Contrarian Secondaries firms harvest golden opportunities»; 11/02/08 64

If the discount rate (WACC) of the cash flows increases, the value of the asset falls mechanically 65

Kosman Josh; «The buyout of America» p 129; Penguin; 2009 66

Goldman Sachs Asset Management; «Observations on the Private Equity Secondary Market»; 2009


And finally, financial institutions, some wounded severely during the crisis, have been

growth catalysts in the secondary market. The large bankruptcies and rescues such as those

of Lehman Brothers, Bear Stearns, Merrill Lynch, Citigroup, ABN Amro, Lloyds, HBOS, RBS or

AIG have been a source of acquisition opportunities in the market through the sale of non-

strategic assets such as Private Equity portfolios. Furthermore, the Basel II Accords multiplies

by approximately 2 to 3 the cost to banks of investing in Private Equity67 providing added

impetus for secondary sales.

Figure 17: Changes to LPs’ exposure to secondary funds over the years 2008-2009

Source: Author’s own based on data from Coller Capital; «Global Private Equity Barometer - Winter 2009-

2010»; 2009.

ii. Falling valuation: a buyers’ market

During this period asset valuations have been driven down due impairment of

company fundamentals and valuation multiple contraction but also from the imbalance

between the abundant offers (due to “distressed sellers”) and reduced demand from

investors in the secondary market.

Indeed, according to David Wachter, Managing Director of W Capital Partners, as much as

$200 billion of Private Equity commitments will be offered in the secondary market in the

period 2010-201168 or approximately $100 billion annually. The demand that can be

quantified by existing “dry powder” is only about $40 billion69 (for active buyers: secondary

funds, funds of funds and other investors with programmes dedicated to the secondary

market) at the beginning of 2009. This supply demand imbalance of close to $60 billion will

create a buyers’ market in which asset valuations fall.

67

Greenpark Capital; «Impact of the credit crunch on the secondaries market»; 2008

See section II, part 4.2.2. i. Basel II 68

Dow Jones; «Guide to Secondary Market Buyers»; 2009 69

According to a survey by UBS at the beginning of 2009. UBS PFG; «Secondary capabilities pitchbook»;

October 2009

Increased

34%

No change

33%

Decreased

4%

Not

committed

to

secondary

funds…


In 2008 and 2009 sellers accepted large discounts

The NAV of their investments refers to the last value published by the GP (published ea

quarter). Due to valuation reductions

value of portfolio companies) and their urgent need

accept high discounts.

iii.

t

Uncertainty regarding the

regarding the quality of assets they buy and the pace of transactions

some cases buyers that signed

Adverse Change clause (MAC)

To compensate for risk incurred by this lack of

their investments increases and high

price expectations do not agree and due to the

carried out as demonstrated

transactions in 2008 were not carried out due to low valuations.

Figure 18: Proportion of investors who ruled out transactions in 2008 because of pricing concerns

Source: Author’s own based on data from Triago; «The Secondary Seller's Options»; 2009.

iv.

During the credit crunch, the Private Equity secondary market is perfected. Many

investors in Private Equity now

transactions or direct (synthetic) transactions of entire portfolios. The

such as advisers have develop

structured transactions.

70

See legal considerations, material adverse change clause71

Private Equity Online; «MAC uncertainty grips sellers in secondary market

14%


In 2008 and 2009 sellers accepted large discounts to net asset value (NAV) of sold assets.

The NAV of their investments refers to the last value published by the GP (published ea

reductions from one quarter to another (due to the fall in the

value of portfolio companies) and their urgent need for liquidity, sellers were forced to

iii. The lack of visibility prevents carrying out the

transactions: the bid-offer spread

regarding the economic outlook causes investors to be very selective

the quality of assets they buy and the pace of transactions subsequently fell

some cases buyers that signed a sale agreement withdrew by exercising the Material

Adverse Change clause (MAC)70 abandoning a transaction agreed a few months

o compensate for risk incurred by this lack of economic visibility return

and higher discounts to NAV are offered. Sellers that have higher

do not agree and due to the wider bid/offer spread transactions are not

demonstrated by a study undertaken by Triago indicating

not carried out due to low valuations.

: Proportion of investors who ruled out transactions in 2008 because of pricing concerns


iv. The market is perfected


investors in Private Equity now access the market increasingly making structured

transactions or direct (synthetic) transactions of entire portfolios. The specialist

developed new strategies to create value by means of

See legal considerations, material adverse change clause

MAC uncertainty grips sellers in secondary market»; 03/11/08

86%

Yes

No

- 45 -

net asset value (NAV) of sold assets.

The NAV of their investments refers to the last value published by the GP (published each

from one quarter to another (due to the fall in the

sellers were forced to

The lack of visibility prevents carrying out the

to be very selective

subsequently fell. In

w by exercising the Material

transaction agreed a few months earlier71.

visibility return requirements on

ellers that have higher

bid/offer spread transactions are not

indicating that 86% of

: Proportion of investors who ruled out transactions in 2008 because of pricing concerns



making structured

specialist participants

new strategies to create value by means of complex


2. The transactions on the market: Description of the

different structures and sale processes

2.1. Different types of transactions

In the market transactions are classified into two groups according to the type of

transferred asset; the sale of limited partnership interests and the sale of direct interests.

Figure 19: Two types of secondary transactions: sale of limited partnership interest and direct sale


2.1.1 Sale of limited partnership interests

This type of transaction occurs when an investor in a fund (LP) is willing to sell his

interest or a portfolio of interests to another investor that becomes the new LP. The

distinguishing feature of this type of transaction is that the buyer purchases the funded part

of the fund but also commits to assume the unfunded commitments that the interest

entails.

2.1.2 Direct sale

Previously called synthetic sales, these transactions occur with the sale of a portfolio

company directly by a Private Equity fund to another Private Equity fund. The object of the

sale may be part or all of the interest in a company or in a portfolio of companies directly

held by a fund. The sale can be carried out by creating a special purpose vehicle which will

buy the companies or interests in the companies and use a new manager (GP) hired to


manage and ultimately sell the vehicle’s assets

acquiring the assets with a vehicle managed by specialised direct sales managers.

A GP may also create an annex fund that takes ownership in companies of the other fund. In

times of crisis underlying companies

have the fund resources to back follow

that invest in the portfolio companies with preferred conditions of returns (1.5 to 2 times

the initial investment) and management fees (

If the GP wants to sell direct

sales structures that can be adapted to the manager’s needs.

According to UBS the sales of limited partnership interests,

represent close to two thirds of the total transactions

other third. However, in 2009, direct transactions only represented 15% of total

transactions73.

Figure 20: Transaction volume breakdown

2009)

Source: Author’s own based on UBS data; «Adams Street Secondary Networking Event»; 2010.

2.2. Different sale structures

There exist different structures that allow

portfolio of interests in companies or funds.

72

Wharton Knowledge; «Private Equity Secondary Funds: Are They Players o

August 2009. http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009)73

UBS Private Funds Group; «Adams Street Secondary Networking Event»


manage and ultimately sell the vehicle’s assets72. A sale can also be accomplished


create an annex fund that takes ownership in companies of the other fund. In

times of crisis underlying companies may need additional investment but the GPs

resources to back follow-on investments. Therefore many create annex funds


the initial investment) and management fees (low management fees and carried interest).

If the GP wants to sell direct company interests out of funds managed

adapted to the manager’s needs.

According to UBS the sales of limited partnership interests, by transaction volume, usually

represent close to two thirds of the total transactions while direct transactions represent the


: Transaction volume breakdown – (Limited partnership interest and Direct sale) (2007 to


Different sale structures

There exist different structures that allow finding liquidity for an interest or a

portfolio of interests in companies or funds.

Private Equity Secondary Funds: Are They Players or Opportunistic Investors?»;

August 2009. http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009)

«Adams Street Secondary Networking Event»; 10 February 2010

- 47 -

also be accomplished by


create an annex fund that takes ownership in companies of the other fund. In

nvestment but the GPs may not

on investments. Therefore many create annex funds


low management fees and carried interest).

there are different

transaction volume, usually

direct transactions represent the


(Limited partnership interest and Direct sale) (2007 to


finding liquidity for an interest or a

r Opportunistic Investors?»; 9

; 10 February 2010


Figure 21: Different sale structures in the secondary market


All the structures from the table above can be applied to each type of transaction: sale of a

limited partnership interest or direct sale. The exception is securitisation of the unfunded

which is a structure that can only be applied to the sale of a limited partnership interest

given that it is the only type of transaction that would entail an unfunded commitment.


Figure 22: Comparison of the characteristics of the different sale structures


As can be seen in the table above each sales structure depends on the type of asset sold and

on the objectives and concerns of the different parties. The structures presented in the table

demonstrate there are various options available to satisfy a seller’s requirements.

2.2.1 Straight sale

This sale structure is the most common and widely used. It consists of the straight

sale of an interest or of a portfolio of interests in portfolio companies or funds. In the case of

a sale of a limited partnership interest the seller sells all his interest to the buyer who pays

for the funded part of the fund and commits to assume the unfunded commitments that the

fund’s interest entails. In a direct sale the buyer acquires the entire portfolio company.


Figure 23: Traditional sale structure: straight sale of a limited partnership interest


2.2.2 Strip Sale74

In this structure, the buyer purchases a part of the interest of a fund in one, some or

all the interests of the manager (funds or companies). The buyer selects the funds or

companies in which he wishes to invest and buys part of the interest of the fund in these.

This structure is usually used more for direct sales transactions (of portfolio companies) in

order to generate valuable liquidity to back the manager’s investments in a much less

dilutive manner than by means of an annex fund with preferred return.

However, it can also be accomplished through the sale of limited partnership interests. With

this structure, the manager of the limited partnership interests may reduce his overall

exposure while maintaining close relationships with the underlying fund managers75.

2.2.3 Stapled Secondary

In this structure, the buyer acquires an interest or a portfolio of interests in portfolio

companies or funds combined with an investment commitment in a new fund managed by

the seller. This structure, imposed by the GPs, allows them to facilitate their next

fundraising. This type of transaction also requires the secondary buyer to have the capacity

to fund primary investments.

This transaction structure was very popular in the years 2006-2007 but is infrequently used

in the current environment due to existing supply/demand imbalances in the market.

74

Probitas; «Second thoughts newsletter»; 2009 75

Campbell Lutyens; «The Private Equity Secondaries market: a complete guide to its structure transaction and

performance»; PEIbooks, 2008


Figure 24: Structure of a stapled secondary sale of a portfolio of limited partnership interests


2.2.4 Structured secondary sale76

These structures are innovative and becoming more frequent since they allow sellers

to achieve much more attractive prices than in a traditional transaction. Additionally they

allow carrying out large transactions by offering downside protection. They vary from one

transaction to another but as a general rule the seller establishes a special purpose vehicle

(SPV) with a company specialising in the secondary market (the buyer) to create a single

legal and financial framework that fulfils seller objectives. The vehicle, typically financed by

the buyer, acquires the assets of the seller, who in exchange receives the proceeds of the

sale in cash and an interest in the capital of the new entity.

In order to successfully execute a structured transaction, the seller must determine his most

important objectives– sale price, liquidity, relief of future capital calls, administrative burden

– and suitably structure the variables of the transaction taking into account legal, tax77,

accounting, administrative and regulatory considerations. It is therefore very advisable to

work with an experienced adviser on these structures.

Each structure is tailor-made according to the asset and the objectives and concerns of the

different parties. Therefore, each is unique but some important common variables stand

out.

� Agreement on the shareout of cash flows:

In several structured transactions a cash flow shareout agreement is defined which governs

all future capital calls and distributions of the assets that belong to the NewCo78. Depending

76

See appendix 7.1, which summarises the call to UBS (26 November 2009) 77

The investor may have the chance to use the losses as a tax shield 78

UBS Private Funds Group; «Private Equity Secondary Market Review»; 2009


on the seller’s objectives - liquidity, reduction of risks, relief from capital calls, etc. - the

terms can be highly specific to each structure.

Figure 25: Structured joint-venture sale of a portfolio of limited partnership interests

Source: Adapted from UBS Private Funds Group; «Private Equity Secondary Market Review»; 2009.

For example, if a seller cannot assume large capital calls, the buyer may finance it. In

exchange the buyer receives all the distributions up to 100% of the capital invested. Then,

depending on the asset and the terms of the transaction, he receives the vast majority of the

distributions (between 80% and 90%) until reaching a preferred return of between 1.5 to 2

times his investment. When this return has been exceeded, the distributions change with

the LP receiving the majority of the distributions (between 70% and 90%)79.

� Seller financing or financing by a third party80:

When structuring a transaction the financing variable is crucial. In order to finance the asset

acquisition, the buyer may request financing in order to leverage the acquisition, lower its

financing cost and obtain some downside protection. Besides the loan, he may request a

credit line in order to finance any imbalance that may appear between the capital calls and

distributions.

79

Dow Jones; «Guide to secondary market Intermediaries»; 2009 80

See appendix 7.1, which summarises the call to UBS (26 November 2009)


He may request this financing from a third party or, since credit availability is currently

restricted, from the seller.

2.2.5 Total return Swaps81

These are derivatives contracts designed to swap the cash flows between two

parties. In this structure, a floating interest rate is swapped for all the cash flows of a

portfolio of interests in funds or in companies. The protection buyer keeps the asset but

exchanges the cash flows from the asset (capital calls, follow-on, dividends and distributions)

for a variable interest determined as benchmark + spread. The protection seller receives the

cash flows of the asset but assumes the risk of valuation fluctuations (capital gain and loss).

This derivative contract seeks to transfer the credit and market risk of the underlying asset

to another party that seeks exposure to this asset. It changes the nature of the asset on each

party’s balance sheet but it does not remove it from the balance sheet of the counterparty

seeking to reduce risk.

Figure 26: Total return swaps for a portfolio of limited partnership interests

Source: Author’s own using data from Probitas Partners; «Routes to liquidity»; 2009.

Advantages:

� Maximises the asset price

� Rapid execution (it does not need the GP’s approval)

Drawbacks:

� It does not remove the asset from the “seller’s” balance sheet and does not

generate liquidity upfront (there is no initial payment)

� The contract entails the creation of counterparty risk.

81

Kelly DePonte; Probitas Partners; «Routes to liquidity»; 2009


2.2.6 Securitisation: CFOs

In this structure the buyer acquires the assets via a SPV and later refinances the

acquisition by issuing CFOs (Collateralised Fund Obligations). This structure divides the cash

flows of the asset into strips or tranches that have different payment priorities and different

risk/return profiles82.

Figure 27: Securitisation by means of CFOs

Source: Adapted from Probitas Partners; «Routes to liquidity»; 2009.

2.2.7 Securitisation of the unfunded83

This structure, which can only be used in the sale of limited partnership interests,

divides the interests between the funded and the unfunded commitments. The LP keeps his

funded interest but the unfunded is securitised and sold off. The secondary investor buys

these new securities by creating a special purpose vehicle of which he can become the

manager.

Figure 28: Securitisation of the unfunded


82

Kelly DePonte; Probitas Partners; «Routes to liquidity»; 2009 83

Private Equity Analyst; «Secondary firms cook up new ways to close deals»; 2009


NYPPEX has also developed a certain type of derivative contract called NYPPEX GICCO

(Guaranteed Capital Call Obligation) that acts as insurance. An LP that does not wish to

finance its unfunded commitment can buy a GICCO protection for a defined period of time.

This contract transfers the financing obligation (the unfunded commitments) to the buyer of

the contract who, should the GP make a capital call during the period of the contract,

provides capital funding and in exchange receives a preferred return on the distributions of

about 1.5 to 2.0 times the investment made. For this transaction NYPPEX charges a

commission of close to 2.5% of the unfunded and mostly to the buyer.

This structure developed by Probitas and NYPPEX is very innovative but has not yet been

implemented.

2.2.8 Spin-out

The term spin-out is used in the Private Equity secondary market when the buyer

acquires an entire portfolio of captive assets. Generally buyers are the previous fund

managers alongside a secondary investment firm. The most famous example of this type of

transaction is that of MidOcean Partners which acquired alongside AlpInvest in 2003 the

portfolio of assets that their managers previously managed in Deutsche Bank for €1.3 billion.

One of the most recent is that of the Venture Capital group of Lehman Brothers (Lehman

Brothers Venture Partners) whose management team and HarbourVest bought in January

2009 for an undisclosed amount84 and called the new entity Tenaya Capital. The secondary

investor may or may not include the management team in the transaction.

This sale structure is usually accompanied by a stapled secondary given that the fund

managers wish to secure interests in subsequent funds in order to continue their investment

activity85.

2.2.9 Tail-end

This sale structure refers to the sale of the remaining assets in a fund that is

approaching or has exceeded its expected life. In this type of transaction the GP seeks to sell

the remaining assets of the fund by means of an accelerated traditional sale that preserves

the IRR already achieved by the fund.

84

Harbourvest press release: http://www.harbourvest.com/news_and_events/pressreleases/1029.htm; last

accessed: 10 January 2010 85

Campbell Lutyens; «The Private Equity Secondaries market: a complete guide to its structure transaction and

performance»; PEIbooks, 2008


2.3. The different sale processes86

When selling one or more interests in a fund or funds, or selling a part or all of one or

more portfolio companies, there are different options for accessing the secondary market.

Figure 29: Comparison of the characteristics of the different sale processes

Source: Author’s own; data from Triago; «The secondary seller’s options»; 2009 and Clark, Geoffrey, and

Christopher Kojima; «Opportunities and challenges in Secondaries» Goldman Sachs in The Journal of

Alternative Investment, 74-86; 2003.

2.3.1 GP option: arrange a sale through the manager

This process is only applicable to the sale of limited partnership interests. The LP

contacts the GP to discuss his intention to sell the interest and seeks the manager’s

assistance in finding a buyer. The GP has no obligation to assist the seller in the sale but

usually accepts because in this way he can control who is going to be his new LP after the

sale. Generally the manager attempts to sell to the existing LPs of the fund (or of another of

the manager’s funds) or to other outside “friendly” investors.

The limited competition in this process makes it uncertain that the LP will achieve the best

price for his interest.

2.3.2 Exclusive sale with a secondary buyer

The seller (LP or GP) decides to negotiate with a single potential buyer. This exclusive

process is usually carried out with a buyer with whom the seller already has a good

relationship. It allows the buyer to obtain more information, meet the seller, understand the

reasons for selling, and potentially offer better pricing and a tailored transaction. However,

due to the absence of other alternatives, execution risk is high.

86

Triago; «The secondary seller’s options»; 2009


2.3.3 Open auction

In this process the potential seller organises and manages an auction which is open to

many potential buyers. The selection of the potential buyers is therefore a critical step.

Furthermore, the seller must manage the flow of information efficiently to ensure that the

process is competitive. A typical auction is carried out in two rounds. In the second round

(the short list) two or three buyers are selected to submit binding bids.

Although this process lacks confidentiality and can be very intense, it allows the seller to

receive many bids and make an informed decision on pricing. However, for confidentiality

reasons, it may not be used in a direct sale.

2.3.4 Targeted auction

This process, although very similar to the open auction, has two notable differences:

� It is managed by a secondary adviser

� The name of the seller is unknown to the potential buyers

In this process the secondary adviser targets the auction to a group of selected potential

buyers and in this way increases the chance of maximising the asset price. Furthermore,

confidentiality and anonymity allows the seller cancel the asset sale (if he does not like the

transaction terms) without the market or GP realising the identity of the seller.

2.4. The execution of the transaction

A typical sale process in the secondary market lasts between two weeks87 and three

months and advances through the following stages88:

� Analysis of the assets being sold according to the buyers’ returns expectations.

Verification of the portfolio according to the buyer’s investment criteria89.

Verification of the LPA conditions and of the transferability of the assets.

� Choice of the sale structure and of a suitable process: GP option, exclusivity,

limited or public auction.

� Preparation of due diligence documents and of the transaction: syndication, joint

venture, etc.

87

Web page Financial Planning; «Private Equity gets liquid»; www.financial-planning.com; 2009 88

Carta Diem; «Private Equity Solutions»; 2005

Triago; «The secondary seller’s options»; 2009 89

Moreno-Barberá Participaciones Financieras; «El Mercado secundario de capital riesgo»; January 2006


� The process of due diligence in a secondary transaction is crucial to be able to

evaluate the quality of the fund’s underlying assets, the quality of the GPs, the

existing agreements and to determine a suitable price.

� Selection of the bidder through different secondary buyers in the market.

� Obtaining GP consent for the transaction.

� Assistance and coordination with legal advisers and drafting of contracts.

� Finalising the documents and negotiations.

� Closing of the transaction: signing the contract, payment of the final price and

change of ownership of the assets.

3. Legal and tax considerations

A Private Equity fund entails many legal and tax considerations flowing from the

limited partnership agreement (LPA) which relate to the transferability of the asset. For this

reason, when buying or selling limited partnership interests in the secondary market, it may

be necessary to review all legal documentation prior to a transaction.

3.1. Legal considerations in the revision of the LPA

The LPA or formation agreement of a fund describes the structure and characteristics

of the fund and governs the relationship between the LPs and the GP. It contains the

different rights and obligations of the respective parties and the different operating

conditions of the fund. Additionally, there may be side letters or other such separate

agreements which can clarify or modify terms of the LPA. For this reason, when selling an

interest it is essential to obtain all legal documentation prior to the transaction.

3.1.1 The Consent of the GP90

LPAs generally require the consent of the GP in order to exchange a limited

partnership interest. In some cases the GP cannot reject a transaction as long as it does not

violate LPA terms but in others consent is left to the GP’s discretion.

Usually, the GP does not exercise its veto right given that a secondary sale typically reduces

the default risk of its LPs91. According to a survey by Preqin published in 2009, 94% of

managers say that they have never used their right to veto a secondary sale92.

90

Wilmer Cutler Pickering Hale and Dorr LLP; «Trends in the Private Equity Secondary Market»; 2009 91

See appendix 7.10, which summarizes the meeting with SJberwin (14 December 2009) 92



3.1.2 Pre-emption rights: Right of First Refusal (ROFR)

In some funds (for example those of Blackstone) the LPA contains a right of first

refusal clause. When an LP sells their interest, these clauses oblige the LP to first offer the

interest to the existing LPs in the fund on the same terms as those agreed with the potential

buyer. If this requirement exists, it must be honoured unless the GP waives it (the GP can

waive this clause).

Furthermore, in the case of a direct sale (interest in a company) there may be shareholder

syndication agreements with pre-emption rights. If so, they too must be honoured unless

shareholders waive them. This clause may delay the closing of the transaction.

3.1.3 Legal reporting requirements

In the case of a secondary transaction some LPAs require that a legal opinion

regarding the transfer be rendered to certify the transaction will not contravene a securities

law or tax laws. In practice it is very rare for the GP or his legal counsel to request it93.

3.1.4 Sale notification requirements

The LPA may require prior notification of the sale within a certain time period. In any

case, in order to finalize the sale, the new and previous LP will have to notify the GP of the

transfer. The new LP will have to comply with the GP’s information requirements and

provide necessary information to complete different documents.

3.1.5 Payment of costs incurred by the transaction

The GP may ask the buyer and selling limited partner to pay the costs incurred by the

transaction which is generally limited to the legal fees associated with the Transfer

Agreements. This fee is generally split between the buyer and seller.

3.2. Legal considerations in the negotiation of the Purchase

and Sale Agreement

Once the buyer and the seller agree on price both parties sign a Purchase and Sale

Agreement (PSA). This contractual document specifies the price, subject assets, closing date,

representations and future commitments. Besides the price and subject assets this contract

includes key legal terms of the transaction.

93

VCFA group; «Secondary sales of Private Equity interests»; 2002


3.2.1 The contingent conditions94

These conditions are those that if not fulfilled cancel the agreed contract. They may

be divided into two sections: conditions precedent or those acts that need to happen before

the contract closes, and conditions subsequent or those acts that need to happen after the

contract closes. In a secondary transaction, the normal contingent conditions are the

following:

� Consent of the fund general partner to the transfer

� Satisfaction or waiver of any rights of first refusal

� Waiver of penalties regarding any defaults by the seller (such as a late capital call

payment)

3.2.2 Material Adverse Change clauses95

These clauses allow a buyer to withdraw from a transaction if the fund (mainly

portfolio companies) undergoes substantial changes between the signing and the closing of

the transaction. These clauses can vary from broad coverage to more specific points such as

the resignation of a key manager.

3.2.3 Clawback provisions96

Clawback clauses are provisions included in the LPA that require LPs to refund

distributions due to special conditions. In the PSA it is essential to indicate that if these

clauses are exercised the seller will compensate the buyer by refunding distributions made

prior to the cutoff date.

The parties can also agree on a mechanism to calculate the liability for a clawback of funds

that are not attributable to a particular distribution according to a pro rata share of the

distributions received. The caps in these refund requirements are often heavily negotiated.

3.2.4 Threshold funds97

In a transaction involving a portfolio of fund interests, threshold funds may be

identified. These are funds that must be transferred before having to buy any other funds in

the portfolio. It enables the buyer to acquire only the funds he is focusing on without being

forced to buy less attractive interests.

94

VCFA group; «Secondary sales of Private Equity interests»; 2002 95

Kaye Scholer LLP; «Key legal and transactional issues in secondary Private Equity fund transaction»; 2009 96


Wilmer Cutler Pickering Hale and Dorr LLP; «Trends in the Private Equity Secondary Market»; 2009


When sellers are distressed they may use thresholds in an attempt to obligate buyers

to purchase less attractive assets when acquiring an interest in a high-quality fund.

3.2.5 Indemnifications98

General partners request indemnifications for breaches of covenants,

representations, and warranties in the sale agreement. Buyers and sellers seek to limit these

indemnification requirements. However the seller and the buyer have little room to

negotiate with the GP given that the same must consent to the transaction.

3.2.6 Joint liability: French legal framework99

In France the law considers the seller jointly liable with the buyer for capital calls of

the transacted fund interest (in an FCPR) during the two years after the transaction. This

legal provision requires the parties to reach an agreement on this particular issue when

drafting the PSA.

3.2.7 Stapled transaction clauses100

This clause obliges the buyer to commit to invest in a new fund managed by the same

GP in order to obtain the GP consent of the secondary transaction. Although more popular in

2006-2007 it has become less common today due to the supply/demand imbalance in the

market.

3.3. Tax considerations101

Besides the LPA, each secondary sale must comply with the taxation regime of the

country for which it is considered resident. The parties must determine the sale does not

alter the fund’s tax status or its exemption from registration requirements.

3.3.1 Taxation of Private Equity funds

In most jurisdictions, Private equity funds (PEF) are subject to favourable regulatory

treatment that exempts them from paying tax on dividends received from portfolio

companies or capital gains generated from the sale of companies (elimination of the entity-

level tax). Typically capital gains and losses and net operating income or loss is taxed in the

hands of the LP.

98


Private Equity magazine; «L’envol du secondaire»; August 2008 100


Dow Jones; «Guide to secondary market buyers»; 2009


3.3.2 The United States: the 2% law102

In the USA, under IRS regulation (section 1.7704), no more than 2% of a private

partnership’s capital commitment can be transferred each fiscal year without the

partnership being considered to be publicly traded. Should this rule be broken the

partnership will be deemed a corporation thus losing the benefits of a flow through entity.

i. The Qualified Matching Service

Transactions in a fund can only be carried out between qualified investors and limited

partner transfers may only occur among 2% of the fund’s capital commitment unless they

occur via a Qualified Matching Service (QMS). A Qualified Matching Service is approved by

the tax authorities and allows exchanging an additional 8% of the fund’s capital

commitment. A QMS provides management services for a secondary transaction.

In consenting to a transfer, the GP will make sure it complies with tax laws in order to

protect the fund’s fiscal status. For this reason an LP, before initiating a sale of interests,

must verify the volume of transferred interests in the fiscal year to ensure that it complies

with regulation and that the transaction can take place.

ii. Block transaction

A fund may allow a transaction of more than 2% of the fund’s capital commitment if

the transferred interest represents more than 2% thereof.

Other exemptions to this 2% law are applied in some specific cases, such as in the sale of an

interest due to the death of its owner or between family members.

4. The future of the market

4.1. Empirical demonstration: The primary market drives the

secondary

As mentioned in 1.1.3, there seems to be a mathematical relationship between funds

raised in the primary market and transaction volume in the secondary market. In order to

produce future growth predictions, the author has developed a model to identify the

relationship between the two markets.

102

Dow Jones; «Guide to secondary market intermediaries»; 2009


4.1.1 Secondary market projections model103

The model is based on an analysis of historical data between 1995 and 2009

(globally). The analysis focuses on primary fundraising and on transaction volume in the

secondary market. Analysis of these data and the projections model are available in

appendices (8 and 9).

The model analyses the historical relationship between primary fundraising volume and

transaction volume in the secondary market in order to determine a correlation that allows

future estimates to be made.

In order to identify a relationship between the secondary and primary market, primary

commitments most likely to be transacted on the secondary market were determined. The

commitments most likely to be sold are those between three and seven years old being the

most often exchanged in the secondary market. It was assumed that transactions will take

place over the life of the fund with the following probability distribution.

Table 4: Distribution of the transaction probabilities during the life of a fund

Year of the

fund

1 2 3 4 5 6 7 8 9 10 Total

Probability 0% 5% 10% 20% 30% 20% 10% 5% 0% 0% 100%

Year average 0.0 0.1 0.3 0.8 1.5 1.2 0.7 0.4 0.0 0.0 5.0


This distribution hypothesis is designed to target an average fund age of 5-years. This

average transaction age of a fund is justified by historical averages that have fallen over time

(they were previously above 5 years; today they are closer to 4.5 years).

By multiplying the probability percentage by funds raised in the primary market in the

corresponding years, the potential volume of primary commitments that are likely to be sold

in the secondary market can be deduced. This potential transaction volume will be called the

secondary base.

103

Model available in appendix 9. Based on a study by Cogent Partners: «Secondary market model projections»

(2006) and a study by Alex Sao-Wei Lee: «Private Equity secondary funds and their competitive strategies»

(2003)


4.1.2 Historical rela

volume in the secondary market

Upon comparing the historical data of the secondary base with the secondary

transaction volume between 1995 and 2009, two trends stand out:

� From 1995 to 2002, an average of 3.4% of

the secondary market.

� From 2003 to 2009, the last relationship was not maintained; an average of 6.4%

of the secondary base was exchanged.

Since 2009 was an atypical year, the mathematical relationship was not maintaine

the crisis in the financial markets that prevented the natural turnover of primary assets

towards the secondary market

2003-2008 in which 7.2% of the secondary base was exchanged in the

4.1.3 Secondary market transaction volume: 2010

In order to be able to estimate volumes within the next five years, it

that volume raised in the primary market will

2010 and 2013 the primary fundraising

tough year for primary fundraising in Private Equity, it is a conservative hypothesis that

allows factoring the possible

due to new regulations (Basel II, “Volcker Rule”). Based on this fundraising data, the

secondary base is calculated.

Figure 30: Secondary base (in bn$)


0

50

100

150

200

250

300

350

400

2005 2006 2007


Historical relationship between the secondary base and the

volume in the secondary market


transaction volume between 1995 and 2009, two trends stand out:

From 1995 to 2002, an average of 3.4% of the secondary base was exchanged in

the secondary market.

From 2003 to 2009, the last relationship was not maintained; an average of 6.4%

of the secondary base was exchanged.

Since 2009 was an atypical year, the mathematical relationship was not maintaine


market. For this reason it is also interesting to analy

2008 in which 7.2% of the secondary base was exchanged in the secondary market.

Secondary market transaction volume: 2010

In order to be able to estimate volumes within the next five years, it

that volume raised in the primary market will remain constant after 2009; that is between

e primary fundraising volume will be the same as in 2009. Since 2009 was a


allows factoring the possible decline in investment by financial institutions in Private E


(in bn$)

2007 2008 2009 2010E 2011E 2012E 2013E

- 64 -

tionship between the secondary base and the


the secondary base was exchanged in

From 2003 to 2009, the last relationship was not maintained; an average of 6.4%

Since 2009 was an atypical year, the mathematical relationship was not maintained due to


. For this reason it is also interesting to analyze the period

secondary market.

Secondary market transaction volume: 2010-2014E

In order to be able to estimate volumes within the next five years, it was assumed

constant after 2009; that is between

will be the same as in 2009. Since 2009 was a


investment by financial institutions in Private Equity


2013E 2014E


The present downside case assumes a historical turnover rate for the period 1995 to

2009 of 5.6%. This hypothesis is very conservative given that it does not take into account

the new dynamic of the secondary market. It estimates a compound annual growth rate

(CAGR) of 13% in volumes transacted in the secondary market which translates to an

average of $17.5 billion per annum in the next five years.

The base case uses the most recent trend from 2003 to 2009 in which 6.4% of the

secondary base was exchanged in the secondary market. If this trend is confirmed, it is

forecast the market will represent an average of $20 billion per annum during the next five

years. This assumption which represents the base or most realistic case estimates a

compound annual growth rate (CAGR) of 16% in the volumes exchanged on the secondary

market.

The present upside case uses the turnover rate of the assets for the period 2003-

2008. Taking this hypothesis of a 7.2% turnover rate allows taking into account the different

future growth catalysts that have appeared mainly due to the crisis effects (denominator

effect, financial pressure on investors due to a fall in distributions, and acceleration of capital

calls) and the new regulations in force (Basel II, “Volcker Rule”). According to this scenario,

the market will grow 19% per annum (CAGR) and will represent an average of $22.5 billion

per annum of secondary transactions during the next five years.

Figure 31: Estimates of the secondary market transaction volume according to the historical

relationship ($ billions)

Source: Author’s own using data from: Dow Jones; «Guide to Secondary Market Buyers»; 2009 (1996-2008)/

UBS Private Funds Group; «Adams Street Secondary Networking Event»; 2010 (2009)/ Author’s own

projections.

0

5

10

15

20

25

30

2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Downside

case (5.6%)

Base case

(6.4%)

Upside case

(7.2%)

Secondary

transaction

volume


This historical relationship is used by different market participants to estimate secondary

dealflow potential. This relationship relies on the main driver of the secondary market: the

natural turnover of primary assets in the secondary market due to portfolio management,

changes in investment strategy, and need for liquidity.

However, it must be noted that although these projections are based on the existing

relationship of historical data, the model is somewhat limited due to the uncertainty of the

historical data.

In conclusion, this model demonstrates that the primary market has been the historical

driver of the secondary market. This verified relationship allows us to estimate that the

secondary market should witness an average transaction value of between $17.5 and $22.5

billion per annum over the next five years (2010-2014)104.

4.2. Future growth catalysts

As stated, due to the historical relationship and the large volumes raised in the

primary market in the last few years, if the historical relationship is maintained it is forecast

that market transactions will represent an average of between $17.5 and $22.5 billion per

annum during the next five years. But what will be the main catalysts of this growth in the

secondary market?

4.2.1 The “denominator effect”

Since public market valuations fell, the percentage of other assets in portfolios

including Private Equity funds has increased on a relative basis exceeding the asset allocation

constraints of many institutional investors. This phenomenon, known as the “denominator

effect”, has forced many investors to restructure their portfolios leading to the potential for

sale of LP interests105.

According to a survey by Fidequity, at the end of the third quarter of 2009 20% of investors

in Private Equity (except secondary funds and fund-of-funds) were overexposed to the asset

class and may lead to an increase in secondary market opportunities106.

According to a survey by Coller Capital, at the end of 2010 31% of American investors and

15% of European investors forecast having Private Equity commitments higher than their

allocation targets107.

104

Using the estimates of the downside and upside cases of the projections model. 105

Ari Nathanson, Reuters; «LPs rush for exits, overwhelming secondary market»; 15 December 2008,

www.reuters.com (Last accessed: 6 November 2009) 106

Fidequity; «Global Private Equity LP survey – Q3 2009»; 2009 107

Coller Capital; «Global Private Equity Barometer - Winter 2009»; 2009


Figure 32: LPs’ anticipated level of Private Equity commitments at the end of 2010

Source: Author’s own based on data from Coller Capital; «Global Private Equity Barometer - Winter 2009»;

2009.

However, some investors, in order to rebalance their portfolio, have increased their Private

Equity allocation (for example, the pension fund CalSTRS had an allocation of 14.4% of its

portfolio when the threshold for this asset class was only 11%; they finally increased their

allocation limit to 15%108). Other pension funds and insurance companies over-allocated to

this asset class have also forced some GPs to lower their NAVs in order to reduce their total

exposure to this asset class.

Figure 33: Plans to address the over allocation issue

Source: Author’s own based on data from Fidequity; «Global Private Equity LP survey – Q3 2009»; 2009.

108

Preqin; «Global Private Equity review»; 2009

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

North American LPs European LPs Asia-Pacific LPs

Lower than target

allocation

Equal to target

allocation

In excess of target

allocation

0% 20% 40% 60% 80%

Wait and see

Increase allocation

Wait for problem to

correct itself through

"numerator" effect

Consider sale on the

secondary market

Investors in Private

Equity (except

fund-of-funds and

secondary funds)

Fund-of-funds


According to a survey by Fidequity carried out in the third quarter of 2009, only 10% of

investors in Private Equity (except secondary funds and funds of funds) and 22% of the funds

of funds considered accessing the secondary market to solve their over allocation to Private

Equity.

4.2.2 The new requirements of the financial institutions

Banks and other financial institutions are selling more and more Private Equity assets

due to a desire to strengthen their balance sheets in order to comply with the new solvency

ratio requirements and the recently approved Volcker rule. It is estimated on the balance

sheets of the six largest American banks and AIG there is currently more than $130 billion

invested or committed in Private Equity funds for sale109.

i. Basel II

Since the implementation of the new Basel II accords which modify the weighting of

assets, the cost of financing Private Equity investments has been multiplied by

approximately 2.0x to 3.0x110. Private Equity assets weigh between 190% and 400%

(depending on the regulator in each country and on the interpretation of Basel II) of their

NAV more than their unfunded part111. In order to comply with the solvency ratios (CT1, Tier

1, Tier 2) banks have to strengthen their balance sheets by increasing capital resources or

selling assets. Private Equity assets, in addition to being illiquid, have now become expensive

to own for the banks who had generally invested in this asset class as a means to win

business with the funds (“pay-to-play funds”) but have never considered these to be

strategic assets112.

ii. “Volcker Rule”: the 3% rule113

In 2010 regulatory changes will be a key element that will have to be monitored.

President Obama’s bill called the “Volcker Rule” was approved on the 20th of May by the US

senate and became a law on the 21st of July 2010.

Under this rule banks will only be allowed to invest up to three percent of their total Tier 1

capital in alternative investments. This bill could result in the secondary sale of proprietary

investments in Private Equity of many banks. With exposure to be capped at three per cent

109

Sarría, Ignacio; «¿Qué pasa en el mercado “secundario” de capital riesgo?»; 14 April 2009,

www.cotizalia.com; (last accessed: 13 January 2010) 110

Greenpark Capital; «Impact of the credit crunch on the secondaries market»; 2008 111

See appendix 7.13 which summarises the call to Campbell Lutyens (10 March 2010) 112

Hoflich Peter; «The search for liquidity focuses on disposing of illiquid assets»; 4 February 2010;

http://www.theinvestoraudit.com/ (last accessed: 05 de February 2010) 113

Davis Polk & Wardwell LLP; «Senate-House Conference Agrees on Final Volcker Rule»; 25 June 2010


many banks will be forced to sell off Private Equity assets mostly by spinning out their

Private Equity investment group (such as Citigroup did in July 2010) or wait and allow the

funds to harvest their investments and wind-down.

Table 5: Tier 1 capital and 3% cap of five major US banks

Source: Author’s own based on data from Q1 2010 financial statements.

The table above provides an estimate of the capacity the five major US banks have to make

proprietary investments in alternative funds. It demonstrates this limit is likely to force

banks such as Goldman Sachs to divest assets from its Private Equity investments. Also this

could result in Goldman abandoning its Bank holding charter so as to avoid the Volcker rule.

The other aspect of the rule would prevent banks from owning a commitment that

represents more than three per cent of the fund’s total capitalization which will force many

banks to sell part of their holdings in Private Equity funds.

Banks would have two years to comply with this new rule and can qualify for an additional

period of three years. Also, banks can benefit from another five year extension to divest

interests in so-called illiquid funds. Essentially banks may have up to ten years to divest

Private Equity assets.

4.2.3 An increasing pressure on the investors: fall in the

distributions combined with an increase in the capital calls

Historically low distributions combined with increased capital calls will increase the

financial pressure on LPs.

In reaction to the credit crunch merger and acquisition volume decreased and IPO exits have

become challenging due to financial market volatility. Therefore, funds are selling fewer

assets which do not allow them to make significant distributions to their investors.

(in billions) Tier 1 3% of Tier 1

BoFA ML 155 4.7

JP Morgan 131 3.9

Citi 119 3.6

Goldman Sachs 68 2.0

Morgan Stanley 49 1.5


Figure 34: Distributions as a % of NAV

Source: JP Morgan Asset Management; «Secondary Private Equity Discussions»; 2009; Thomson Financial/

VentureXpert.

Economic uncertainty combined with the high volatility of the markets has slowed the pace

of the capital calls. According to a study by Cogent Partners, capital calls in the first quarter

of 2009 represented 24% of those made in the fourth quarter of 2007114.

However since economic indicators are improving GPs are expected to accelerate capital

calls within the coming months which, combined with historically low distributions, will

increase financial pressure on LPs115. According to a study by Fidequity in 2009 more than

80% of traditional and non-traditional investors forecast that GPs were going to increase the

pace of capital calls in the next 12 months116.

114

Cogent Partners; «Cogent Research: First Quarter 2009 Valuation and Cash Flow Analysis»; 2009 115

Permal Capital Management LLC; «Private Equity observations-Golden age of secondaries?»; August 2009 116

Fidequity; «Global Private Equity LP survey – Q3 2009»; 2009


Figure 35: Anticipated changes in capital calls in the next 12 months


According to a survey by Coller Capital it is likely that 10% of LPs will not be able to comply

with their financing requirements within the next two years117 dramatically increasing their

need for liquidity. Therefore, in order to prevent default, these LPs are likely to seek liquidity

by accessing the secondary market118.

4.2.4 The improving economic outlook

After the economic crisis that began in 2007 and following the bankruptcy of Lehman

Brothers, the rescue of many banks and insurance companies gave way to great uncertainty

in the markets. Since March 2009 macroeconomic indicators have improved and the public

markets have rebounded reflecting better economic conditions. Companies can now look

forward to stabilisation or growth. Due to this improved outlook, the net asset value of the

underlying assets is stabilising.

This environment allows for greater optimism regarding investee companies prospects and

their respective valuation reducing the risk of investments in Private Equity (primary and

secondary).

117

Coller Capital; «Global Private Equity Barometer - Summer 2009»; 2009 118

The Boston Consulting Group, Inc.; IESE; «Driving the shakeout in private equity: The role of investors in the

industry’s renaissance»; 2009

0% 20% 40% 60% 80%

Stay the same

Significantly decrease

Moderatly decrease

Significantly increase

Moderatly increase

Non-traditional

Traditional


4.2.5 The bid offer spread is reduced

In 2008-2009, the spread between bid and offer prices prevented many transactions

from being executed. The closing rate for transactions was very low and limited the

transaction volume in the market. This chasm between buyer and seller pricing expectations

prevented many transactions from being carried out in the short term and was the greatest

constraint for the period 2008-2009. According to AlpInvest Partners, only 20% of secondary

investment opportunities which came to market in the second half of 2008 actually

closed119.

In order to understand when this spread can be reduced one must analyze its causes. The

spread has three major explanations:

� The valuation imbalance: This imbalance is attributable to the lag between the

NAV and the market value. When public valuations are falling the value of Private

Equity investments fall as well creating a difference between the real market

valuation and the last published net asset value (NAV) of the fund. This difference is

due to timing (the so-called lag of the NAV120) and the managers’ valuation methods.

Although this gap has been narrowing since the application of rule FAS 157, it

remains an issue.

� The uncertainties of public market and global economic outlook.

� The traditional mechanical imbalance in each market between seller and buyer.

As macroeconomic and market conditions are improving, the outlook for the

portfolio companies improves as do their fundamentals. Buyers reflect the improvement in

the companies’ fundamentals and the reduction in risk by increasing their valuations. When

market valuations increase, the valuation imbalance (1) is reduced. As the outlook improves,

the natural imbalance (2) due to uncertainties in the economic environment is also reduced.

Finally, due to the reduction in distributions and increased capital calls121, financial pressure

increases on sellers, which also reduces the traditional bid/offer spread (3). For all these

reasons, we can see the components of the spread are reduced which subsequently reduces

the bid-offer spread.

According to a survey by Fidequity in 2009, this spread reduced at the end of 2009122 and

will be sufficiently reduced in 2010 to increase deal flow. Indeed, more than 80% of

119


August 2009. http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009) 120

See section III; 3.3.4. The lag of the NAV 121

See 4.2.3. An increasing pressure on the investors: fall in the distributions combined with an increase in the

capital calls 122

See appendix 7.3 and 7.9 which summarise the call to Breslin (2 December 2009) and Campbell Lutyens (10

December 2009)


traditional and non-traditional investors forecast this spread will have fallen enough at the

end of the first half of 2010 to be able to stimulate deal flow123.

Figure 36: Timing of the tightening of the bid/offer spread


The sellers and the fund managers (GPs) must also have realistic pricing expectations

reflecting future value rather than historical market valuations124. Fund managers must

value their investments in a fair manner (fair value) to avoid creating an imbalance between

the valuations. When the spread is reduced, participants will be able to agree on valuations

and deal flow will be able to grow to never-before-seen levels in this market.

4.2.6 A market that is becoming a more important asset class for

investors

Investors are increasingly attracted to this asset class due to its growth and

opportunities. According to a study by Coller Capital, 32% of limited partners intend to

increase their allocation to secondary funds within the next two years125.

123

Fidequity; «Global Private Equity LP survey – Q3 2009»; 2009 124


August 2009. http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009) 125

Coller Capital; «Global Private Equity Barometer - Winter 2009-2010»; 2009

0% 5% 10% 15% 20% 25% 30% 35% 40%

Never

2011 or later

Q4 2010

Q3 2010

Q2 2010

Q1 2010

Q4 2009

Q3 2009

Traditional

Non-traditional


Figure 37: Anticipated changes to LP’s exposure to secondary funds over 2010-2011

Source: Author’s own based on data from Coller Capital; «Global Private Equity Barometer - Winter 2009-

2010»; 2009.

4.3. Ever more structured operations

According to UBS’s secondary advisory team, structured transactions are the subject

of growing interest given current risk aversion126. A well-structured transaction provides

desired liquidity, allows maintaining relationships with GPs, and minimizes accounting

impacts of the transaction. Furthermore, it allows for maximization of transaction value for

the seller without impairing the investor’s returns. However, these sophisticated structures

do require the use of an experienced adviser.

126

UBS Private Funds Group; «Secondary capabilities» (Pitchbook); 2009

Increase

32%

No change

37%

Decrease

5%

No plans to

invest

26%

PART III:

Valuation in the Private

Equity secondary market

III. Valuation in the Private Equity secondary market - 76 -

III. VALUATION IN THE PRIVATE EQUITY SECONDARY MARKET

This section focuses on valuation in the Private Equity secondary market. Given that

transactions of direct interests in portfolio companies are valued according to well

established valuation methods, this section will concentrate on the valuation of limited

partnership interests and intends to provide a reliable guide to valuation in the secondary

market.

1. Historical market valuations

1.1. Transactions: historical valuation

1.1.1 General trend

After an analysis of the available data on secondary market valuations127; it was

decided that data from the secondary advisory firm Cogent Partners’ would be used. Since

2003 Cogent Partners has published an annual, and since 2008 a biannual, analysis of Private

Equity secondary market valuations. These market valuation analysis reports128 are

reference points and provide us with the result of bids that Cogent has received for the

assets that it has placed in the market for its clients. Since this company’s dealflow is the

largest among all the advisers (in terms of number of transactions), the information provided

in these reports allows us to glean an accurate valuation of the market.

The reports provide the average of the best, medium and lowest bids from the first rounds

of received offers. The valuation in relative terms measures the value of the bid in relation

with the asset’s last published NAV129.

127

Analysis in appendix 10. Historical valuations in the secondary market by asset type 128

See Cogent Partners «Secondary Pricing Trends and Analysis» available on Cogent Partners’ website 129

The valuations de the Private Equity portfolios (NAV) are usually published each quarter.


Figure 38: Secondary bids over time (as a % of last fund’s NAV)

Source: Author’s own using data from Cogent Partners pricing analysis (2007-2008-2009-2010).

The figure above portrays the historical trend in the secondary market and the spread in the

different bids. One can clearly see a very large increase in valuations from the first half of

2009 to the first half of 2010 at 79.6% of NAV.

However, this analysis does not take into account the funds’ funding ratios and can

therefore be altered by a change in the mix of the assets placed in the market.

Given that the least funded interests entail greater unfunded commitments for buyers, the

application of a discount on this unfunded part (that must be funded at nominal value)

mathematically entails an even larger discount on the asset’s NAV. In order to overcome this

effect it is necessary to compare the value of the bid plus the unfunded part with the total

value of the exposure to the asset (that is, the value of the last published NAV plus the

unfunded part of the asset)130.

130

Cogent Partners; «Secondary Pricing trends & analysis, January 2010»; 2010

30%

40%

50%

60%

70%

80%

90%

100%

110%

2003 2004 2005 2006 2007 H108 H208 H1 09 H2 09 H1 10

Average

High

Average

Median

Average

Low


Figure 39: Value of the best bid in comparison with the total exposure to the asset (NAV +

unfunded)

Source: Author’s own using data from Cogent Partners pricing analysis (2007-2008-2009).

Given the liquidity squeeze that has affected many institutions since the market downturn in

2007, many institutions have wanted to get rid of the unfunded commitments on their

balance sheets. This has led to many highly unfunded limited partnership interests being

offered in the market.

This analysis removes the effect of the change in the mix of the assets available in the

market. Upon comparing the two analyses in the graph above, we can clearly observe the

effect of the credit crisis that increased the mix of highly unfunded interests sold in the

market.

We can also observe that the recent increase in secondary valuations is not due to a change

in the mix of the assets but rather is based on a real increase in the valuation of the

underlying assets.

Furthermore it may be highlighted that the current valuation slightly exceeds that of 2003

when the market rebounded after the technology bubble burst. Therefore, the current trend

seems to be following the historical trend.

1.1.2 The valuation depends on the type of asset

Depending on economic conditions, each type of asset behaves in a different

manner. It would therefore be important to compare the valuations over time across the

different fund types according to whether they are leveraged buyout funds (LBO), Venture

Capital funds, or other funds investing in real estate, infrastructure or distressed assets.

30%

40%

50%

60%

70%

80%

90%

100%

110%

2003 2004 2005 2006 2007 H108 H208 H1 09 H2 09

% of total

exposure

% of NAV


Figure 40: Historical valuation of the best bids received for each fund type (% of the NAV)

Source: Author’s own using data from Cogent Partners pricing analysis (2007-2008-2009).

Clearly, there is an overall trend in the secondary market. We may also highlight in the graph

above a trend for each type of asset exchanged in the secondary market. This is due to the

fact that underlying assets of each fund evolve differently according to economic cycles.

Valuation of the funds is therefore driven by valuation of the underlying assets.

Although sector specific valuations for the years 2003-2004 are not available, the period

after the technology bubble burst stands out with the low valuation of Venture Capital funds

that reflect the fall in the valuation of these funds’ underlying assets.

Since 2009, the value of leveraged buyout funds has been lower (68.9% of their NAV) than

those of Venture Capital (75.4% of their NAV) due to the impairment of many portfolio

companies in these funds which are highly leveraged and therefore have a high default risk

in difficult economic conditions combined with high refinancing risk.

1.1.3 The valuation depends on the funding ratio

The valuation of an asset in the secondary market largely depends on its funding

ratio. This ratio measures the capital funded by the investors against the total commitment

of the investors in the fund.

Since investors generally do not know in which assets the unfunded commitment is going to

be invested it represents a “blind pool” that conveys an additional risk producing a negative

effect on valuation. Furthermore, since the buyer will have to assume this commitment at its

nominal value if acquiring a fund interest, there tends to be a positive correlation between

the funding ratio and valuations.

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

2005 2006 2007 H108 H208 H1 09 H2 09

LBO

Venture Capital

Others (Real estate,

infrastructure,

distressed)


Table 6: Effect of the funding ratio on the valuation (H1 2009)

Average of the best bids (% of the NAV)

<50% funded >50% funded

LBO 27.2% 42.7%

Venture Capital 51.7% 36.0%

Source: Author’s own using data from Cogent Partners; «Secondary Pricing analysis interim update, summer

2009»; 2009.

The table above demonstrates that leveraged buyout funds follow this correlation unlike

Venture Capital funds. The additional discount applied to mature Venture Capital funds can

be explained in that buyers discount the risk these mature funds will not have enough

capital to fund next rounds of financing if required by their portfolio companies. For this

reason the GPs of these funds will have to invest in these companies from subsequent funds

or may need to raise annex funds that usually have preferred conditions131 and are more

dilutive.

1.1.4 The valuation depends on the vintage year of the fund

As well as depending on the type of asset or on the funding ratio, the valuation of a

fund also depends on its vintage year. After a period of fundraising a fund enters the

investment period which is usually five years. Depending on where in the economic cycle the

fund places investment, it may be investing funds at high or low company valuations which

directly affect its future returns.

In addition, a fund with a more recent vintage year would typically have a larger unfunded

commitment for its investors (or a lower funding ratio) when compared to a fund with an

older vintage year.

131

Cogent Partners; «Secondary Pricing analysis interim update, summer 2009»; 2009


Figure 41: Valuation according to the vintage year of the fund (H1 2009) in % of its NAV

Source: Author’s own based on data from Cogent Partners; «Secondary Pricing analysis interim update,

summer 2009»; 2009; average of the best bids received for all the funds.

Upon analysing the graph above, it highlights the low valuations for the vintage years 2006

to 2008 with 2007 being the lowest (26.1% of the NAV). These valuations may be explained

by the fact that while 2006 vintage funds paid higher multiples for their investee companies

and 2008 vintage funds have a low funding ratio, 2007 is the only vintage year that is

affected by both issues132.

1.2. Listed Private Equity funds

1.2.1 Concept133

Listed Private Equity funds are listed vehicles that allow participation in Private Equity

investments in unlisted companies or in fund portfolios, without needing to invest much

money or be an institutional investor.

There are two broad types of listed Private Equity funds:

� Listed funds that invest directly134: These funds invest directly in companies that

together constitute a Private Equity portfolio. Example: HgCapital.

� Fund of funds135: These funds invest in a portfolio of Private Equity funds that

then invest in companies. Example: Pantheon International Participations.

132

Cogent Partners; «Secondary Pricing analysis interim update, summer 2009»; 2009 133

Listed Private Equity Association; «Eight Steps for analysing Listed Private Equity Companies»; 2009 134

See scheme available in appendix 11.1

43.0%

39.7%

26.1%

41.3%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

2005 and before

2006

2007

2008


There are also hybrid funds such as Graphite Enterprise or Electra Private Equity that invest

directly and indirectly (through Private Equity funds) in companies.

Listed funds that are invested directly are usually managed by an investment firm that may

be related to the listed vehicle (Beteiligungs AG) or not (Standard Life European Private

Equity). In any case, even if the listed vehicle has no ownership interest in its investment

firm, the manager usually has the same name as the listed fund (F&C Private Equity

managed by F&C Asset Management).

1.2.2 Historical trading: a proxy towards the valuation in the

secondary market

Since these listed funds are invested in Private Equity assets, they usually represent a

good proxy for valuation in the secondary market. Upon comparing the trading average of

some listed vehicles with their last published net asset value (NAV) it appears they can be

useful in approximating valuation in the Private Equity secondary market.

Figure 42: Historical trading of the listed Private Equity funds – Premium / (discount) with its NAV

Source: UBS; Thomson Datastream (19 July 2010)136

.

As of the 19th of July 2010, these funds on average were trading at 66.4% of their NAV (that

is, with a 33.6% of discount).

After comparing the historical trend of the trading average of some listed Private Equity

funds to the best bids received in secondary transactions it is apparent there is a very clear

correlation.

135

See scheme available in appendix 11.2 136

The index includes the following listed Private Equity funds: Candover Investment Trust, Dunedin Enterprise

Investment Trust, Electra Private Equity Investment Trust, F&C Private Equity A Trust, F&C Private Equity B

Trust, Graphite Enterprise Trust, HG Capital Trust, Mithras Investment Trust, New Star Private Equity, Northern

Investors Company, Pantheon International Participations, Prelude Trust plc, Private Equity Investors plc,

Standard Life European Private Equity Trust, and SVG Capital.


Figure 43: Comparison between trading of listed Private Equity funds and bids received in the

secondary market

Source: Author’s own using data from UBS and Cogent Partners pricing analysis.

Preqin, a firm that undertakes studies and maintains databases of the secondary market,

developed an algorithm that provides price indications for interests in the market by using

the trading activity of listed Private Equity funds. It has demonstrated a correlation between

trading of these funds and their valuations in the secondary market. However, in order to

accurately estimate the real value of these assets, the following elements need to be

considered: fund type (VC/LBO/ Other), vintage year, GP’s historical returns, fund’s track

record, funding ratio and market effect137.

1.2.3 Limits of comparison with the Private Equity secondary

market138

The use of trading activity of listed Private Equity funds provides an approximation of

value in the secondary market. However, it integrates components that distort its value and

limit the chances of precisely valuing assets in the secondary market.

i. The valuation depends on the underlying asset

The valuation of a limited partnership interest or of a portfolio company depends on

each type of asset according to its investment targets (LBO, VC, Other), funding ratio, vintage

year, management team and the quality of the portfolio’s assets.

137

See appendix 7.4 which summarises the email from Preqin (2 December 2009) 138

See appendix 7.9 which summarises the call with Campbell Lutyens (10 December 2010)

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

2006 2007 H108 H208 H1 09 H2 09 H1 10

Average

highest

bid on the

secondary

market

Listed

Private

Equity

funds


ii. Market effect

The trading of Private Equity funds is distorted by market effects. It is distorted by the

general mood of the market (bearish/bullish) and the effects of more or less liquidity in the

market.

iii. Over-commitment strategies

Listed Private Equity funds, particularly those invested indirectly (funds of funds),

usually employ an over-commitment strategy in the underlying funds. That is, they commit

more money to the underlying funds than they have to finance their capital calls. This

strategy is based on the fact that since not all commitments are called for at the beginning of

the life of a fund investors can attempt to finance future capital calls with distributions from

other funds.

This allows for an increase of the investor’s returns by reducing the negative effect of the

cash drag (negative effect of un-invested money) on returns and by efficiently managing the

investor’s resources. In bullish economic cycles this strategy significantly improves returns.

However, when the pace of distributions falls and capital calls increase it may put the fund in

danger of not fulfilling its obligations due to investor capital call default.

iv. Use of leverage

Listed Private Equity funds are usually leveraged vehicles that allow maximization of

returns in bullish markets but may have the opposite effect in bear markets. This effect,

called leverage effect, can distort the trading value of the fund.

In view of these limitations, the use of trading activity of listed Private Equity funds

may not be an entirely accurate measure of the real value of secondary assets. It does

however allow approximating the general trend of the market.


2. How to theoretically value this asset

When valuing a limited partnership interest there are two valuation methods. The

top-down method consists of applying the current discount/premium present in the

secondary market to the last published NAV of the fund manager. In contrast, the bottom-up

method is based on the intrinsic value of the fund’s underlying assets and values the interest

by discounting its cash flows. The bottom-up method can only be applied if the information

necessary to value the asset is available.

Figure 44: Two valuation methods of the secondary assets

Source: Author’s own using data from Clark, Geoffrey, and Christopher Kojima. «Opportunities and challenges

in Secondaries»; Goldman Sachs in The Journal of Alternative Investment, 74-86; 2003.

2.1. Top-down method

This method focuses on valuing assets using the current market valuation. In the

secondary market this can be done by two main methods:

� Valuation by comparable transactions

� Valuation by the historical trading of listed Private Equity funds

As a traditional valuation using multiples a universe of funds with similar characteristics must

be established. Characteristics would include investment style (VC, LBO, Other), funding

ratio, vintage year, management team track record and fund returns.

2.1.1 The transaction or trading value/NAV ratio

Both methods are based on applying the average existing valuations or the trading

value divided by the most recent value of the asset (NAV) to the net asset value of the asset

that we wish to value.


However, depending on the manager and the LPA, there may be different ways to value the

assets and calculate the NAV. For this reason one must first check that the NAV used in the

valuation reflects the real value of the underlying assets and that they are valued in the

same way as comparable funds.

Currently managers use very similar methods to calculate the NAV of their fund given that

organisations such as the IPEV (International Private Equity and Venture Capital Valuation) in

Europe or the PEIGG (Private Equity Industry Guidelines Group) in the United States have

created Private Equity fund valuation guides which strongly influence the general method to

be followed in calculating the NAV of portfolio assets139.

2.1.2 Comparable transactions method

After having determined the characteristics of the fund to be valued, transactions of

comparable funds in the last quarter are researched in order to compare NAVs for the same

quarter and since NAVs are usually published quarterly.

The ratio of the price paid divided by the NAV of these comparable transactions (Price/NAV)

is determined and this ratio applied to the last published NAV of the fund to be valued.

If an interest in the same fund was exchanged, assuming enough public information, the

ratio is applied in this transaction and corrected for further capital calls or distributions that

have taken place after the transaction.

2.1.3 The valuation method by the trading multiples

After having determined the characteristics of the fund to be valued, listed Private

Equity funds with similar characteristics are researched. The ratio is calculated by dividing

the total value of the fund (market capitalisation + debt) by its last published NAV. This ratio

is then be applied to the last NAV of the fund to be valued.

2.2. Bottom-up method: the valuation model

In this method the value of a limited partnership interest will be determined by using

the fundamental value of the fund’s underlying assets and the fund’s individual

characteristics. These considerations are based on the valuation guidelines developed by the

IPEV140 (International Private Equity and Venture Capital Valuation), theoretical and practical

knowledge, present research, and interviews with market participants. The result is a

valuation model that can be used to value a limited partnership interest in a Private Equity

fund.

139

IPEV; «International Private Equity and Venture Capital Valuation Guidelines»; September 2009 140

IPEV; «International Private Equity and Venture Capital Valuation Guidelines»; September 2009


2.2.1 Structure of the bottom-up valuation method of a fund’s

interest

The bottom-up valuation method consists of the valuing the fund’s interest by

discounting its future cash flows.

Underlying investments and the unfunded commitments are projected over time and a

timing of the fund’s cash flows (capital call, distributions) is assumed. After being projected,

the cash flows are adjusted according to distribution priority or “waterfall” of the fund and

then discounted at the target gross rate of the secondary investor.

Figure 45: Structure of the bottom-up valuation method


This valuation model, used by the majority of secondary market investors, requires flexibility

that allows simulation of different assumptions according to the scenario being analysed

(upside, base, downside).

2.2.2 Valuing the underlying asset

The valuation of a limited partnership interest is based on the collective valuation of

the fund’s underlying assets. The value of underlying investments needs to be projected over

time; that is, how much the investments are worth in each year of the life of the fund. It


basically consists of projecting the value of the assets over time by using growth and

valuation assumptions.

This valuation depends on the type of asset: debt or equity, leveraged buyout, Venture

Capital, real estate, infrastructure etc. This paper does not attempt to explain the valuation

method for each type of underlying asset, but rather for a limited partnership interest. For

this reason, we shall focus more on the valuation of the two most important funds types in

the secondary market: LBO funds and Venture Capital funds.

i. Valuation of investments in leveraged buyouts (LBOs)

Leveraged buyout funds usually have recurring and stable cash flows over time. In

order to value a leveraged investment over time, a projection of the operations of the

company will be made according to growth assumptions. These assumptions must be based

on discussions with the managers if possible and if not then on reasonable inferences about

the sector using public information.

In this valuation model, it is assumed that cash flows serve to repay the debt as projected

over time.

Each year the equity is valued by applying a multiple (EV/EBITDA) to the EBITDA of the

company and deducting the existing net debt. The value of the investment is then calculated

by applying the fund’s ownership percentage.

If the debt financing of the transaction is traded (the company Cortefiel as an example) then

current trading levels141 are considered as they provide insight on how company’s creditors

view the company’s risk profile. If the debt is traded at a deep discount it is inferred that

creditors do not expect to recover all their money and it is also assumed that the value of

the shareholders’ investment has fallen dramatically142.

ii. Valuation of investments in Venture Capital

Venture Capital portfolio companies generally have limited operational track records.

They often do not have steady cash flow generation and are valued in a very particular way

depending on their activity and business model. For example, companies that operate

websites can be valued with multiples such as EV/Number of unique users or EV/Number of

registered users. The investor must analyse the company’s business plan, its strengths and

advantages over its competitors, the quality of the management team and the likelihood of

being diluted in new financing rounds.

141

Loan trading levels can be found on Markit (https://products.markit.com/home/login.jsp) 142

Clark, Geoffrey, and Christopher Kojima; «Opportunities and challenges in Secondaries»; Goldman Sachs in

The Journal of Alternative Investment, 74-86; 2003


If a recent corporate transaction exists that allows us to value the company (financing, share

transaction) then this can be used to value the investment143.

2.2.3 Project the unfunded144

Besides the underlying assets, the acquisition of a limited partnership interest entails

financing commitments. This part, called the unfunded commitment, must be projected over

time in order to estimate its potential returns to value the limited partnership interest.

The unfunded can be invested in two ways:

• Follow-on investments: The managers reinvest funds in portfolio companies. The

projection of these investments is similar to the projection of the underlying assets

and is fairly objective.

• New investments: The projection of the returns of these investments is much more

subjective and is usually conditioned by the quality of the management team.

The secondary investor usually speaks to the manager about his plans for investing the

unfunded in order to be able to project as precisely as possible the returns that may

reasonably be expected. However if this information cannot be obtained it is usually

projected according to the quality of the fund managers.

i. Evaluate the quality of the management team (GP)

In order to be able to project the returns of the unfunded commitment, the quality of

the managers is key given that they decide on future investments. The quality of a

management team is usually evaluated by examining the previous experience of the

members of the investment team, the track record of their previous funds, and the returns

of current fund. In addition, the risk of that some members of the management team may

leave is usually evaluated (a clause called “Key man clause” can be included in the PSA). Last

but not least the secondary investor needs to assess if the GP plans to raise further funds

since the managers may not be incentivised to achieve high returns in order to facilitate

further fundraising145.

ii. The projection multiples of the unfunded

Discussions with different participants in the market provided insight on the

projection multiples used to project the returns of unfunded commitments over time. These

143

Clark, Geoffrey and Christopher Kojima; «Opportunities and challenges in Secondaries»; Goldman Sachs in

The Journal of Alternative Investment, 74-86; 2003 144

See appendix 7.1 which summarises the call to UBS (26 November 2009) 145

Real Deals; «Secondaries roundtable 2009»; 2009


multiples should be used when available information is not enough to estimate returns

according to a more objective criterion than the quality of the management team. The table

below provides projection multiples for unfunded commitments over time according to the

quality of the management team. However it does not pretend to be exact given that it may

vary by each fund type (VC, LBO, Mezzanine, etc.), size, and average historical returns146 of

the fund type which change over time.

Table 7: Projection multiples of the unfunded according to the quality of the management team

Quality of the management team Good Base Bad

Return multiple 1.7 1.4 1.2

Source: Author’s own based on own survey.

2.2.4 Determine a timing of capital calls/distributions

Once the underlying assets have been valued over time according to different growth

scenarios and the unfunded commitments have been projected, the timing for different

fund’s cash flows then needs to be determined.

If possible, the secondary investor must speak with the fund managers to understand their

capital call/distribution calendar and obtain the most accurate information possible. If it is

not possible to get this information from the GPs a calendar must be estimated. In order to

make a prudent valuation an aggressive calendar of capital calls (managers call for the funds

very rapidly) and a conservative one for distributions (it takes a bit longer than expected to

sell the companies) is usually followed147.

2.2.5 Aggregate the cash flows in the fund’s waterfall

Once the underlying assets have been valued over time according to different growth

scenarios and unfunded commitments projected throughout the life of the fund, it is

necessary to aggregate the different cash flows in the waterfall. That is, one has to add all

the cash flows of capital calls and distributions of cash in the accounting structure of the

fund according to the previously determined timing.

This structure, called waterfall, simulates the capital calls and distributions within the fund’s

vehicle. Basically, the capital calls are cash inflows throughout the investment period and the

distributions are cash outflows during the distribution period. The fund will also have

management costs that will be integrated into its structure.

146

The historical returns usually come from databases such as Venture Expert 147

Cogent Partners; «Pricing private equity secondary transactions» 22 July 2002; www.altassets.com (last

accessed: 26 January 2010)


i. Capital calls

During the investment period, usually the first 5 years of the fund’s life, the fund

managers will gradually call for the capital committed by the investors every time they find

an investment opportunity. They will also call for capital in order to cover fund

administration and management costs. Until distributions outweigh the necessary capital

calls, they will keep calling on investors. GPs may call for less than what was originally

committed by the investors (because they cannot find investment opportunities) but cannot

call for more unless the investors agree.

ii. Fund management costs

Throughout its life, the fund must assume costs that are detailed and explained in the

LPA. The three largest categories are the following:

• The fund’s annual operating expenses

The determination of costs covered by the fund is completed by examining its LPA. They

usually seek to cover the basic administrative costs of the fund: administrative staff,

accountancy, tax and legal advice, travel costs, communications, etc.

• The fund management fees148

Management fees are defined in the LPA. They usually represent 2% of the assets under

management. This management fee usually evolves throughout the life of the fund.

During the investment period, the management fees are usually 2% and are calculated on

the total amount committed to the fund until the deployed capital reaches a pre-determined

threshold. The logic is that since the managers do not manage many assets, given that they

have not called for all the commitments, but are actively looking for investment

opportunities, they are remunerated for their work according to the total amount

committed to the fund.

During the distribution period, GPs do not have to seek further investment opportunities

and therefore it is assumed that their management fee must fall according to the

distributions. For this reason, during this period, the management fees usually fall to 1.5%

and are based off the aggregate cost of the portfolio companies, which is reduced with each

distribution.

• The management fees of the portfolio companies:

The general partner also charges the portfolio companies consulting fees. This fee may be

fixed or indexed on an indicator (sales, EBIT). The fund receives the commission (inflow) and

148

Tuck School of Business - Center for Private Equity and Entrepreneurship; «Note on limited partnership

agreements»; 2003


usually shares it between the general partner and the LPs (“management fee offset”). The

allocation of the fee is usually 80/20, that is LPs receive 80% and GPs 20%. Currently, this

consulting fee is controversial and moving more and more towards the return of all of this

fee revenue to the LPs.

The key for determining the costs of a fund is to analyse the fund’s documentation (LPA).

This provides a better understanding of future costs and allows for a more accurate

projection of the fund’s future cash flows.

iii. The waterfall

Once the fund has been fully invested, it seeks to sell its investments during the

distribution period in order to distribute sales proceeds to its LPs. The structure of the

distributions (the waterfall) between the managers and the investors is unique to each fund

and defined in the LPA. However Private Equity funds usually have a similar structure and

allocation of the distributions.

There are two distribution models: the American model, which divides the distributions on a

deal by deal basis and the European model, which divides the distributions on the total of all

distributions. This paper explains the European model of the waterfalls.

The European model of distributions operates as follows:

1. Repayment of the principal of the investment and of the costs borne by the LPs.

Once the investor has recovered his investment then distributions are divided out between

the fund manager and the investor. The allocation is usually on a 20/80 basis however it

varies according to the type of assets managed (VC, LBO, funds of funds, etc.) and according

to the quality of the management team. The part the manager receives is called carried

interest.

2. The investor’s hurdle rate is a minimum preferred return that the investor is

promised in the LPA. It is usually 8% per annum. Therefore, the investor will receive 100% of

distributions until an IRR of 8% on investment has been provided for.

3. The GP catch-up is a part of the carried interest that the manager receives once the

hurdle rate has been paid. The manager then receives 100% of distributions until reaching

the agreed upon allocation of the distributions defined by the carried interest (20/80) with

the investors. If the carried interest is 20/80, he will receive 20% of the hurdle; that is:

Catch up = Total hurdle ×��Carried interest rateHurdle rate 1 − Carried interest rateHurdle rate

��


4. Other distributions: The distributions that exceed the combined investor hurdle rate

and GP catch up are then allocated between the manager and the investors by following the

LPA defined allocation of the carried interest (usually 80/20). That is, 80% of the remaining

distributions go to the LP and 20% to the GP.

This division of distributions pays investors and the manager on an 80/20 basis in a specific

order that allows the investors to achieve a minimum return first and to provide incentive

for the managers to achieve good returns.

It is essential to thoroughly understand the allocation of fund distributions that are being

valued in order to project the cash flows the investor will receive.

Table 8: Cash flows of the fund and distributions - Waterfall

Fund’s cash flow

- Investment costs

- Annual operating cost of the fund

- Management fee

= Capital funded for the investments and costs

+ Distributions

= Cash available for distributions to investors

- Repayment of the principal

- Hurdle rate

= Cash post hurdle

- GP Catch up

= Cash post Hurdle and GP Catch up available for distribution

- Carried Interest for GP

= Distributions to investors


2.2.6 Discount the cash flows by the cost of capital

In this part the limited partnership interest is valued by discounting the cash flows

specific to the secondary investor (capital calls of the unfunded part, distributions) at a

discount rate.

The rate used to discount the cash flows depends on the gross returns that the secondary

buyer desires. This rate changes over time according to economic conditions and perceived

risk (operating and financial) but also depends on the buyer’s cost of capital. If the buyer is a

secondary fund its cost of capital will depend on returns committed to its investors.


According to the survey held with different market participants, at the end of 2009 and the

beginning of 2010 this discount rate was about 20% (IRR). The asset’s present value (NPV) is

calculated by discounting the cash flows at the discount rate. Upon multiplying this value by

the percentage of the fund’s interest (% of fund’s interest = Commitment of the

interest/Total amount of the fund) the value of the interest is derived. This value will be the

maximum price that may be offered in order to achieve the return rate sought.

2.2.7 Sensitivity valuation analysis

At the end of the valuation process a sensitivity test to different key variables is

conducted. The aim is to determine the valuation range that can be offered for the asset

according to different scenarios.

The key variables in the sensitivity analysis are the growth scenario figures, valuation

multiples of the portfolio companies, the quality of the management team, and the timing of

capital calls and distributions.


3. Real world valuation: empirical contrast of the two

methods

This section applies the theoretical valuation fundamentals developed in the previous

sections to a real world case. A limited partnership interest is valued by applying the two

methods in order to contrast the results and to determine the optimum method of valuing

secondary assets.

In this case, the fund is a €40 million European leveraged buyout fund (LBO). The fund began

to invest on 1 June 2008 and has invested in 4 companies to date. It is 30% funded so the

interest comes with a large unfunded commitment. The GPs are of high quality given their

track record is in the top IRR quartile of LBO funds. The interest analysed involves a

commitment of €2 million. The fund’s last NAV, published on 31 December 2009 is

€10,879,000.

3.1. Top-down method: market valuation

This 2008 LBO fund has a 30% funding ratio and a quality management team. To find

the market valuation it is necessary to find valuations of transactions of funds that have the

same characteristics. Secondary market specialists use databases which contain the latest

transactions with basic characteristics listed in order to follow the valuations of each fund

type in the market.

In this case the most up-to-date available valuations of high quality LBO funds in the

secondary market will be applied. However, we do not have enough updated data to be able

to include the funding ratio in this analysis of the valuation. The funding ratio may have a

negative effect on market value and therefore the value of the fund interest from this

analysis may be higher than that existing in the market.

According to Cogent Partners, at the end of the first half of 2010, leveraged buyout funds

were traded on average at 86.4% of their NAV. Upon applying this discount to the last

published NAV, the value of the present interest will be €469,973.

Table 9: Top-down valuation of a limited partnership interest


Market value of the interest € 000

Total fund amount (nominal value) 40,000

Commitment of the interest (5%) at nominal value 2,000

Last published NAV 10,879

Current market pricing 86.4%

Value of the fund in the market 9,399

Market value of the interest (5%) 470


Due to the limitations of the valuation as a result of using the trading activity of listed Private

Equity funds, this method will not be used to value the interest. However, the current

valuation of listed funds being 66.4% of the NAV (as of 19 July 2010), the value would be

slightly inferior to the one achieved with the comparable transaction method.

3.2. Bottom-up method: valuation using the model149

This method, which requires the use of the valuation model developed with different

market experts, needs much more information than the top-down method. However, due to

the flexibility of the developed model, the valuation of a limited partnership interest is very

straightforward150.

3.2.1 Introduce the fund’s financial data and growth estimates

The fund’s last report is used to gather the financial data necessary to project and

value the portfolio companies. These data are introduced into the valuation model.

It is first necessary to know the basic characteristics of the fund: date of creation, cost

structure, total amount, commitment of the interest, funded commitment, last published

NAV and other required details. This information can be found in the LPA and in the last fund

report. Talking to the GPs can be a huge advantage in that it allows having more accurate

information on future investment plans and the state of the portfolio companies and their

growth outlook.

149

Private and confidential, this valuation model is available upon request to Arnaud van Tichelen:

[email protected] 150

It is only necessary to introduce the data into the grey cells in the hypothesis tab and then sensitise the sale

price of the interest in the tab “command table” in order to stress the returns to the sale price, the quality of

the manager and the different scenarios (upside, base, downside).


Table 10: Main characteristics of the fund


After entering the main characteristics of the fund (table 10), the financial data of the

portfolio companies and their growth assumptions must be introduced following 3 different

scenarios (downside, base, upside).

For the present analysis, we have used the financial data published in the last fund’s report

of the four portfolio companies. In this part we only present the analysis and the valuation of

Company A, however it has been done for the four portfolio companies of the fund.

The data has been projected using growth assumptions based on the managers’

expectations and on the growth rates of the sector of each company (table 11). We have

assumed that only maintenance investments (CAPEX) will be made in the portfolio

companies and that it will equal depreciation for each year. For all the companies, three

growth scenarios were developed to be able to sensitise the valuation to different cases. The

valuation multiple (“exit multiple” in the table) used in the different scenarios is the one paid

by the fund to invest in the company +/- 0.5 according to the scenario (upside/downside).

KEY ASSUMPTIONS (€000)

Investment period

Creation date of the fund 01/06/2008 Capital already commited 12.000

Next Year end of the fund 31/05/2010 Remaining investment years 3

Year

Management fees during commitment period 2,00% 1 33,3% of unfunded 9.333

Management fees post commitment period 1,50% 2 33,3% of unfunded 9.333

GP Carried interest 20,0% 3 33,3% of unfunded 9.333

Prefered return hurdle 8,0%

GP Carry catch up 100,0% Investment holding period (Years) 4

Years to liquidation 7

Total fund size (committed capital at nominal value) 40.000 Annual partnership Expenses 150,0

% of committed capital expected to be called for investments 100% Annual assumed director's fees, 500,0

Investor commitment (nominal value) 5% 2.000 transaction fees, investment banking fees,

break-up fees, advisory fees,

Invested capital 10.413 monitoring fees, or other similar fees

Other Capital calls to pay expenses 1.587 Fee income offset 80,0%

Total called capital 12.000 Charge on management fee 4,0%

Funding ratio 30,0% Charge on capital already commited 5,0%

Unfunded commitment 28.000

Last Euribor (1y) 1,30%


Table 11: Financial data and growth hypotheses of a portfolio company


COMPANY A (€000)

Acquisition date 30/10/2008 Exit multiple 5.11 Spread debt 4.0%

Next Year end 30/10/2010 Upside 5.61 Implied Cost of debt 5.3%

Fund's Share (%) 60.0% Base 5.11 Tax rate 35.0%

Total Investment 3,000 Downside 4.61

Last NAV reported 3,128

Total net debt (last released) 7,322

Key financial inputs 30/10/2008 30/10/2009 30/10/2010 30/10/2011 30/10/2012 30/10/2013 30/10/2014 30/10/2015 30/10/2016 30/10/2017

Sales 10,014 8,848 8,317 8,151 8,151 8,314 8,564 8,820 9,085 9,358

% growth - -11.6% -6.0% -2.0% 0.0% 2.0% 3.0% 3.0% 3.0% 3.0%

Upside NA NA -6.0% -2.0% 2.0% 4.0% 5.0% 5.0% 5.0% 5.0%

Base NA NA -6.0% -2.0% 0.0% 2.0% 3.0% 3.0% 3.0% 3.0%

Downside NA NA -10.0% -8.0% -6.0% -4.0% -2.0% 0.0% 0.0% 0.0%

EBITDA Margin 3,197 2,468 2,345.5 2,298.6 2,298.6 2,344.6 2,414.9 2,487.4 2,562.0 2,638.9

% margin 31.9% 27.9% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2%

Upside NA NA 28.5% 28.8% 29.1% 29.4% 29.7% 30.0% 30.3% 30.6%

Base NA NA 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2%

Downside NA NA 27.8% 27.6% 27.4% 27.2% 27.0% 26.8% 26.6% 26.4%

Depreciation/Amortization (implied) 280 239 225 220 220 224 231 238 245 253

Exceptionnal Items - - - - - - - - - -

EBIT Margin 2,917 2,230 2,121.0 2,078.5 2,078.5 2,120.1 2,183.7 2,249.2 2,316.7 2,386.2

% margin 29.1% 25.2% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5%

Upside NA NA 26.0% 26.3% 26.6% 26.9% 27.2% 27.5% 27.8% 28.1%

Base NA NA 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5%

Downside NA NA 25.2% 25.1% 25.0% 24.9% 24.8% 24.7% 24.6% 24.5%

CAPEX - - 224.6 220.1 220.1 224.5 231.2 238.2 245.3 252.7

Capex as a % of depreciation 0% 0% 100% 100% 100% 100% 100% 100% 100% 100%

Net Working Capital 1,001.4 876.0 815.1 790.7 782.5 789.8 805.0 820.3 835.8 851.5

Working capital (as a % of sales) 10.0% 9.9% 9.8% 9.7% 9.6% 9.5% 9.4% 9.3% 9.2% 9.1%

Change in working capital - (125.4) (60.9) (24.5) (8.2) 7.3 15.1 15.3 15.5 15.7

Pension funds and liablities - - - - - - - - - -

Exit multipleTransaction details Other assumptions


3.2.2 The analysis and the valuation of the portfolio companies

After entering the company data into the hypothesis tab, each portfolio company is

valued. In this case, the portfolio companies are valued by using a leveraged buyout

valuation model.

First a profit and loss account is created and projected following the case being analysed

(downside/base/upside) in order to be able to project and analyse the company’s cash flows:

table 12.

Then repayment of debt is projected using the operational cash flow to repay outstanding

debt. The enterprise value of the company is then calculated using an EV/EBITDA multiple.

By deducting the net debt, we can value the equity of the company over the life of the fund.

In order to value the investment the ownership percentage of the fund is applied to the

equity value of the company.

Finally the exit of the investment is projected according to the timing assumptions (table 10)

of distributions151 and returns are calculated: table 13.

This analysis of the underlying companies allows us to project their value over the life of the

fund according to different scenarios and to estimate the distributions they may generate.

151

Depends on the investment holding period (“Investment holding period” in the model), which is usually

about four years


Table 12: Analysis and projection of the operating data of a portfolio company (base case)


COMPANY AScenario Base

Next year end (Accounting) 30/10/2010

Exit Year 30/10/2012

Date 30/10/2008 30/10/2009 30/10/2010 30/10/2011 30/10/2012 30/10/2013 30/10/2014 30/10/2015 30/10/2016 30/10/2017

Year>>>>> 1 2 3 4 5 6 7 8

Profit & Loss (€000)

Sales 10,014 8,848 8,317 8,151 8,151 8,314 8,564 8,820 9,085 9,358

% Growth - -11.6% -6.0% -2.0% 0.0% 2.0% 3.0% 3.0% 3.0% 3.0%

EBITDA 3,197 2,468 2,346 2,299 2,299 2,345 2,415 2,487 2,562 2,639

% margin 31.9% 27.9% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2% 28.2%

Depreciation/Amortization 280 239 225 220 220 224 231 238 245 253

Exceptional - - - - - - - - - -

EBIT 2,917 2,230 2,121 2,079 2,079 2,120 2,184 2,249 2,317 2,386

% margin 29.1% 25.2% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5% 25.5%

Interests - - 388 325 263 200 135 65 - -

-

PBT - - 1,733 1,753 1,815 1,920 2,049 2,184 2,317 2,386

Taxes - - 607 614 635 672 717 764 811 835

-

Net Income - - 1,126 1,140 1,180 1,248 1,332 1,420 1,506 1,551

Cash Flows (€000)

Net Income 1,126.4 1,139.7 1,179.8 1,247.8 1,331.8 1,419.8 1,505.9 1,551.0

+ Depreciation/Amortization 224.6 220.1 220.1 224.5 231.2 238.2 245.3 252.7

- Change in Working Capital 60.9 24.5 8.2 (7.3) (15.1) (15.3) (15.5) (15.7)

- CAPEX (224.6) (220.1) (220.1) (224.5) (231.2) (238.2) (245.3) (252.7)

- Exceptional - - - - - - - -

= Cash flow for debt repayment 1,187.2 1,164.2 1,188.0 1,240.4 1,316.7 1,404.4 1,490.3 1,535.3


Table 13: Projection of the debt repayment and valuation of the investment


Debt repayment and interests (€000) 30/10/2008 30/10/2009 30/10/2010 30/10/2011 30/10/2012 30/10/2013 30/10/2014 30/10/2015 30/10/2016 30/10/2017

Opening net debt Opening 7,322 6,135 4,971 3,783 2,542 1,226 - -

-Cash flow for debt repayment 1,187 1,164 1,188 1,240 1,317 1,226 - -

=Closing debt 7,322 6,135 4,971 3,783 2,542 1,226 - - -

Interests 388 325 263 200 135 65 - -

Investment value (€000) 30/10/2008 30/10/2009 30/10/2010 30/10/2011 30/10/2012 30/10/2013 30/10/2014 30/10/2015 30/10/2016 30/10/2017

EBITDA 2,468.2 2,345.5 2,298.6 2,298.6 2,344.6 2,414.9 2,487.4 2,562.0 2,638.9

Exit multiple 5.11 5.11 5.11 5.11 5.11 5.11 5.11 5.11 5.11

Enterprise Value 12,612.7 11,985.7 11,746.0 11,746.0 11,980.9 12,340.3 12,710.5 13,091.8 13,484.6

Net debt 7,322.3 6,135.0 4,970.9 3,782.9 2,542.5 1,225.8 - - -

Pensions funds and other liabilities - - - - - - - - -

Equity Value 5,290 5,851 6,775 7,963 9,438 11,114 12,711 13,092 13,485

Investment Returns (€000) 30/10/2008 30/10/2009 30/10/2010 30/10/2011 30/10/2012 30/10/2013 30/10/2014 30/10/2015 30/10/2016 30/10/2017

Fund's Share (%) 60%

Investment date 30/10/2012

Initial investment 3000

Market value 3,174 3,510 4,065 4,778 5,663 6,669 7,626 7,855 8,091

Cash Flows 3,000- - - - 4,778 - - - - -

Expected IRR 12.3%

Return multiple 1.6


3.2.3 Adding of the cash flows in the waterfall of the fund

After having valued the underlying companies, it is necessary to add all the cash flows

from the capital calls and distributions in the waterfall of the fund. The cash flows of the

underlying investments are added together with the costs and distribution structure of the

fund in order to calculate the total cash flows of the fund.

First, the different cash flows from the investments and distributions are added together,

but so too is the projection of the unfunded part of the fund: table 14.

The different costs of the fund are then calculated. If there are not enough distributions to

cover these costs, they will have to be funded by the LPs. In the opposite case, the cash

flows available for distributions are calculated: table 15.

The distributions then pass through the waterfall as previously explained152 (hurdle, catch

up, carried interest): table 16.

After these intermediate steps, the net cash flow available for LPs is calculated. The capital

calls are subtracted from the distributions that the limited partners receive (table 17) and

the net cash flow is calculated in each year of the life of the fund.

Finally, in order to calculate the gross return of the secondary investment, the cash flow of

the acquisition of the limited partnership interest is subtracted153 from the net cash flow

available for LPs: table 18.

152

See 2.2.5. iii. The waterfall 153

The cash flow of the acquisition of the limited partnership interest comes from the tab “Command table”. It

is calculated as if seeking to value the total fund given that it is later multiplied by the percentage of the

interest that we wish to value. Here 5%


Table 14: Cash flows from the fund’s investments


Table 15: Calculation of the costs of the fund


Date 31/05/2010 31/05/2011 31/05/2012 31/05/2013 31/05/2014 31/05/2015 31/05/2016 31/05/2017 - - -

Year>>>>> 0 1 2 3 4 5 6 7 - - -

Cash flows to fund from underlying investments (Year end)

Invested capital 10,413 9,333 9,333 9,333 - - - - - - -

Capital under management after investment period - - 30,150 28,000 18,667 9,333 0 - - -

Distributions - - 14,108 3,939 15,867 15,867 15,867 - - -

Invested capital - - 14,108 3,939 - - - - - -

COMPANY A - - 4,778 - - - - - - -

COMPANY B - - 4,258 - - - - - - -

COMPANY C - - 5,072 - - - - - - -

COMPANY D - - - 3,939 - - - - - -

Unfunded part - - - - 15,867 15,867 15,867 - - -

Year 1 - - - - 15,867 - - - - -

Year 2 - - - - 15,867 - - - -

Year 3 - - - - 15,867 - - -

Year 4 - - - - - - -

Fund income & costs

Distributions from investments - - 14,108 3,939 15,867 15,867 15,867 - - -

Annual partnership expenses (150.0) (150.0) (150.0) (150.0) (150.0) (150.0) (150.0) - - -

Annual management fee (800.0) (800.0) (800.0) (420.0) (280.0) (140.0) (0.0) - - -

Management fee offset (related to portfolio company's fees) 400.0 400.0 400.0 400.0 400.0 400.0 400.0 - - -

Cash available for distribution to LPs (550.0) (550.0) 13,558 3,769 15,837 15,977 16,117 - - -


Table 16: Waterfall of the fund


Table 17: Net cash flows available for LPs


Fund Cash Flows 31/05/2010 31/05/2011 31/05/2012 31/05/2013 31/05/2014 31/05/2015 31/05/2016 31/05/2017 - - -

Capital drawn to fund investment & Expenses 12,000 9,883 9,883 9,333 - - - - - - -

Purchase of investments 10,413 9,333 9,333 9,333 - - - - - - -

Annual Partnership Expenses (150.0) (150.0) (150.0) (150.0) (150.0) (150.0) (150.0) - - -

Annual Management Fee (400.0) (400.0) (400.0) (20.0) 120.0 260.0 400.0 - - -

Distributions from Investments - - 14,108 3,939 15,867 15,867 15,867 - - -

Cash available for LP distributions - - 13,558 3,769 15,837 15,977 16,117 - - -

Repayment of Invested capital - - (13,557.8) (3,768.8) (15,836.7) (7,936.7) - - - -

Repayment of Preferred return to LPs - - - - - (8,039.9) (4,549.7) - - -

Cash available Post Preferred Return to LPs - - - - - 0.0 11,566.9 - - -

GP Catch Up - - - - - (0.0) (3,147.4) - - -

Cash available post Preferred Return and GP Catch Up to LPs - - - - - - 8,419.5 - - -

Carried Interest to GP - - - - - - (1,683.9) - - -

Distribution to LPs - - - - - - (6,735.6) - - -

Total LPs Cashflows

Investment (capital drawn and expenses) (12,000) (9,883) (9,883) (9,333) - - - - - - -

Capital repaid in period (Capital drawn and expenses) - - 13,557.8 3,768.8 15,836.7 7,936.7 - - - -

Repayment of Preferred Return - - - - - 8,039.9 4,549.7 - - -

Distribution to LPs - - - - - - 6,735.6 - - -

Total LPs Flows (12,000) (9,883) (9,883) 4,224 3,769 15,837 15,977 11,285 - - -


Table 18: Determination of the returns of the secondary investor according to the acquisition price


Date 31/05/2010 31/05/2011 31/05/2012 31/05/2013 31/05/2014 31/05/2015 31/05/2016 31/05/2017 - - -

Returns at targeted price

Price paid 4,000

Total secondary investor flow (4,000) (9,883) (9,883) 4,224 3,769 15,837 15,977 11,285 - - -

Implied IRR 20.04%

Capital returns - - - 4,224 3,769 15,837 15,977 11,285 - - -

Capital paid (4,000) (9,883) (9,883) - - - - - - - -

Total return of the operation 2.15


3.2.4 Determination and sensitisation of the price of the limited

partnership interest according to different scenarios

The price payable for the entire fund that we wish to value is then entered.

Depending on the price used and the different scenarios chosen (of growth of the portfolio

companies and of quality of the manager), the gross return on the secondary investment will

be determined. The value of the interest is determined by multiplying the price to be paid

for the whole fund by the percentage of the interest being valued.

Table 19: Determination of the price to be paid according to scenarios and returns


In this case, a base scenario (of growth and valuation of the portfolio companies) and a high-

quality management team have been chosen.

According to present growth assumptions and the timing of capital calls and distributions

applied, the valuation of the fund that allows achieving an IRR of 20% with a multiple higher

than 1.8 times (typical minimum gross returns that secondary investors seek) is €4,000,000.

This values the analysed interest (5%) at €200,000 and represents 36.8% of its last NAV.

The model also analyses the sensitivity of the investment returns to the different key

variables used in this valuation (growth scenario, quality of the manager, and timing of the

investment).

Target returns (€000)

Price willing to pay (for 100% fund) 4,000

Implied price for LP interest 200 Target IRR 20.0% YES

Implied IRR 20.04% Target Multiple return 1.8 YES

Implied Multiple Returns 2.15

% of reported NAV 36.8%

% Discount to NAV 63.2%

Command

Scenario (Growth assumptions & Exit multiple) 2 Investment holding period (Years) 4

Unfunded Multiple

Quality of the GP (trackrecord, info available) 1 Good 1.7

Multiple of return (x) for unfunded 1.7 Base 1.4

Bad 1.2

Does investment at this price reache target?

Base

Good


Table 20: Sensitivity of the returns to the different key variables


Sensitivity to Price and other assumptions

Scenario (IRR) 0.20 3,700 3,800 3,900 4,000 4,100 4,200 4,300

Upside 1 23.4% 23.2% 23.0% 22.9% 22.7% 22.5% 22.4%

Base 2 20.5% 20.4% 20.2% 20.0% 19.9% 19.7% 19.6%

Downside 3 16.0% 15.8% 15.7% 15.6% 15.4% 15.3% 15.2%

Scenario (Returns) 2.15 3,700 3,800 3,900 4,000 4,100 4,200 4,300

Upside 1 2.29 2.28 2.27 2.26 2.25 2.24 2.23

Base 2 2.18 2.17 2.16 2.15 2.14 2.13 2.12

Downside 3 1.94 1.94 1.93 1.92 1.91 1.91 1.90

Quality of the GP 0.20 3,700 3,800 3,900 4,000 4,100 4,200 4,300

Good 1 20.5% 20.4% 20.2% 20.0% 19.9% 19.7% 19.6%

Base 2 17.0% 16.8% 16.7% 16.5% 16.4% 16.2% 16.1%

Bad 3 14.9% 14.7% 14.6% 14.5% 14.3% 14.2% 14.1%

Investment holding period (Years) 0.20 3,700 3,800 3,900 4,000 4,100 4,200 4,300

3 3 28.9% 28.6% 28.4% 28.1% 27.9% 27.6% 27.4%

4 4 20.5% 20.4% 20.2% 20.0% 19.9% 19.7% 19.6%

5 5 16.9% 16.8% 16.7% 16.5% 16.4% 16.3% 16.2%

6 6 14.8% 14.7% 14.6% 14.5% 14.4% 14.4% 14.3%


3.3. Comparison of the results: explanation of the difference

3.3.1 Comparison of the results

By applying the two valuation methods to the same limited partnership interest we

find very different results. The market valuation method (top-down) values the interest at

86.4% of its NAV, although the bottom-up valuation method using the valuation model

values it at 36.8% of its NAV.

Table 21: Contrast of the valuation according to the different methods

Method Top-down Bottom-up

Value of the interest (5%) 469,973 200,000

% of the NAV 86.4% 36.8%


In view of these results, it seems clear that valuation method is very important when buying

(or selling) in the secondary market. But, why is there such a difference between the two

methods and which is more trustworthy?

3.3.2 The concept of NAV is subjective

The top-down method is based on the valuation of the manager. However, although

there are portfolio valuation guidelines, GPs value their portfolio in very different ways.

Some leave the assets at their investment price, other at their market value, and some at the

price of the latest share issuance. The valuation of their portfolios is also very subjective154

given that the manager himself may make very optimistic/pessimistic estimates of the

growth of portfolio companies.

For these reasons, the concept of NAV is very subjective and cannot be used as the base for

the valuation as in the top-down method. It is therefore very advisable, when possible, for a

buyer to make his own valuation of the investments in the portfolio using the bottom-up

method.

3.3.3 Each asset is different

One of the key considerations when choosing a valuation method is the uniqueness

of each asset. Indeed, each asset is different given that it has different underlying assets,

management teams of differing quality, different cost structures, and different allocations of

the distributions. Despite trying to compare similar assets, the top-down method does not

154

“Valuation [of the NAV] remains part science, part art”: Triago; «The secondary seller’s options»; 2009


take into account the singularity of each asset and therefore does not constitute an accurate

valuation method. The only method capable of valuing the intrinsic value of the assets is the

bottom-up method that takes into account all the characteristics of the fund and its

underlying assets.

The following table clearly demonstrates that the assets’ value cannot be generalised given

that for a single type of asset there are significant variations in the valuation according to the

asset being exchanged.

Table 22: Discrepancy in the valuation of the assets (H1 2009)

% of bids on

funds Bids ≤0% of the NAV Bids <20% of the NAV Bids >60% of the NAV

All 7% 17% 13%

LBOs 8% 20% 12%

Venture 4% 17% 13%

Other 5% 5% 21%

Source: Author’s own using data from Cogent Partners; «Secondary Pricing analysis interim update, summer

2009»; 2009.

3.3.4 The lag of the NAV

The top-down method applies the valuations of the market to the last published NAV.

However, there may exist a difference between the last published NAV and the assets’

current market value due to the time that passes between the publication of the NAV and

the valuation of the asset. Since GPs usually take between 1 and 4 months to publish the

NAV of their assets the last NAV available may be up to four months old.

In a bear market valuations fall over time so that is very probable the next NAV will be lower

than the last published. The concept of NAV is very static given that it gives the value of the

asset at the end of each quarter. Although it is not very accurate as a rough proxy to market

value, the performance of a basket of public market comparables can be considered. The

gain or decline in that basket from the day of the last valuation can provide an indication of

how the NAV may have changed155.

However, because the top-down method does not take into account the change in value

between the valuation and the publication of the last NAV, it does not constitute a robust

method to value assets in the secondary market.

155

Cogent Partners; «Pricing private equity secondary transactions» 22 July 2002; www.AltAssets.com (last

accessed: 26 January 2010)


3.3.5 A buyers’ market

In the secondary market there currently exists an imbalance between large supply

and limited demand that negatively impacts valuations.

According to a study by Probitas Partners in February 2010, it was estimated that about $75

billion of assets were being offered on the secondary market156. The imbalance of capital

available to purchase funds in the secondary market minus the transaction volume closed

during the year is the capital overhang, or dry powder. This is calculated in Figure 46 below.

Figure 46: Dry powder in the secondary market in 2010 ($ billions)

Source: Author’s own; data: Dry powder and secondary transactions 2009: UBS Private Funds Group; «Adams

Street Secondary Networking Event»; 2010 – Secondary funds raised in 2009: Preqin; «Private Equity Spotlight

January 2010»; 2010.

Compared to the offerings of some $75 billion, the dry powder of the secondary funds in

2010 is about $50.8 billion. There is therefore an imbalance of some $25 billion that provides

a clear advantage to the buyers, creating a buyers’ market.

However, in view of the forecasts for 2010, it is interesting to compare this same $75 billion

of offerings with the dry powder that is expected in 2011.

156

Probitas Partners; «Adams Street Secondary Networking Event»; 2010

41.4

50.8

(9.1)

18.5

0

10

20

30

40

50

60

Dry powder at the

beginning of 2009

Secondary transaction

volume in 2009

2009 secondary

fundraising

Dry powder at the

beginning of 2010


Figure 47: Estimate of the dry powder in the secondary market in 2011 ($ billions)

Source: Author’s own; data: Dry powder and secondary transactions 2010: Author’s own estimates – Secondary

funds raised in 2010: Probitas Partners; «Adams Street Secondary Networking Event»; 2010.

If we assume that the transaction volume will be about $20 billion (forecast with the model

assuming the base scenario) and that secondary funds raise about $27 billion in 2010

(estimate by Campbell Lutyens157 and Probitas Partners158), it is forecast that dry powder at

the beginning of 2011 will be about $57.8 billion. This represents a $17.2 billion imbalance in

the market. Therefore it is clear that the imbalance in the market will slowly be reduced. The

reduction of this imbalance will gradually end the buyers’ advantage in the market159. A

buyers’ market may change even more rapidly if transaction volume in 2010 is lower than

forecast.

However, due to the imbalance in the secondary market, valuations are distorted from the

real value of the assets and therefore cannot be used to provide an accurate value of an

asset in the secondary market: the inefficiency of the top-down method is once more

demonstrated.

157

See appendix 7.13 which summarises the call to Campbell Lutyens (10 March 2010) 158


See appendix 7.13 which summarises the call to Campbell Lutyens (10 March 2010)

50.857.8

(20)27

0

10

20

30

40

50

60

Dry powder at the

beggining of 2010

2010 Estimated

transaction volume

2010 Estimated

secondary fundraising

Dry powder at the

beginning of 2011


3.3.6 Key valuation method: bottom-up

These explanations of the difference in valuations of a limited partnership interest

when using the two methods clearly demonstrate that the bottom-up method is the most

appropriate method to ascertain the value of assets on the secondary market. Indeed, it is

the only method that allows us to take into account the uniqueness of the assets and the

growth perspectives of each underlying company. Furthermore the bottom-up method

minimizes the valuation distortion attributable to the imbalance between buyers and sellers

in the market and NAV lag.

However when there is not enough information available to make a bottom-up valuation,

the top-down method should be used.

PART IV:

CONCLUSIONS

IV. Conclusions - 114 -

IV. CONCLUSIONS

1. Conclusions

1.1. Analysis of the secondary market: an opportunity for the

Private Equity industry

Analysis of the theoretical characteristics of Private Equity, its history and of current

conditions highlights the growing importance of the secondary market and its crucial role in

the development and maturity of the Private Equity industry.

The existence of a secondary market has a beneficial effect on primary assets. It allows

investors to find liquidity without needing to sell the underlying assets. This liquidity in the

market has many advantages both for LPs and GPs. It supports the investments and prevents

LPs from defaulting thereby building a strong investor base for future funds. Moreover, this

market provides value indication, price discovery, and facilitates future fundraising160.

By reducing the liquidity risk inherent in the Private Equity asset class, investment in Private

Equity is made much more attractive transforming the secondary market into a driver of

growth in the primary market.

In view of the capital raised in 2009, the secondary market is the only segment that grew in

comparison with 2008. Therefore it not only benefited the industry by attracting more

capital by reducing the liquidity risk but also by raising further capital in this growing market

segment.

For all of the reasons mentioned above, it is in the best interest of general partners to

facilitate transactions in their funds and allow limited partners to turnover within their

fund161.

1.2. The future: growth and sophistication

� A constantly growing market

Although 69% of investors hoped that 2009 would be a record year in the secondary

market162, the transaction volume ($9.1 billion in 2009163) has been disappointing due to

160

Campbell Lutyens; «The Private Equity Secondaries market: a complete guide to its structure transaction

and performance»; PEIbooks, 2008 161

Ansbacher, Richard I. and Rosh, Kenneth I. and Neuschatz Zelenka, Rebecca; «Heightened Managers

Concerns for Secondary Transfers»; Fried Frank PEP Talk, 2010 162


UBS Private Funds Group; «Adams Street Secondary Networking Event»; 2010


market circumstances (low valuations, large bid/offer spread, FAS 157, lack of visibility).

However, it seems that 2010 will be the record year that participants in the market have

longed for to prove that it is not a current trend, nor an ephemeral market.

According to the results of the application of the present statistical correlation model, it is

projected that the market may have an average volume of between $17.5 and $22.5 billion

per annum during the next five years (2010-2014) which represents a compound average

growth rate (CAGR) of between 13% and 18.8%.

Regulated financial institutions will be the main sellers in 2010 due to the need to repay

public funds and restructure their balance sheet. Moreover, the cost of financing Private

Equity assets, the need to liquidate “pay to play” funds combined with an increase in

secondary valuations will promote activity in the market.

� An increasingly sophisticated market

The market is becoming increasingly sophisticated and innovative sales structures are

used to better realize all parties’ objectives. This market sophistication is reflected in the

growing importance in the use of an adviser experienced in secondary transactions. In the

medium term it is forecast that there will be more spin-outs164 of captive Private Equity

managers of financial institutions. But there will also be more direct sales of interests in

companies165 as current market conditions necessitates their use to generate valuable

liquidity for managers.

� Monitor regulatory changes

In 2010, regulatory changes will be a key element that will have to be monitored. In the

US the famous “Volcker Rule” limits banks’ proprietary investments and will have a major

impact on Private Equity activity. Although there is a transition period to comply with this

rule many financial institutions are considering selling their Private Equity investment

divisions and holdings. Any change that increases regulatory pressure on financial

institutions’ investments will have a direct effect on the sale of their Private Equity assets in

the secondary market and the spin-out of several captive Private Equity managers.

164


Probitas Partners; «Adams Street Secondary Networking Event»; 2010


1.3. Valuation in the secondary market: trend and method

� Market valuations: a controlled rebound?

After having fallen to 36% of the NAV in the first half of 2009 the market has rebounded.

During the first half of 2010, pricing for limited partnership interests in the secondary market

increased steadily to 80%166 of NAV anticipating an increase in the valuations of LP interests.

However, valuations are expected to halt their increase in the medium term due to the

supply/demand imbalance that acts as a natural ceiling167.

Although we are currently in a buyers’ market due to the supply/demand imbalance its

evolution must be tracked closely. Indeed, this imbalance may be reduced due to volumes

being raised in secondary funds and the large amount of dry powder accumulated by

secondary buyers (“There are a lot of secondary buyers that have a lot to deploy”168 Jeffrey

Bollerman; SecondMarket).

According to a survey by Probitas Partners published in November 2009, 16.4% of investors

fear there is too much dry powder in the secondary market and that it will have a negative

impact on returns169.

� Valuation method for secondary assets: the supremacy of the bottom-up

valuation method

When valuing LPs’ interests in the secondary market, the bottom-up method is the most

appropriate method to ascertain the intrinsic value of the assets. This method, which is

based on analysis and valuation of the underlying assets, allows the investor to produce an

informed valuation and gives him a clear advantage. If he has the resources, experience and

necessary information, he may have more confidence in his valuation and be more

aggressive in his bid because he has a greater chance of achieving his returns170. However,

the top-down method is a good method to approximate valuations and the mood of the

market in the absence of information required for the bottom-up method.

In this context access to information becomes a significant challenge in order to be able to

make a bottom-up valuation and highlights the importance of having strong relationships

with GPs. For this reason successful secondary managers usually have primary capacities

that allow them to have relationships with GPs and get access to the necessary information.

166

See appendix 7.13, which summarises the call to Campbell Lutyens (10 March 2010); Cogent Partners;

«Secondary pricing trends and analysis, July 2010»; 2010 167


Deal Flow Media; «The Distressed Debt Report, Volume VI Nº4»; 2010 169

Probitas Partners ; «Private Equity Market Review and Institutional Investor Survey»; 2009 170

Clark, Geoffrey and Christopher Kojima; «Opportunities and challenges in Secondaries»; Goldman Sachs in

The Journal of Alternative Investment, 74-86; 2003


2. Future research

Being an initial analysis of this segment of Private Equity, some suggestions for future

research are in order.

This dissertation has discussed throughout the Private Equity secondary market but it would

also be useful to study other secondary markets such as those of hedge funds or assets

invested in debt (syndicated loans, private placements, etc.).

In studying the Private Equity industry the funds’ cost structures were examined and this

brought up the tensions currently experienced between GPs and LPs the most significant

being fees. There have been many concerns raised with respect to GP compensation and it

would be interesting to analyse the debate in the context of future fundraising.

Glossary - 118 -

GLOSSARY

Blind pool: investment commitments with no stated investment target. In Private Equity the

unfunded commitment is a blind pool given that the managers’ exact future investments are

unknown.

Bottom-up: information-processing strategy that begins by analysing the individual parts in

order to then analyse larger components. Applied to asset valuation, it consists of analysing

the underlying assets in order to then value the fund.

Capital calls: request from fund managers to draw down a part of the committed capital to

fund an acquisition or funds’ costs.

Carried interest (“Carried”): the share of profits of the fund managers in the capital gains

resulting from the operations carried out by the fund. In Private Equity funds the "carried" is

usually about 20% of the capital gains obtained by the fund.

Cash drag: negative effect caused by cash balances (or money invested in treasury assets) on

the overall return of a portfolio.

Catch up: part of the carried interest that the manager receives once the principal and a

hurdle rate has been paid to LPs. The manager typically receives 100% of the distributions up

to a shareout of the distributions defined by the carried interest (20/80).

Catch up = Total hurdle ×�� !"# !$%" "&% �%"

'( #)" �%" *+�� !"# !$%" "&% �%"'( #)" �%"

��

Clawback provision: clause in the LPA by which the GP can require the LPs to return some

distributions in special circumstances.

Collateralized Fund Obligation (CFO): debt securitization of Private Equity fund or hedge

fund assets.

Covenants: agreements between a company and its creditors that indicate the financial

conditions that the debtor must observe.

Credit crunch: squeeze in the availability of credit that causes the economy to contract.

Deal flow: flow of transactions.

Glossary - 119 -

Denominator effect: in a portfolio when the value of one asset class falls, the percentage

allocation to other assets rises mechanically in the portfolio, exceeding the allocation targets

of the portfolio which then requires re-balancing.

Distressed: an asset or an investor that lacks liquidity to finance short-term commitments.

Dry powder: capital reserves available to invest.

Due diligence: process of auditing financial, legal and tax aspects of a transaction.

EBIT: earnings before interests and taxes. Operating profit.

EBITDA: earnings before interest, taxes, depreciation and amortisation.

Endowment: institution’s investments that seek to cover a part or all the needs of the

institution to which it belongs with its investment returns.

Equity: part of the company that belongs to the shareholders once they have paid their

financial obligations. Asset minus liabilities.

Fair value: amount or value for which an asset may be exchanged between interested and

fully-informed parties.

Family office: a company that offers advisory services to family assets.

Follow-on: is said of an investment when it backs an existing investment.

Funding ratio: ratio of capital funded by investors to the total commitment of investors in

the fund.

Fundraising: activity that consists of raising funds in the market.

General Partners (GPs): Private Equity fund managers.

Hurdle rate: also called preferred return, is the minimum amount of return sought by the

investor. It is usually an Internal Rate of Return (IRR) of 8%. Before this return is earned by

the LP, the fund manager can not receive any share in the capital gains.

Internal Revenue Service (IRS): tax authority in USA.

Key man clause: clause within an agreement that indicates if one or more specific key

named managers stops dedicating a required level of time to the management of a fund, the

investment activity is halted.

Know Your Customer (KYC): due diligence requirement that financial institutions must

perform to identify their client and ascertain relevant information in order to transact

financial business with them. This policy is intended to prevent money laundering and

terrorist financing.

Glossary - 120 -

Lag: a delay caused in a communication. In the case of Private Equity funds, the lag refers to

the delay between the publication of the NAV and the current asset valuation (between 1

and 4 months) that makes the valuation process more difficult.

Limited Partners (LPs): institutions or individuals that contribute capital to a Private Equity

fund.

Limited Partnership Agreement (LPA): formation agreement which sets out in detail legally

binding relations between the LPs and GP (investment policy, profit sharing, fees and

expenses, etc.).

Lock-in performance: process that consists of realizing the existing return on an asset (by

hedging, selling the asset).

Material Adverse Change (MAC): in a sale contract it is a legal provision that allows the

acquirer to withdraw from the transaction if the target suffers a substantial change.

Over-commitment: allocation of resources to an asset class in excess of the capacity.

Pay-to-play funds: funds which the banks had invested as a way to get business with the

Private Equity funds (advisory mandate, leverage) but that have never been a strategic asset.

Pre-emption right: right of first refusal.

Qualified Matching Service: approved management services for secondary transactions by

the tax authorities. The use of a QMS allows exchanging an additional 8% above the

statutory 2% of a fund’s capital commitment in a single fiscal year.

Representations and warranties: statements by which one party gives certain assurances to

the other, and on which the other party may rely.

Right of First Refusal (ROFR): right that gives its holder the option to enter a transaction

with the owner of an asset before the owner can enter into that transaction with a third

party.

Seniority: order of repayment in the event of bankruptcy. In the capital structure, this refers

to the subordination level. When one is more senior it means that it is less subordinated.

Side letter: separate agreement that is used to clarify or modify the terms of a previous

agreement.

Special Purpose Vehicle (SPV): legal entity created to fulfil a temporary and specific

objective. It may be owned by one or more persons.

Spin-out: when a division of a company becomes an independent business. In the secondary

market it is a sale structure in which the buyer acquires an entire portfolio of captive assets.

Stapled secondary: sale structure in which the buyer acquires assets of a fund together with

investment commitments in the next fund of the manager (GP).

Glossary - 121 -

Straight sale: traditional sale structure of one or more interests in funds or companies.

Strip sale: sale structure in which only a part of one or more portfolio companies or interest

in funds are sold.

Tail end: sale structure in which a fund sells its remaining assets.

Top-down: information-processing strategy that analyses the system as a whole without

going into subsystem details. Applied to asset valuation, it consists of analysing market

valuations and applying them to the asset being valued.

Total Return Swap: derivative contract in which two parties swap the cash flows. A floating

interest rate can be exchanged for the cash flows of an asset.

Track record: past performance. In the case of a fund manager, it refers to the past returns

of previously managed funds.

Unfunded: uncalled part of the committed capital.

Venture Capital (VC): Private Equity investment style that invests in the early stages of

companies.

Vintage year: the year in which the fund makes its first investment.

Waterfall: structure of how distributions are shared between the GPs and the LPs. It is

defined in the LPA.

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2009. http://www.cotizalia.com. (last accessed: 13 January 2010).

References - 129 -

- VCFA Group. «Secondary sales of private equity interests.» AltAssets. 18 February 2002.

www.AltAssets.com (last accessed: 14 January 2010).

- Weil, Gotshal & Manges. «Secondary investing in private equity funds: Primary issues for

general partners.» 28 January 2004. www.AltAssets.com (last accessed: 06 February

2010).

- Wharton Knowledge. «Private Equity Secondary Funds: Are They Players or Opportunistic

Investors?» 09 August 2009.

http://knowledge.wharton.upenn.edu/ (last accessed: 20 December 2009).

4. Databases

- Preqin

- Private Equity Analyst

- Venture Expert

- Thomson financial

APPENDIX

Appendix - 131 -

APPENDIX171

1. DATABASE OF THE ADVISERS IN THE PRIVATE EQUITY SECONDARY MARKET133

1.1 Database of the financial advisers ............................................................133

1.2 Database of the legal advisers ....................................................................135

1.3 Database of the private marketplaces .....................................................136

2. DATABASE OF THE BUYERS IN THE PRIVATE EQUITY SECONDARY MARKET137

2.1 Database of the dedicated secondary buyers (LPs interest and

direct) ...................................................................................................................137

2.2 Database of the dedicated secondary buyers (only direct

transactions) ......................................................................................................139

2.3 Database of firms investing part of their funds in the secondary

market...................................................................................................................140

3. REQUEST FOR SPONSORSHIP .......................................................................... 143

4. NEWSLETTER Nº1 ........................................................................................... 144

5. SPONSORS OF THE STUDY AND INTERVIEWS................................................. 146

6. MEETING GUIDELINES..................................................................................... 147

7. SUMMARIES OF CALLS AND MEETINGS .......................................................... 149

7.1 Call with UBS (26 November 2009) .........................................................149

7.2 Call with Secondmarket (01 December 2009) .....................................151

7.3 Call with Breslin AG (02 December 2009) .............................................153

7.4 Email from Preqin (02 December 2009) ................................................155

7.5 Call with Fidequity (03 December 2009) ...............................................157

7.6 Meeting with Altamar (07 December 2009) .........................................159

7.7 Call with Pantheon Ventures (09 December 2009) ...........................161

7.8 Call with Headway Capital (09 December 2009) ................................164

171

Every appendix is available upon request to Arnaud van Tichelen: [email protected]

Appendix - 132 -

7.9 Call with Campbell Lutyens (10 December 2009) ..............................165

7.10 Meeting with SJberwin (14 December 2009) .......................................168

7.11 Call with UBS (02 February 2010) ............................................................170

7.12 Call with HarbourVest Partners (09 March 2010) .............................172

7.13 Call with Campbell Lutyens (10 March 2010)......................................174

7.14 Meeting with Arcano Capital (18 March 2010) ...................................176

8. ANALYSIS OF PUBLISHED HISTORICAL DATA ................................................ 178

8.1 Historical transaction volume in the secondary market ..................178

8.2 Secondary fundraising ...................................................................................180

8.3 Primary fundraising .......................................................................................181

9. SECONDARY MARKET PROJECTION MODEL ................................................... 182

10. HISTORICAL VALUATIONS IN THE PRIVATE EQUITY SECONDARY MARKET186

10.1 LBO funds ...........................................................................................................186

10.2 Venture capital funds .....................................................................................186

10.3 Other funds (real estate- infrastructure- distressed) ........................187

11. STRUCTURE OF LISTED PRIVATE EQUITY FUNDS ......................................... 188

11.1 Structure of listed direct Private Equity fund ......................................188

11.2 Structure of listed indirect Private Equity fund (listed fund of

funds) ....................................................................................................................189

Appendix - 133 -

1. Database of the advisers in the Private Equity secondary market

1.1 Database of the financial advisers

Company Name Position Mail

Almeida Capital Richard Sachar Managing Director [email protected]

Alpha Associates AG Peter Derendinger CEO [email protected]

Altitude Capital Advisory Brett A. Nelson Managing Director [email protected]

Ariane Capital Partners Donald W. Kraftson Managing Director [email protected]

Augusta & Co John Edwards Partner [email protected]

Autumn Capital Partners Matthew Longhurst Partner [email protected]

Axon Partners Andrew Kellett Partner [email protected]

Axonia Partners Alexandre Alfonsi Partner [email protected]

Azla Advisors David Waxman Managing Director [email protected]

Boyd & Co Todd Boyd Managing Partner [email protected]

Bluetower Capital Tim Griggs Managing Partner [email protected]

Breslin AG David Karabelnik CEO [email protected]

Campbell Lutyens Thomas Liaudet Principal [email protected]

Capital Dynamics Olav Koenig Managing Director [email protected]

Capstone Partners David Chamberlain Managing Director [email protected]

Carta Diem Philippe d’Hémery Managing Principal [email protected]

Champlain advisors Terence M. Crikelair Managing Partner [email protected]

Cogent Partners Bernhard Engelien Managing Director [email protected]

Continental Capital Partners Roger Luscombe Managing Partner [email protected]

Credit Suisse Group Mike Custar Director [email protected]

Fidequity Francois Garcin Partner [email protected]

Global Finance Matthias Stanzel Managing Director [email protected]

Greenhill & Co. Patrick S. Dunleavy Managing Director [email protected]

Griffin Private Equity Group Paul Delaney Managing Director [email protected]

Appendix - 134 -

Source: Author’s own- Dow Jones; «Guide to Secondary Market Intermediarie.»; 2009 – Companies websites


Houlihan Lokey Paul Sanabria Managing Director

Lancea Partners Pascal Isbell Partner [email protected]

Lazard

Matrix Group Edward Holdsworth Partner edward.holdsworth@ matrixgroup.co.uk

Mercury Capital Advisors1

Enrique Cuan Managing Partner

MHT Partners Secondary Advisors James Lee Principal [email protected]

Mummert & Company Harald Maehrle Managing Partner [email protected]

Nakatomi Capital Monica Vinje Managing Partner [email protected]

Palomar Corporate Finance Markus Kroll Partner [email protected]

Park Hill Group Lawrence Thuet Managing Principal [email protected]

Patronus Capital Paul Delaney Managing Director [email protected]

plurisvaluation Espen Robak President [email protected]

Preqin Mark O'Hare Managing Director [email protected]

Probitas Partners Kelly DePonte Parner [email protected]

Rainmakers Partners Jim Soleymanlou Managing Partner [email protected]

Richmond Park Partners David Morton Partner [email protected]

Rothschild

Roux Capital Francois Roux Managing Principal [email protected]

Scalar Partners Nick Hatch Vice President [email protected]

Secondcap Francois Gamblin CEO [email protected]

Setter Capital2

Simren Desai Associate [email protected]

Somerset Capital James Miller Managing Partner [email protected]

The Camelot Group International [email protected]

Triago Mathieu Dréan Managing Principal [email protected]

UBS Private funds Group Nicolas Lanel Executive Director [email protected]

1. Spin Out of the Merrill Private Placement team

2. Only Brokerage

Appendix - 135 -

1.2 Database of the legal advisers



SJberwin Nigel van Zyl Partner [email protected]

Goodwin Procter Rufus C. King Partner [email protected]

Wilmer Cutler Pickering Hale and Dorr Thomas A. Beaudouin Partner [email protected]

Fried Frank Richard I. Ansbacher Partner [email protected]

Covington & Burling Hilary Prescott Partner [email protected]

Debevoise & Plimpton David J. Schwartz Partner [email protected]

O'Melveny & Myers John Daghlian Partner [email protected]

Weil, Gotshal & Manges Shukie Grossman Partner [email protected]

Kirkland & Ellis Michael D. Belsley Partner [email protected]

Kaye Scholer Emanuel S. Cherney Partner [email protected]

Appendix - 136 -

1.3 Database of the private marketplaces



IlliquidX Zachary Latif Partner [email protected]

ICAP Alternative Investment Group Laura Prager Managing Director [email protected]

NYPPEX MaryAnn Sapione Vice President [email protected]

SecondMarket1

J. Bollerman Director [email protected]

Trusted Insight [email protected]

PEFOX2

Kishore Kansal Managing Partner [email protected]

1. Biggest marketplace for Limited partnerships

2. Marketplace to negotiate derivatives on funds

Appendix - 137 -

2. Database of the buyers in the Private Equity secondary market

2.1 Database of the dedicated secondary buyers (LPs interest and direct)

Company

A.U.M ($m) dedicated to

secondaries Name Position Mail Comments

Lexington Partners 15,900 Marshall Parke Partner [email protected]

Goldman Sachs Private Equity Group 12,000 chris Kojima Managing Director [email protected]

HarbourVest Partners 10,000 Peter Wilson Managing Director [email protected]

Coller Capital 8,400 Sebastien Burdel Principal [email protected]

Credit Suisse Strategic Partners 8,200 Stephen Can Managing Director [email protected]

Landmark Partners 6,700 Ian Charles Principal [email protected]

Partners Group 6,000 Marc Weiss Partner [email protected]

AlpInvest Partners 4,644 Philip Viergutz Investment Manager [email protected]

AXA Private Equity 5,000 Olivier Decannière Managing Director [email protected]

Pantheon Ventures 4,600 Elly Livingstone Partner [email protected]

Paul Capital Partners 4,400 Guy Rico Partner [email protected]

Adams Street Partners 3,500 Gregory J. Holden Partner [email protected]

Pomona Capital 3,000 Mark McDonald Principal [email protected]

Neuberger Berman 2,800 Brian Talbot Managing Director [email protected]

LGT Capital Partners 2,750 André Aubert Principal [email protected]

Greenpark Capital 1,589 Matthew Arkinstall Investment Director [email protected]

AIG PineStar Capital 1,800 Harvey Lambert Managing Director [email protected]

Liquid Realty Partners 1,500 Jeff Giller Chief Investment Officer [email protected] Only Real Estate

Morgan Stanley Alternative Investment Partners 1,500 John Wolak Managing Director [email protected]

SVG Advisers 1,222 Sam Robinson Director [email protected] Listed PE vehicle

Fondinvest Capital 978 Charles Soulignac CEO [email protected]

JP Morgan Asset Management 1,060 Jarrod Fong Portfolio Manager [email protected]

Arcis Group 917 Henri Isnard Managing Partner [email protected]

Hamilton Lane 1,000 Tom Kerr Principal [email protected]

RREEF Private Equity 775 Charles Smith Managing Director [email protected]

Montauk Triguard 750 Edgar J. Pfohl Principal [email protected]

VCFA Group 730 Dayton T. Carr Founder [email protected]

Newbury Partners 702 Richard Lichter Managing Partner [email protected]

Appendix - 138 -

Source: Author’s own- Dow Jones; «Guide to Secondary Market Buyers»; 2009 – Companies website

Company



Millennium Technology Ventures 700 Dan Burstein Managing Partner [email protected]

PEIFunds 684 Chuck Stetson Managing Director [email protected]

Auda Private Equity LLC 600 Thimothy Brody Managing Director [email protected]

JP Morgan Private Equity Limited 544 Troy Duncan Managing Director [email protected] Listed vehicle

Permal Capital Management 575 Robert DiGeronimo Managing Director [email protected]

Willowridge Partners 535 Jerrold Newman Managing Member [email protected]

Industry Ventures 500 Justin Burden Principal [email protected]

Unigestion 279 Hanspeter Bader Managing Director [email protected]

Madison International Real Estate 300 Michael Siefert Managing Director [email protected] Only Real Estate

Headway Capital Partners 244 Christiaan de Lint Founder and Partner [email protected]

Vintage Investment Partners (Ex Vintage Ventures) 225 Abe Finkelstein General Partner [email protected] Only Israeli funds

Beleveron Real Estate Partners 200 Paul Oldland Managing Director [email protected] Only Real Estate

RCP Advisors 200 Tim Danis Senior Managing Principal [email protected]

Symmetry Investment Advisors 171 Marshall Greenwald Principal [email protected]

BEX Capital 122 Benjamin Revillon Managing Partner [email protected]

Anchor Capital 100 Jens A. Wilhelmsen Managing Partner [email protected]

Cubera Private Equity 100 Jørgen Kjærnes Managing Partner [email protected]

Nottingham Capital Management 100 Michael T. Pilson Managing Partner [email protected] Raising 1st fund

NorgesInvestor 37 Dylan Wolff Managing Director [email protected]

Gutmann Group 32 Friedrich Strasser Partner [email protected]

MidCoast Capital 12 Michael Cuneo Managing Partner [email protected]

The Aldenwood Group Jamie Hale Managing Partner [email protected]

Ant Global Partners Shunsa Hayashi Managing Director [email protected] Focus on Asia

Capital Dynamics David Woolford Managing Director [email protected]

Hollyport Capital John Beatty Chairman [email protected]

TMT Capital Partners Thomas M. Turmell Managing Partner [email protected]

Live Oak Secondary Harbert Mulherin Managing Partner [email protected]

Performance Equity Management Charles Froland CEO [email protected]

TOTAL 117,974

Appendix - 139 -

2.2 Database of the dedicated secondary buyers (only direct transactions)

Source: Author’s own- Dow Jones; «Guide to Secondary Market Buyers»; 2009 - Companies website

Company



Vision Capital 2,444 Alister Wormsley Managing Partner [email protected]

Saints Capital 1,300 Ken Sawyer Managing Director [email protected]

W capital partners 1,100 David Wachter Managing Director [email protected]

Protostar Partners 1,000 Joseph Haviv Managing Partner [email protected]

Nova Capital Management 880 Michael Kelly Managing Director [email protected]

Verdane Capital Advisors 489 Bjarne Lie Chief Investment officer [email protected]

Lake Street Capital 400 Gretchen Knoell General Partner [email protected]

Tempo capital partners 269 David Tate Managing Partner [email protected]

Omega funds 250 Otello Stampacchia Managing Director [email protected] Only healthcare companies

Heidelberg Capital 122 Martin Weiblen Managing Partner [email protected]

Annex Capital 131 [email protected]

Endeavor Capital Management 120 Anthony Buffa Managing Partner [email protected]

Accretive Exit Capital Partners 110 Andrew Reilly Managing Director [email protected]

SMAC Partners 100 Dietrich Ulmer Managing Partner [email protected]

Azini Capital 88 Michael Bennett Managing Partner [email protected]

Shackleton Ventures 55 Michael Low Partner [email protected]

Morning Street Capital 20 Paul Misir Managing Partner [email protected]

Chamonix Private Equity Jane Crawford Managing Partner [email protected]

Cipio Partners Tom S. Anthofer Managing Partner [email protected]

Mustang Capital Partners Parker Brophy Managing Partner [email protected]

S1 Capital Partners David Baum Managing Partner [email protected]

17Capital Pierre-Antoine de Selancy Managing Partner [email protected]

Preferred equity and

mezannine financing to PE

portfolio owners

TOTAL 8,878

Appendix - 140 -

2.3 Database of firms investing part of their funds in the secondary market

Company



Portfolio Advisors LLC 1,100 Paul R. Crotty Managing Director [email protected]

Stepstone Group 800 Tom Keck Chief Investment Officer [email protected]

SL Capital Partners 340 Patrick Knetchi Investment Director [email protected]

Altamar 244 José Luis Molina Partner [email protected]

Key Capital Corp 250 Bart Shirley Managing Director [email protected]

VenCap International 250 Tim Cruttenden Director [email protected]

Venture Investment Associates 250 Cliff Gilman Managing Director [email protected]

Wilshire Private Markets Group 237 Amanda Ulczynski Associate [email protected]

Thomas Weisel Asset Management 200 Clifford Meijer Managing Partner [email protected]

Northen Trust Corp 200 Brad Dorchinecz Vice President [email protected]

AGF Private equity 147 Christophe Simon Investment Manager [email protected]

Kensigton Capital Partners 100 Tom Kennedy Managing Director [email protected]

Fort Washington Capital Partners 85 Stephen Baker Managing Director [email protected]

Altius Associates 75 Garth Troxell Partner [email protected]

Montagu Newhall Associates 75 Ashton Newhall General Partner [email protected]

LLM Capital Partners 73 Frederick Moseley Managing Director [email protected] Only directs

Abbott Capital Management 72 Charles van Horne Managing Director [email protected]

Paragon Partners 61 Edin Hadzic Managing Partner [email protected] Only directs

Access Capital Partners Philippe Poggioli Managing Partner [email protected]

ACP Investment Group [email protected]

Aldius Capital Saul Meyer Managing Partner [email protected].

Allianz Private Equity Partners Claus Zellner Managing Director [email protected]

Alpha Associates AG Peter Derendinger CEO [email protected]

Amundi Private Equity Funds Richard Dalaud Manager [email protected]

Appendix - 141 -

Company



Arcano Capital Vanessa Campion Analyst [email protected]

ATP Pivate Euqity Partners Torben Vangstrup Partner [email protected]

Aviva Investors Nick Mansley Director [email protected] Only Real Estate

Barclays Private Equity Paul Goodson Managing Director [email protected]

Bay Hills Capital Albert Chiang Partner [email protected]

Blue Capital [email protected] Only directs

California State Teachers Retirement System Set Hall Portfolio Manager [email protected]

Calpers

Canada Pension Plans Mark Wiseman [email protected]

Carlyle Group

Centinela Capital Partners Robert D. Taylor Partner [email protected]

CMS Fund Advisors Inc. William A. Landman Principal [email protected]

Danske Private Equity John Danielsen Managing Partner [email protected]

DuPont Capital Management Carmen Gigliotti Managing Director [email protected]

F&C Private Equity Hamish Mair Diirector [email protected]

Finama Private Equity [email protected]

Frontiers Capital Partners Herman Spruit Managing Partner [email protected]

Guggenheim Partners Amit Dabas [email protected] Interest in India funds

Hovde Private Equity Advisors Joseph Thomas Managing Director [email protected]

Horsley Bridge Partners Dan Reeve Managing Director [email protected]

Invesco Private Capital Phillip M. Shaw General Partner [email protected]

Itaventure Capital Partners Michele Gardelli Managing Director [email protected]

Macquarie

MSD Capital Glen R. Fuhrman Managing Partner [email protected]

Appendix - 142 -

Source: Author’s own- Dow Jones; «Guide to Secondary Market Buyers»; 2009 - Companies website

Company



Natixis Private Equity Jean Duhau de Berenx CEO [email protected]

New Jersey State Investment Council Maneck Kotwal Investment Officer [email protected]

Northsea Capital Patrik Nevsten Partner [email protected]

Oak Hill Jeffrey M. Mills Principal [email protected]

Ontario Teachers Pension Plan Erol Uzumeri Senior Vice President [email protected]

OPSEU Pension Trust

Parish Capital Charles Merritt Managing Partner [email protected]

Pathway Capital Management Philip Godfrey Director [email protected]

PCG Asset Management Michelle Davidson Managing Director [email protected]

Quay Partners Stephen White Managing Partner [email protected]

Rho Capital Partners Gordon Hargraves Partner [email protected]

Robeco Capital Henk Saeijs Partner [email protected]

Susquehanna International Group [email protected]

Teacher Retirement System of Texas

Triginta capital Clemens von Berger CEO [email protected] Only directs

Turan Corporation Robert Towler Partner [email protected] Emerging market

Von Braun & Schreiber Private Equity Partners Timothy J. Reynolds Managing Director [email protected]

Hermes Private Equity Andrew Raisman Director [email protected] Only Directs

Institutional Venture Partners Tod Chaffee General Partner [email protected] Only directs

Ventizz Capital Partners Helmut Vorndran CEO [email protected] Only directs

Bregal Investments [email protected]

Conversus capital [email protected] Listed PE vehicle

Nordea Private Equity [email protected]

Appendix - 143 -

3. Request for sponsorship

Appendix - 144 -

4. Newsletter nº1

Appendix - 145 -

Appendix - 146 -

5. Sponsors of the study and interviews

Company Agent type Contact Position Mail Comment

1. UBS Private funds Group Adviser Stéphane Vojetta Executive director [email protected] IBD Team

Nicolas Lanel Executive director [email protected] Call on 19th January 2010. Meeting 3rd March 2010 at 14:00

Francesca Paveri Analyst [email protected] Meeting 3rd March 2010 at 14:00

Jasmine Hunet Analyst [email protected]

Conf call on 26th Nov. 2009 15H00 UK Time. Other call

made in December. Call on 19th January 2010. Call on 8th

March 2010. Model and sale structures comments

2. Arcano Capital Buyer Vanessa Campion Analyst [email protected] Meeting on 18th March 2010 18:00

Steve Sceery Vice President [email protected] Meeting on 18th March 2010 18:00

Ricardo Miró-Quesada Associate [email protected] Meeting on 18th March 2010 18:00

3. Fidequity Adviser Francois Garcin Partner [email protected]

Christophe Tymen Partner [email protected] Conf. call on 3rd December 2009 16:00 UK time

Amit Sanghvi Associate [email protected] Conf. Call 3rd December 2009 16h00 UK Time

4. Breslin AG Adviser David Karabelnik CEO [email protected] Call on Wednesday 02nd Dec. 2009 at 10:00 AM

5. Headway Capital Partners Buyer Christiaan de Lint Founder and partner [email protected] Call Wednesday 9th Dec. 2009 17:00

6. Preqin Adviser Mark O'Hare Founder and Managing Director [email protected]

Kerry Pogue Head of research [email protected] Call on Wednesday 2nd Dec. 2009.

7. Campbell Lutyens Adviser Thomas Liaudet Principal [email protected]

Julien Marencic Vice President [email protected]

Call Thursday 10th Dec. 2009 15:30 (UK time). Call on the

10th March 2010 at 14:00 UK time. Comments on model

8. Altamar Buyer José Luis Molina Principal [email protected] Meeting Monday 07 Dec. 2009 17:00

Ignacio de la Mora Senior Associate [email protected] Meeting Monday 07 Dec. 2009 17:00. Model comments

9. Pantheon Ventures Buyer Francesco Di Valmarana Principal Call on Wednesday 09th Dec. 2009 13:00 UK Time

Arantxa Prado Senior Associate [email protected] Call on Wednesday 09th Dec. 2009 13:00 UK Time

10. Secondmarket Marketplace Jeffrey C. Bollerman Director LP interest [email protected] Call Tuesday 01st Dec. 2009 at 21:30

11. SJberwin Legal adviser Isabel Rodriguez Partner [email protected] Meeting on Monday 14th Dec, 2009 17:30

Roberto Pomares Botana Partner [email protected] Meeting on Monday 14th Dec. 2009 17:30

12. Lexington Partners Buyer José Sosa del Valle Senior Associate [email protected] Call on 15th and 20th of January 2010

13. HarbourVest Partners Buyer Peter Wilson Managing Director [email protected] Call on 9th March 2010, 14:00 UK time

Appendix - 147 -

6. Meeting guidelines

Meeting guidelines

1) Presentation:

a) The project: Thesis, Model, sponsors.

b) Company profile: Leading buyer on the secondary market, AUM, targeted assets

(size, funding ratio), funds, last closed operations, sourcing of transactions.

2) Market insight:

a) Could you send me historic data of primary and secondary fundraising?

b) What was the transaction volume on the market from 2000 to 2009?

c) Correlation between primary fundraising and secondary transaction volume

(turnover rate, average age of funds sold)?

d) How do you see the future of the market? (Tightening of the Bid/Offer spread,

Growth, correlation between primary and Secondary PE market)

e) Nowadays who are the main sellers on the market? And what is their main reason to

sell?

f) What about the pricing? (Current and outlook)

g) Could you describe a classic transaction process? Obama bank project: Citi deal

($10bn on the sec. market), potential buyers. Will JP Morgan sell its PE unit? $8bn?

Will it occur this year? Goldman will give up bank status? Other banks plan to sell

h) Which advisers do you work with?

i) What are the typical fees of advisers on the market?

3) Structuring of the operations:

a) What are the different possible structures on the market?

b) In case of a structured operation (JV) do you consider the counterparty risk as an

issue?

4) Valuation Issues:

a) Could you describe your valuation method of this asset class? (Bottom-up/Top-

down?) Multiples.

b) What are the returns and IRR you are looking for?

c) How do you project the unfunded commitment? (In order to project cash flows)

Appendix - 148 -

d) Are listed Investment trusts a good proxy for valuation?

e) What are the main components of the value of a secondary asset? (Funding ratio,

Growth of underlying, exit timing…)

5) Legal issues:

a) What are the legal issues when considering buying/selling a LP stake? (pre-emption

rights, indemnifications…)

b) Does a GP have a right to veto the transfer of a limited partnership interest in a fund?

Other: Review and comments of the model

Appendix - 149 -

7. Summaries of calls and meetings

This part contains the summary of the various meetings, calls that have allowed me to

gain much information of this study. These summaries are in chronological order. Three

other investment funds shared their thoughts with me but asked to remain anonymous. All

errors are mine.

7.1 Call with UBS (26 November 2009)

Call UBS 26th

November

Contact: Jasmine Hunet (UBS Private Funds Group – Secondary Market Advisory, Analyst)

When: 26th November, from 16h15 to 17hoo

Subject: Valuation issues, modelling and structuring of operations

Content:

1. Pricing / Valuation

a) Secondary Buyers’ Target Returns

All depends on each buyer’s cost of capital, but when modelling, we generally assume that a

typical secondary buyer looks for a 1.8x-2.0x return multiple and a 20%+ IRR. These target

returns are adjusted when modelling non vanilla sale structures which have different risk

profiles.

b) Capital Calls & Distribution Profile

You need to project the future capital calls/distributions profile for your portfolio. The

profile mainly depends on (i) remaining unfunded to be called, expected return on NAV and

expected return on unfunded (ii) timing of capital calls & distributions.

Historical returns data sourced from the “VentureXpert” database can be used to project

return multiple and timing.

c) Consideration Relative to the Unfunded Commitment:

The return multiple assigned to the unfunded part of a commitment mainly depends on the

overall economic outlook, quality of the GP (track record, team stability …) as well as on the

expected use of the unfunded (new investments vs. follow-on investments…).

Appendix - 150 -

d) Considerations Relative to Management Economics

To model the carried interest, you have to do it step by step

1. Hurdle rate or preferred return to LPs is around 8%

2. Then there is a catch up for the GP

3. Lastly profit is shared between LPs and GP (80/20% for a 20%

carried interest)

There are two different ways of computing the carried interest

- US: Deal by deal

- EMEA: Calculated at the overall fund level

2. Structuring Alternatives

Different sale structures can be used to sell a portfolio of LP interests:

- Straight sale: Plain vanilla sale. In current market conditions, discounts are still

substantial (approx.: 30/40% discount) for average quality buyout funds

- Joint-Venture Sale, used to minimize discount. The assets are placed into an SPV owned

by seller and buyer. The distribution waterfall is then negotiated (and is often

asymmetric)

- Seller financing: The seller finances part of the price paid by the buyer via a loan of (for

example approx. 30% of the price). You can add a mechanism of “revolver” to cover

capital calls as well.

- Listing of the Portfolio. Not used today because of market conditions

- Securitization. Not used today either.

Appendix - 151 -

7.2 Call with Secondmarket (01 December 2009)

Call Secondmarket 01st December

Contact: Mr Jeffrey Bollerman (Head of Limited Partnership Interests Marketplace, New

York)

When: 01st December, from 09:30PM to 10:15PM

Subject: Marketplace for illiquid assets.

Content:

1. Company Profile Secondmarket is the largest independent marketplace and auction platform for

illiquid assets with over 4,000 participants and height asset class traded on its online

platform.

Secondmarket is a fast growing company providing intermediary services. It competes with

every other intermediary. Other online platforms as Preqin (more based on research

publication) and NYPPEX (which seems to be quite absent on the market nowadays) are

smaller than Secondmarket.

They do not provide advisory on any of those transactions and can offer a low cost

intermediary service. Instead of all Investment Banks and Boutiques, Secondmarket

positions itself as a fast growing company on a low-cost model based only on intermediary

services. It employs 100 people.

2. The LP Interest market:

a. Size of the market, growth rate:

With nearly $2bn in LP interests listed, Secondmarket is the largest marketplace of LP

interest in Private Equity, Venture capital, Funds of funds and Hedge funds. Mr Bollerman

could not give me the actual growth of the market because of the confidentiality of this

information but he told me it was an exceptional fast-growing market.

b. Sellers on the market, reasons to sell

Sellers are mostly financial institutions in terms of transaction volume, but are also

endowments, Corporations, high net worth individuals, pension funds…

Appendix - 152 -

The main reason to sell is to rebalance the portfolio because of change in the strategy, poor

results, denominator effect… Also many sellers are in distressed situation.

c. Pricing on the market

Mr Bollerman could not tell us the actual discount on the market because of

confidentiality but also because it depends on each asset.

For him the unfunded is the major determinant of the pricing. Also quality of GPs and of

underlying assets are other determinants.

3. The process on the market: Participants enter online on the market and meet anonymously on the platform.

Once they have agreed on deal conditions (price, other conditions), they get identified and

they close the deal.

Fees depends on the sale proceeds, they are generally around 3%. If the transaction price is

too low to cover fixed cost of the platform, then other fees are added.

Appendix - 153 -

7.3 Call with Breslin AG (02 December 2009)

Call Breslin AG 02nd December

Contact: Dr. David Karabelnik (CEO Breslin AG)

When: 02nd December, from 10:00AM to 11:00AM

Subject: Market insight, transaction process.

Content:

1. Why this market is a hidden-market Two reasons justify why this market is hidden:

- It is a New Market: The PE secondary market is all new. Since 2002/2003, the market

exploded with much more deals and fund raised. Nowadays it is considered as an

established market but because of the wide spread between Bid and offer it remains

inefficient.

- It is a Private Market: Agents working on this market do not want it to become

public. It is a secret market; people do not want their assets to be known as on sale.

Confidentiality is a key for success on the market. That is why agents always sign

CDAs (Confidential Disclosure Agreements).

2. About Mr Karabelnik and his company Breslin AG: Mr Karabelnik is a Doctor in Biochemistry; he first began as an entrepreneur in

Biotech. In 1999 he came back from San Francisco with a background in Venture Capital. He

met Dresdner Bank and decided to set a vehicle with them to invest in Venture Capital.

For this purpose, he founded a Joint-Venture with Dresdner: Breslin Biotech.

In 2003, after the bubble crisis, the Private Equity secondary market began to grow because

of concerns from banks to go out from this asset class. At this time Dresdner sold a portfolio

of VC and PE assets (mainly to Axa and Harbourvest).

Mr Karabelnik then brought part of the Dresdner team to Breslin AG and they began working

on secondary transactions with a focus on buyers in 2004.

They quickly realized fees where much better working for sellers. That is why in 2005, they

began going out on the market and look for sellers.

Their clients include many big companies such as Bayer, Henkel, Roche…

Appendix - 154 -

In those big companies the realisation of transactions is easier because they are not so much

price-sensitive and accept discounts of the market.

Breslin is an intermediary and an adviser on the market more focused on Venture Capital.

Valuation advices are mainly based on the current discount to NAV of the market.

3. Market insight:

a. Pricing on the market:

The market is clearly offering large discounts to NAV. In the peak of the crisis

discounts were up to 50/60%. But now things are coming back and discount is tightening, it

will now be around 40% of the existing NAV.

The gap between bid and offer is likely to tighten because of the amount of money on the

market. Buyers are sitting on large amounts of money and are likely to invest it revising their

pricing. For example Mr Karabelnik during a process did not accept a bid from a fund and 6

months later the bidder came back with a revised and more acceptable price for the same

asset.

b. Size of the market:

There are clearly a lot of people who want to sell and a lot of money raised by buyers.

Mostly transactions led by Mr Karabelnik are likely to realize between 6 weeks and one year.

When Breslin goes on the market to find asset for sale he contacts 50 potential sellers, get

10 closest conversations and finally sign an exclusive agreement with 3 to 4 sellers. They get

c.5-10% of the potential sellers.

4. The transaction process:

- Go on the market to find sellers: Advice them on value (give them price range).

- Sign an exclusive sale agreement

- Get all the info (financials, LPAs…)

- Sign a CDA with GPs to allow communication

- Go on the buyer market and pitch clients. Database of c. 200 buyers. At this stage of

the process Seller and Assets are not disclosed.

- Sign a CDA with interested buyers to provide them with more information

- Auction of asset

- Negotiation with Breslin to agree on a price

- Closing: Sign sale and legal agreements.

Fees are based on success fees of c. 3,5-5% of the transaction value with addition of

retainers for sale of direct investments of c.4,000 to 5,000€/month because of the

complexity of the work.

Appendix

7.4 Email from Preq

Mail Preqin 02

Contact: Kerry Pogue (Head research Secondary PE market)

When: 02nd December, by mail to replace a call

Subject: Market insight.

Content:

1. Preqin Company profile:a. Activity:

There has been some talk recently regarding online exchanges and the scepticism

around them. We do not aim to do this. We aim instead to provide an information service

and network to help inform buyers, sellers and advisors, and to bring them closer togeth

Preqin’s secondary market monitor service creates leads for buyers and sellers in two ways.

Firstly, we call investors to find out their secondary market plans and then we provide this

information in the form of a database.

Secondly, we have created a confidential network whereby sellers of fund interests can

come anonymously to the service and submit fund interests for indicative valuations, both

from Preqin’s algorithmic model and from third party buyers subscribed to our service. A

buyer can submit a rough price indication and make initial contact with the seller but any

transaction is not completed through Preqin’s service. It is completed between the buyer

and seller externally.

b. Competitors

Other participants in the market are Secondmarket, Investo

online trading platforms (often initially set up for the trading of hedge fund interests) which

have begun to look at adding private equity fund interests to the assets they trade.

However, as far as I know, we are the only service t

acts as our exclusive pricing partner and guarantee to provide price indications to anyone

that submits a portfolio for third party price indications. We do not provide advice on the

secondary market. Rather, we pro

2. Valuation method: A proxy to Listed FoF’sWith regards to the online algorithm, we have demonstrated a correlation between

listed private equity and secondary market pricing and therefore use listed private equity as

a proxy and take the following into consideration: type of fund; vintage year of fund; fund

manager track record; fund performance; amount of capital called. We also assess market

trends and factor these in accordingly.

Email from Preqin (02 December 2009)

Mail Preqin 02nd December

Kerry Pogue (Head research Secondary PE market)

December, by mail to replace a call

Preqin Company profile:



and network to help inform buyers, sellers and advisors, and to bring them closer togeth



information in the form of a database.

confidential network whereby sellers of fund interests can



a rough price indication and make initial contact with the seller but any


in the market are Secondmarket, Investor Flow and some other



However, as far as I know, we are the only service to offer free pricing indications. NYPPEX



secondary market. Rather, we provide information and data.

Valuation method: A proxy to Listed FoF’s With regards to the online algorithm, we have demonstrated a correlation between


take the following into consideration: type of fund; vintage year of fund; fund


trends and factor these in accordingly.

- 155 -

December



and network to help inform buyers, sellers and advisors, and to bring them closer together.



confidential network whereby sellers of fund interests can



a rough price indication and make initial contact with the seller but any


r Flow and some other



o offer free pricing indications. NYPPEX



With regards to the online algorithm, we have demonstrated a correlation between


take the following into consideration: type of fund; vintage year of fund; fund


Appendix - 156 -

We feel that while this method cannot be substituted for a thorough due diligence of the

fund’s underlying assets, it does give a good general indication of the fund interest’s

approximate worth on the secondary market and we have received lots of good feedback

regarding the accuracy of the indications. I’m unable to go into any more depth with an

explanation of the model, unfortunately.

3. Market insight: The research report which will be released next week freely on the website will cover

this point.

4. who are the main sellers and why:

a. Reasons to sell:

I would say there are two types of reasons for selling fund interests: a) liquidity

requirements b) strategic purposes.

Strategic purposes would include rebalancing investment portfolio, reducing administrative

burden, gaining exposure to top managers that the LP may have missed in the primary round

of commitments etc.

b. Who are the main sellers:

I would say that all LPs could benefit from selling for strategic purposes, providing the

prices are right, but there are a few firm types that are particularly susceptible to selling,

mainly for liquidity requirements.

Endowments: ‘a closed box’, with no income and they often employ an over commitment

strategy. A decrease in distributions from fund investments has therefore hit them

particularly hard.

Banks: Banks tend to enter and leave the PE market in cycles. For example, one secondaries

manager has purchased portfolios from the same bank 3 times over the past 15 years. In

order to generate liquidity, banks have been keen to offload illiquid assets including private

equity fund interests. Furthermore, many banks were initially attracted to the private equity

market by the opportunity to provide finance in the form of leveraged buyout deals.

However, the financial turmoil of 2008 rendered them unable to fulfil the role of financier,

prompting many to reduce their exposure to an asset class that never did form a core part of

their investment strategies.

Listed FOFs: another closed box until they issue additional securities. Again, they employ an

over commitment strategy and have probably borrowed too much. They’re a good indication

for the volume of selling we should expect and their selling activity is generally well-

documented as a result of their public status.

Appendix

7.5 Call with Fidequity (03 December 2009)

Conference call Fidequity 03

Contact: Mr Christophe Tymen (Partner) and Mr Amit Sanghvi (Associate)

When: 03rd December, from 5:15PM to 5:45PM

Subject: Valuation, structuring, legal.

Content:

1. Fidequity company profile

Fidequity is an adviser in

operations and fundraising.

It is a global group with offices in London, Paris and New York.

2. Valuation issues

In general the GP do not release enough information in its financial reports to value

each underlying asset.

In this case, the valuation process is to make a market valuation. Depending on the Funding

ratio of the fund, the market discount of same vintage

then applied to the NAV of the fund provided by the GP. The lowest the funding ratio, the

lowest the price because investors do not like backing managers they do not know.

In the case of enough financial information a

underlying assets. A new NAV is estimated and depending on the capital call/distribution

profile of the fund, cash flows are discounted at the targeted IRR and the NPV is the price

the buyer is willing to pay. A sensitivity analysis is done on growth assumptions of underlying

assets and Capital Call/distribution profile.

3. Structuring of the operations:

Mainly two structures:

-Straight sale

- Joint venture: Buyer and seller share the economics. The buyer answer

calls but gets a preferred return until he reaches a targeted return, then the distribution is

shared.

4. Legal issues:

It mainly depends in which jurisdiction the fund belongs to. It also depends if the

fund is an FCR or a limited Partnership

Call with Fidequity (03 December 2009)

nce call Fidequity 03

rd December

Mr Christophe Tymen (Partner) and Mr Amit Sanghvi (Associate)

December, from 5:15PM to 5:45PM

Valuation, structuring, legal.

Fidequity company profile

Fidequity is an adviser in Private Equity which mainly focuses on Secondary

It is a global group with offices in London, Paris and New York.



ratio of the fund, the market discount of same vintage funds is used. The market discount is



In the case of enough financial information available, a bottom-up valuation is done valuing



. A sensitivity analysis is done on growth assumptions of underlying

assets and Capital Call/distribution profile.

Structuring of the operations:

Joint venture: Buyer and seller share the economics. The buyer answer



fund is an FCR or a limited Partnership.

- 157 -

December

Private Equity which mainly focuses on Secondary



funds is used. The market discount is



up valuation is done valuing



. A sensitivity analysis is done on growth assumptions of underlying

Joint venture: Buyer and seller share the economics. The buyer answer all capital



Appendix - 158 -

Basically pre-emption rights and remaining liabilities of previous LPs are issues considered

during secondary transactions.

The GP do have a veto right on a secondary transaction of a LP stake in its fund.

A Limited Partnership does not have to pay tax, but the limited partners pay it. It means

there is no double taxation on income. In order to be considered as a Limited Partnership,

you have to prove that your fund is illiquid and not traded on a public place. That is why a

Limited Partnership can’t transfer more than 2% of committed capital each fiscal year

whether it will be considered as a Public traded partnership (and taxation also) by the IRS.

However, by using a qualified service (defined by the IRS) on the secondary market, a fund

can add 8% on the previous percentage of transferable assets.

Appendix - 159 -

7.6 Meeting with Altamar (07 December 2009)

Meeting Altamar 07th December

Contact: Mr José Luis Molina (Partner) and Mr Ignacio de la Mora (Investment Director)

When: 07th December, from 5:00PM to 6:45PM

Subject: Market insight, Valuation, legal, structuring, modelling.

Content:

1. Altamar company profile Altamar is a Private Equity fund of fund founded in 2004. Altamar currently has three

funds and asset under management of approx. € 1bn. invested mainly in LBOs (80% of AUM)

and Real Estate (20% of AUM). Its funds have a capacity to invest until 20% of committed

capital in secondary transactions.

Recently they opened a new fund dedicated to secondary operations. This fund only invests

in funds Altamar already invested in on the primary market. They use to invest in early

secondary (50/60% funded) looking for 2x returns.

2. Market insight The size of the secondary market is really difficult to determine, however it seems

that the volume of transaction was c. $16 bn. in 2008 and c. $4 bn. in H1 2009. For Mr

Molina, no clear correlation exists between the primary Private Equity market and secondary

transactions because each market relies on different drivers.

Main reasons of selling were distressed situations and the denominator effect. Today the

denominator is no longer a reason because boards voted to lift threshold of the Private

Equity allocation and also because large pension funds forced GPs to write-down their NAV.

Today sellers are mostly listed fund of funds (because of over commitment strategy and high

leverage�breaching of covenants) and family offices (mainly distressed sellers).

They believe the tightening of the bid/offer spread will happen when the visibility and

macroeconomic conditions will better.

It is a market similar to the Real Estate one because it is a buyer market where agents are

looking to buy quality assets and where sellers are mostly distressed and have to sell with a

discount to the real price of those assets in the future.

Appendix - 160 -

3. Valuation issues In order to value this asset class, a simple market valuation (applying a discount on

the GP’s NAV) is not a good method. A bottom-up valuation has to be performed in order to

value underlying assets. Underlying is valued via EBITDA multiples; it is not possible to do it

via a DCF method because we need to approach the value of the assets in the time.

A new NAV is estimated and depending on the capital call/distribution profile of the fund,

cash flows are discounted at the targeted IRR and return. The NPV is the price the buyer is

willing to pay. A sensitivity analysis is done on growth assumptions of underlying assets and

exit timing.

The cash is not an issue because it is always an insignificant part of the fund and usually the

final price paid for the asset is corrected by the existing cash.

4. Legal issues: Two most important legal issues:

- Existing legal agreement of the fund: not applicable for Altamar because they only

invest in funds where they already invested in primary.

- The Share Purchase Agreement (SPA)

Particular attention has to be paid if remaining LPs have pre-emption rights (ex:

Blackstone).

GP consent is required in secondary transactions.

Also fiscal issues have to be considered, for example, when buying in the US, if you want to

benefit from the local tax treatment you have to buy a resident vehicle.

5. Structuring of operations: Altamar only buy assets via straight sale. Structures where the buyer and the seller

share the economics (like JV) are not used because of the risk of bankruptcy. Also for fiscal

reasons because an FCR cannot invest in a structured note; they have to invest in Private

Equity funds if they want to keep their tax treatment.

6. Modelling: Mr de la Mora reviewed the valuation model. Discussions were on the following

elements:

- Growth assumptions

- Cash flow for debt repayment

- Waterfall

- Management fees/Carried

Appendix - 161 -

7.7 Call with Pantheon Ventures (09 December 2009)

Conference call Pantheon

Ventures 09th December

Contact: Mr Francesco Di Valmarana (Principal) and Mrs Arantxa Prado (Senior Associate)

When: 09th December, from 11:00AM to 12:00AM (UK time)

Subject: Market insight, structuring, Valuation, legal.

Content:

1. Pantheon company profile Pantheon Ventures is a Private Equity primary and secondary fund-of-funds manager

founded in 1982. Pantheon currently manages approx. $ 23bn. invested mainly on the

primary (80% of AUM) and on the secondary market (20% of AUM).

Pantheon has been a pioneer on the Private Equity secondary market beginning its activities

on this market in 1988. Today Pantheon is the fourth biggest player by assets dedicated to

this market. On the secondary market they mainly invest (85%) in funds where they already

participate in the primary. They use to invest in late secondary (60/70/80% funded).

Generally Secondary funds perform better than Primary in terms of return.

2. Market insight The size of the secondary market is really difficult to determine, however it seems that

the volume of transaction (Purchase Price + Unfunded) was c. $23,5 bn. in 2008 and c. $5,5

bn. in H1 2009. In 2010 the market is likely to be much more important than in 2009.

Transaction volume should be approx. $30 bn.

Quoted investment trusts give a good proxy for valuation, in 2006-2007, a 5 to 15% premium

to NAV was paid. Pricing on the secondary Private Equity market was very similar. Today

listed investment trusts show a reduction in the discount to NAV, which should be likely to

tighten the gap between the bid and offer on the secondary market.

Players mainly sell on the secondary market for three different reasons:

- Cash flow distressed: It can be every players but it is mainly the case for family

offices.

- Balance sheet issues: Risk capital allocation. Regulation. Banks and insurance

companies.

- Portfolio allocation: Rebalance portfolio, change strategy. Pension funds, insurance

companies and endowments.

Appendix - 162 -

There are two types of classic transaction process depending on where the deal is sourced:

• Deal sourced via an intermediary: The transaction process last mainly 3 months.

- Intermediaries come up with a list of assets and their characteristics

- If the buyer is interested by an asset he makes an initial bid: 1month

- More information is given to the different parties who have to make a final bid:

1month

- Closing of the deal: Legal (SPA,…) 1 month.

• Deal sourced by Pantheon: Same steps as the previous process but is usually a lot

more complicated and longer (can last years).

Typically adviser fees are c.1 to 2% of NAV + Unfunded depending on the size of the

transaction.

3. Structure of transactions Pantheon mainly buys assets agreeing on a price with differed payments. They have

also used other different structures using SPV and sharing the economics where the

counterparty risk is carefully assessed. Generally deal structures are proposed and accorded

with the seller.

4. Valuation issues In order to value this asset class, a bottom-up valuation is performed to value the

underlying. Underlying is valued via multiples; it is not possible to do it via a DCF method

because we need to approach the value of the assets in the time.

A new NAV is estimated and depending on the capital call/distribution profile of the fund,

cash flows are discounted at the targeted IRR (20/25% for Pantheon) and return (1,8x to 2x

for Pantheon). The NPV is the price the buyer is willing to pay. A sensitivity analysis is done

on growth assumptions of underlying assets and exit timing.

The unfunded is separated and valued in two parts:

- The part which will be used to back existing investments: This part is projected as per

returns expected of each investment in existing business.

- The capital for new transactions: On this part the return applied is usually bigger.

The cash is not an issue because it is always an insignificant part of the fund however it is

included in the model.

For Pantheon, as a late secondary buyer, the main component of the value of a secondary

asset is the quality of the underlying. For an early secondary the main component would be

the funding ratio.

5. Legal issues:

- Indemnities: In case a GP sold an asset and need to call back distribution.

- Fiscal issues: Tax situation of the vendor, buyer and underlying assets.

- Composition and agreements in the investor base

Appendix - 163 -

Depending of the LPA, the GP can have a veto right.

In the US, the 2% transfer law is applicable to limited partnerships and 8% can be added to

this percentage if the transaction is advised by a Qualified Matching Service (QMS) defined

by the fiscal authorities.

Appendix - 164 -

7.8 Call with Headway Capital (09 December 2009)

Call Headway Capital 09th December

Contact: Mr Christiaan de Lint (Founder and Partner)


Subject: Market insight, Valuation

Content:

1. Headway Capital company profile Headway Capital is a Private Equity secondary fund-of-funds manager founded in

2004. Headway currently manages two funds totalling c.€ 200 million invested mainly in

Direct secondary (75% of AUM) and in LP Positions (25% of AUM). They specialize in small to

mid-size transactions (<€40m).

2. Market insight For Mr de Lint a correlation exists between the primary and the secondary market of

around 3 to 5%. However it is difficult to determine its future.

Sellers are cyclical; before it was corporations, then banks and today it is everybody.

Reasons are also changing in the time; before people were selling for portfolio management,

today people are selling for distressed reasons.


underlying. A new NAV is estimated and depending on the capital call/distribution profile of

the fund, cash flows are discounted at the targeted IRR and return (which for Headway are

similar to a primary Private Equity fund). A sensitivity analysis is done on growth

assumptions of underlying assets and exit timing.

The valuation of the unfunded depends on the quality and the reliability of the GP:

- If the GP has a good track record and is likely to make good investments then the

unfunded is not taken into account.

- If the GP is not that good then the unfunded is projected at an inferior return to the

target one in order to penalise the value for the risk taken.

Appendix - 165 -

7.9 Call with Campbell Lutyens (10 December 2009)

Call Campbell Lutyens 10th December

Contact: Mr Julien Marencic (Vice President)

When: 10th December, from 02:30PM to 03:30PM (UK time)

Subject: Market insight, Transaction process, Structuring, Valuation.

Content:

1. Campbell Lutyens company profile Campbell Lutyens is an advisory firm founded in 1988 focused on Private Equity and

Infrastructure. The company specialises in raising private equity and infrastructure funds

from institutional investors worldwide and in advising on the secondary sale or restructuring

of portfolios of direct or fund investments.

On the Private Equity secondary market it advises on the sale or restructuring of portfolios of

Private Equity fund or direct investments. They recently closed the sale of the European VC

portfolio of 3i and the restructuring and refinancing (c.€200m) of APEN, a listed vehicle

previously affiliated with AIG.

2. Market insight The size of the secondary market is really difficult to determine, however it seems

that the volume of transaction (Purchase Price + Unfunded) was c. $14/15 bn. in 2008 and

will be around $5/6 bn. in 2009 (apart from sales of single interests). In 2010 the market is

likely to be much more important than in 2009.

The Bid/Ask spread is already tightening but its evolution in the near future will depend on

macroeconomic developments and on the change in NAVs (How GPs mark their investment).

Nowadays the average discount for a portfolio of buyout funds is ca. 20/30%, and can even

be closer to NAV in certain cases.

In 2010 sellers will mainly be Banks and endowments. Indeed, many banks are now focusing

on their core business (and are likely to divest non-core activities) and seeking liquidity (for

instance to repay government’s loans). Endowments should mainly be affected because of

their overcommitment strategy to Private Equity and the denominator effect (Public markets

dropped more than Private Equity NAV).

Reasons for selling are the following:

Appendix - 166 -

- Liquidity concern

- Over-commitment strategy

- Denominator effect

- Change of strategy / Exit of non-core activities

3. Transaction Process All transactions are unique but most transactions can be divided in 4/5 phases:

1. Preparation Phase: Adviser’s due diligence and preparation of the data room

2. Marketing Phase: An NDA (Non Disclosure Agreement) is signed with each investors

to enable them to access the data room. Investors then review the information

contained in the data room and submit an indicative offer for the assets.

3. Due Diligence Phase: A short list of investors is made and the short-listed investors

get access to more information on the data room so they can refine their due

diligence and submit a binding offer.

4. Negotiation and Closing Phase: The preferred party(-ies) enters in exclusive SPA

negotiations with the seller until the document is signed.

5. (Funds transfer)

Typically adviser fees are c.1,5 to 3,5% of NAV + Unfunded depending on the size and

complexity of the transaction.

4. Structure of transactions Straight sales are used but also different structures using SPV and sharing the

economics. Economic-swap agreements (in which the legal ownership and economics of the

assets are decoupled) or Top slicing (in which an investor buys a part of each of the vendor’s

LP interests) are also used.


underlying assets. A secondary price is calculated, which depends on the level of undrawn of

the fund, future cash flows are discounted at the targeted IRR (depending of buyers’ cost of

capital, and target IRR marketed to their own investors) to achieve the target MM return

(typically between 1,8x to 2x).

When more visibility on the future use of cash flows is available, the unfunded component

can be separated and valued in two parts:

- The part which will be used to back existing investments: This part is projected as per

returns expected of each investment in existing business.

- The capital for new transactions: On this part the return depends on how the GP

plans to invest it.

Quoted investment vehicles can be used as a proxy to secondary market pricing, bearing in

mind the following caveats:

Appendix - 167 -

- the NAV of a listed vehicle is based on the underlying NAV of the underlying assets

available at the time of reporting (e.g. usually NAV from the previous quarter)

- the share price of listed investment vehicles can be distorted by the lack of liquidity

in the shares and/or the structure of the vehicle itself (such as use of leverage,

overcommitment strategy…).

The value of a secondary asset is mainly driven by its underlying assets: trading activity

(growth outlook), economic environment (entry multiples…), manager’s experience and

reputation, exit market (M&A and IPO); but also by the unfunded part (depending on the

access to investment plans of the GP and on the quality of GPs) and the exit timing.

Appendix - 168 -

7.10 Meeting with SJberwin (14 December 2009)

Meeting SJberwin 14th December

Contact: Mrs Isabel Rodríguez (Partner) and Mr Roberto Pomares (Partner)


Subject: Market insight, legal issues.

Content:

1. SJ Berwin company profile SJ Berwin is a leading international law firm founded in 1982 delivering legal advice to

financial institutions and international companies. With c. 600 lawyers, SJ Berwin is present

in 12 different countries. SJ Berwin is a leading adviser in the primary Private Equity sector.

They also advise their clients (GPs) and sellers in their client fund on secondary transactions.

As a participant on the secondary market they are also involved on the buy-side.

2. Market insight They advise on transactions of LP interests but also on synthetic transactions where

the GP is selling a part or an entire portfolio.

The Spanish Private Equity market is really a small market (Biggest fund: Magnum Capital

€850m), secondary operations are reduced and players mainly sell for distressed reasons.

GPs also sell because of poor performance in their portfolio.

Reason to sell is mainly because of distressed situation; however for GPs it can also be to sell

a non performing asset/portfolio. Nowadays for a straight sale, discounts are c.25% of NAV.

3. Legal issues Basically in a transaction process, lawyers have two major roles:

- To analyse the existing LPA (Limited Partnership Agreement) of the fund:

Indeed at the very beginning of a transaction, the GP or even the seller requires to

understand what are the transfer conditions and possibilities.

Also the potential buyer requires understanding the LPA and will need a summary of

all its conditions and characteristics.

- To redact the SPA (Share Purchase Agreement): The buyer when closing the

transaction will have to redact the adequate legal document transferring assets and

remaining liabilities. This part is much more complicated in the case of a synthetic

sale (GP direct sale) than in a straight sale of a LP interest.

Pre-emption rights: In general funds do not have pre-emption rights in their LPA.

However if they do it is a crucial issue when planning to sell a LP position.

Appendix - 169 -

GPs generally have a right to veto the transfer but they generally do not use it. Indeed they

more often help the LP to find an investor for its interest in order to reduce the risk of a

default in their fund.

In case of a LP default, the GP can generally choose between different options:

- A secondary sale of the LP interest

- A reduction in the LP’s capital account, typically 25/50% of its investment. Also

incurred costs are reducing the investment.

In the case of a synthetic sale, GPs usually do not give much representation (Reps) or

warranties to the buyer because they want to get rid of sold investments.

In their opinion, the IAFM proposal is not likely to become a law because of the importance

of other markets (US and emergent ones).

Legal advisers usually work about 30/50 hours on a straight sale of LP interest. For a

synthetic sale they work c.500/1000 hours.

Appendix - 170 -

7.11 Call with UBS (02 February 2010)

Call UBS 02nd February

Contact: Nicolas Lanel (UBS Private Funds Group – Head of European Secondary Market

Advisory Team), Jasmine Hunet (UBS Private Funds Group – Secondary Market Advisory)

When: 02nd February 2010, from 3:30PM to 4:30PM (UK time)

Subject: Advisers, Market insight, valuation

Content:

1. UBS PFG profile

UBS PFG is the advisory group in charge of raising private equity funds from

institutional investors worldwide and is advising on the secondary sale or restructuring of

portfolios of direct or fund investments.

The secondary advisory team is composed of 22 professionals across London and New York.

It was founded 6 years ago in New York by Nigel Dawn.

The Secondary advisory team focuses primarily on large or structured transactions and has

pioneered a number of innovative solutions to maximise value or achieve sellers objectives.

The team competes primarily with Campbell Lutyens in Europe and Cogent Partners in the

US.

2. Market insight

� Dry powder:

According to UBS estimates $45bn of dry powder was available to buyers at the beginning

of 2010.

� 2009 transaction volumes decreased to app. $9bn from a peak in 2008 of $20bn.

� Correlation between the primary and the secondary market:

It is estimated that historically, +/-3 to 5% of primary fund commitments are ‘turning

over’ in the secondary markets. This number had been rising steadily up to 2009 when

market conditions made it prohibitive to use the secondary markets as a portfolio

management tool.

UBS estimates that volumes should bounce back to in excess of $20bn, driven by the

resurgence of large portfolio deals.

� Outlook for the next years:

Appendix - 171 -

As the economic outlook further improves and capital calls resume, liquidity pressure will

rise again on certain over-committed investors. This, combined with sustained regulatory

pressure on banks will drive deal flow which will be facilitated by rising valuations supported

by rising public markets and underlying NAV’s. However, as deal flow reaches record levels,

sellers’ ability to drive deal terms will be eroded by human resource limitations at buyers

who will have to carefully elect where to deploy their limited human capital.

� Volcker Rule:

Mr Lanel does not think that the Volcker Rule will lead to a sudden wave of transactions

by banks given the time horizon which has been granted to them to transaction out of

restricted areas. However, regulatory pressure imposed by Basel II had already put things in

motion for banks to dispose of non-core assets in particular in PE and a number of legacy

“pay to play” programmes have already been sold down.

3. Valuation issues

� Listed Investment trusts:

Listed investment trusts have provided a good proxy for the secondary markets until

recently where they have failed to ‘catch up’ with the marked reduction in discounts.

� Expected returns:

During the crisis, returns targeted by buyers went up because of the lack of visibility and

the associated risk. Nowadays, it went back to ‘normalized’ levels of 15 to 20% IRR and app.

1.8x return for LP portfolios and app. 25% and in excess of 2x for ‘secondary directs’.

Appendix - 172 -

7.12 Call with HarbourVest Partners (09 March 2010)

Call HarbourVest Partners 09th March

Contact: Mr Peter Wilson (Managing Director)

When: 09th March 2010, from 2:00PM to 2:30PM (UK time)

Subject: Market insight, Valuation.

Content:

1. HarbourVest Partners company profile HarbourVest Partners is one of the biggest independent buy-side firm that provides

private equity solutions to its clients. Founded in 1982 as an investment division of John

Ancock insurance company, the firm spun out and became independent in 1997. Up to date

it manages $32bn in primary, secondary and direct investments. Its secondary program is

currently investing its seventh fund: Dover Street VII, a vehicle of $2.9bn dedicated to

secondary investments. Their secondary investments include LP interests, direct investments

but also hybrid structures. HarbourVest who already invested $7bn in the secondary market

has a dedicated secondary team of 24 professionals.

2. Market insight

� 2009 secondary transaction volume: $6-8bn was transacted in 2009 on the secondary

market which represents a 25% decline from previous year.

� Correlation between the primary and the secondary market: Historically, +/-3 to 4% of

primary fund commitments are exchanged in the secondary market after an average 4 to

5 years. Considering historical data Mr Wilson also see an increase in the percentage of

exchanged commitment as per last years.

� The Bid/Ask spread is tightening; current discount trend is about 20% to NAV on the

market and should remain similar this year because of the constant perceived risk in the

market.

� Market imbalance: The secondary market is still a buyer market. The dry powder should

be around $20bn in dedicated secondary capital and c. $35-40bn is potentially available

on an opportunistic basis. This total $55-60bn of dry powder which will be invested on

average in the next 4 years should be compared with a potential transaction volume of

about $100bn in the next 4 years which clearly evidences an imbalance on the market

� The Volcker Rule: Mr Wilson does not think this project will be translated in a similar law.

It should not urge banks to sell their PE division/assets. However, the trend clearly

Appendix - 173 -

indicates that regulated financial institutions have to watch carefully if they want to keep

those assets because of its cost of capital and regulatory concerns (Basel II).


underlying assets. They never use a market valuation method (applying the existing discount

of asset class and vintage year to the fund’s NAV).

� Listed Investment trusts: Listed investment trusts do not reflect an accurate trend of the

secondary market. Indeed, the market value of these assets is distorted by market effects

and used leverage.

� Expected returns: Returns depend on the type of assets (LP portfolio/Direct deal).

However as a general rule, they are looking to generate mid twentieth IRR and c. 2x

multiple.

Appendix - 174 -

7.13 Call with Campbell Lutyens (10 March 2010)

Call Campbell Lutyens 10th March

Contact: Mr Julien Marencic (Vice President)

When: 10th March, from 02:00PM to 03:00PM (UK time)

Subject: Financial adviser market, Market insight.

Content:

1. Financial adviser market Key advisers on the market are UBS PFG, Cogent and Campbell Lutyens. Distinction

between secondary advisers and brokers should be made. Several firms offer secondary

transactions brokerage services but few are able to advise and handle large, structured or

complex deals.

As the placement agent activity was dramatically reduced in late 2008/2009, many

placement agents have tried to develop a secondary advisory practice, in an attempt to

offset their declining fundraising revenues.

2. Market insight Nowadays the average discount for a mid-quality portfolio of buyout funds is ca.

10/20% and can be closer to NAV in certain cases (best quality funds); certain funds even

trade at a premium.

� Sellers: Mainly financial institutions

In 2010 most of the secondary deal flow should come from banks. Indeed, in 2009 banks

were facing much pressure because of public recapitalization, M&A, restructuring activities

or even bankruptcy. Since then, banks have been busy trying to survive in a hostile

environment by cleaning up their balance sheet and repaying the public loans they received.

Since September 2009, a number of banks have started to re-assess their PE strategy and

potential solutions could include a sale of all or part of their private equity assets. Indeed,

under Basel II RWA rules, PE assets held by banks typically attract capital requirements from

190% to 400% (depending on the regulator and on each bank’s interpretation and

application of the rules). Since this weighting is applicable to NAV+Unfunded, holding PE

assets requires a lot of capital and is therefore very expensive for regulated financial

institutions. Because of this regulation and of the volume of PE assets on their balance

sheets (for instance, banks used to invest in PE funds in order to gain access to leverage

finance deals), many financial institutions are starting to consider their PE assets as non

Appendix - 175 -

“core” and are likely to divest all or part of their holdings. Additionally, the recovery of

secondary market pricing could accelerate/reinforce this trend.

� Still a buyer market… but not for a long time

The market is still a “buyer’s market”, however some signs that competition is

intensifying are being perceived in recent transactions. As of Q1-2010, CL estimates that the

dry powder available for secondary transactions is about $41-42bn (including announced

interim closes for current fundraisings). Secondary current and future fundraisings for 2010

could add ca. $27bn to this amount, should most of the secondary fundraising targets be

reached.

In terms of volume of transactions, we estimate that there will be ca. $20bn of transactions

per year over the next 3 years, which is consistent with the current dry powder available for

secondaries (up to $60bn, if secondary fundraisings are on target) and a historical average

deployment period of 3 years.

Appendix - 176 -

7.14 Meeting with Arcano Capital (18 March 2010)

Meeting Arcano Capital

18th March

Contact: Vanessa Campion (Analyst); Steve Sceery (Vice President); Ricardo Miró Quesada

(Associate)

When: 18th March, from 06:00PM to 07:15PM

Subject: Fund of fund activity and approach on the secondary market.

Content:

1. Arcano company profile

The Arcano group, founded in 2003 is an independent company with three divisions:

I) Corporate Finance Advisory, (II) Alternative Investment Management, (III) Multi-family

Office Advisory.

Arcano Capital is a Private Equity fund of funds manager. They currently have assets under

management of approx. € 800 m. invested globally. Its funds have a capacity to invest up to

20% of the committed capital in secondary transactions.

2. Approach on secondary assets:

Arcano Capital invests on an opportunistic basis in secondary assets. They prefer to

invest in funds where they have already invested in on the primary market. They usually

invest in early secondary looking for at least 25% IRR.

To this date they have closed one secondary transaction in November 2009 buying an LP

stake in a fund where they already have a primary commitment. The secondary market is for

them a way to re-balance their portfolios, take advantage of market inefficiencies, gain more

exposure to managers they like and to enter funds where they previously did not invest in

the past.

Main sources of secondary opportunities are portfolio GPs and family offices. Advisers are

also an important source of opportunities.

3. Market insight

� NAV levels:

Last quarter the general trend of NAV surge 15% mainly due to the increase in EBITDA

and valuation multiples of portfolio companies.

Appendix - 177 -

� Primary fundraising

Primary fundraising in 2009 did not meet expectations. 2010 is expected to improve

although it is also expected to be a difficult year in terms of fundraising.

� Valuing the dry powder of opportunistic buyers in the secondary market

Opportunistic buyers such as mainly primary fund of funds represent a big part of the

secondary market volume. However this part of the secondary volume is difficult to value

because of the size of deal and of their opportunistic condition.

By applying a discount to the traditional allocation of fund of funds (c. 20%) to the secondary

market on the total dry powder of mainly primary fund of funds, we could get a good proxy

to the money they can dedicate to this market.

Appendix - 178 -

8. Analysis of published historical data

As the volumes in the market are very difficult to value precisely, I analyzed the data published by different participants,

compared it and used the most reliable. In the following analysis the data used for this study is in the grey cells.

8.1 Historical transaction volume in the secondary market


In $bn

Source 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

Inside the growing market for VC 0.6

Dow Jones Guide to sec Market

Permal capital Mangement

UBS (presentations)

Carta Diem (Lexington Estimates) 0.2 0.4 0.4 0.8 0.5 1 0.5 0.6 1.4 2.2 2.8

PE Magazine (PE Analyst)

PEI Manager (Cogent/Capital Dynamics)

Triago 2.2 2.8

Dow Jones Guide to sec Market Buyers 0.579 0.71 1.494 2.35 3.09

Capital Dynamics

Green Park Cap

Campbell Lutyens (Mail Mr Marencic)

Lexington Partners (Distressed debt report)

HarbourVest Partners (Mr Wilson call)

Cogent Partners (Cogent and VentureXpert) 0.5 0.6 1.4 2.2 2.8

Selected data 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

0.2 0.4 0.4 0.8 0.5 1 0.579 0.71 1.494 2.35 3.09

Appendix - 179 -


In $bn

Source 2001 2002 2003 2004 2005 2006 2007 2008 2009

Inside the growing market for VC 8

Dow Jones Guide to sec Market 10/15

Permal capital Mangement 6.5 7 6.5 8 11 14

UBS (presentations) 8 12 15 20 9.1

Carta Diem (Lexington Estimates) 2.1 1.9 5 6.9

PE Magazine (PE Analyst) 5 7 6.7 10 18

PEI Manager (Cogent/Capital Dynamics) 6.5 7 6.5 12 13.5 20

Triago 2.1 2.8 7 7.7 7.5 10 13 14.5

Dow Jones Guide to sec Market Buyers 2.278 2.092 6.904 8.38 7.468 10.268 13.35 16.116

Capital Dynamics 4 5.1 11 17 18 17

Green Park Cap 1.9 15

Campbell Lutyens (Mail Mr Marencic) 6

Lexington Partners (Distressed debt report) 8.8

HarbourVest Partners (Mr Wilson call) 6/8

Cogent Partners (Cogent and VentureXpert) 2.1 1.9 5 7 6.7 10 18 30 6/7

Selected data 2001 2002 2003 2004 2005 2006 2007 2008 2009

2.278 2.092 6.904 8.38 7.468 10.268 13.35 16.116 9.1

Appendix - 180 -

8.2 Secondary fundraising


Source (in $bn) 1995 1996 1997 1998 1999 2000 2001 2002

Probitas Partner 0.8 0.8 0.4 2.6 2.2 2.1 4.5 4.1

UBS

PE Magazine (PE Analyst)

Dow Jones Guide to sec Market Buyers 1.068 0.653 2.741 2.021 2.445 6.405 3.961

Green Park Cap

JP Morgan AM (Thomson Reuters; VentureXpert) 2.9 5.3 3.6

Preqin (Private Equity spotlight January 2010)

Selected data 1996 1997 1998 1999 2000 2001 2002

Dow Jones Guide to sec Market Buyers (1996-2008)/Preqin (2009) 1.068 0.653 2.741 2.021 2.445 6.405 3.961

Source (in $bn) 2003 2004 2005 2006 2007 2008 2009

Probitas Partner 3.5 8.4 5.6 6.1 15.1 7.4

UBS 7.7 8.6 9.1 20.2 26.7 30.2

PE Magazine (PE Analyst) 3.1 9 6.3 10.7 16.2

Dow Jones Guide to sec Market Buyers 7.425 7.812 7.245 12.955 12.316 8.893

Green Park Cap 20

JP Morgan AM (Thomson Reuters; VentureXpert) 6 5.5 6.9 7 14.2 5.5

Preqin (Private Equity spotlight January 2010) 18.5

Selected data 2003 2004 2005 2006 2007 2008 2009

Dow Jones Guide to sec Market Buyers (1996-2008)/Preqin (2009) 7.425 7.812 7.245 12.955 12.316 8.893 18.5

Appendix - 181 -

8.3 Primary fundraising


In $bn

Source 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Partners Group

Permal Capital Management

Carta Diem (Fuente Private Equity Analyst) 21.1 13.9 17.4 17.8 33.3 38.6 49.5 80.5 117.2 132.7

Preqin 93 143 180

JP Morgan AM (Thomson Reuters; VentureXpert)

Selected data 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Carta Diem/Partners Group/Preqin 21.1 13.9 17.4 17.8 33.3 38.6 49.5 80.5 117.2 132.7

In $bn

Source 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Partners Group 250 140 70 80 120 255 370 455 375 200

Permal Capital Management 265 155 75 85 125 250 340 395 255

Carta Diem (Fuente Private Equity Analyst) 243 167.8 91.8 82.3 126.7

Preqin 250 190 146 135 206 344 535 644 629 246

JP Morgan AM (Thomson Reuters; VentureXpert) 333 244 175 133 183 334 449 585 636 221

Selected data 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Carta Diem/Partners Group/Preqin 250 140 70 80 120 255 370 455 375 246

Data: Thomson Reuters; AVCJ; EVCA; Asia Private Equity; NVCA; Dow Jones PE Analyst; Preqin (2009)

Appendix - 182 -

9. Secondary market projection model

I. Historical Data

$ bn 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

21.1 13.9 17.4 17.8 33.3 38.6 49.5 80.5 117.2 132.7 250 140 70 80 120 255 370 455 375 246

0.2 0.4 0.4 0.8 0.5 1 0.579 0.71 1.494 2.35 3.09 2.278 2.092 6.904 8.38 7.468 10.268 13.35 16.116 9.1

2. Assumption - Probability of transaction distribution

Fund year 1 2 3 4 5 6 7 8 9 10 Total

Probability 0% 5% 10% 20% 30% 20% 10% 5% 0% 0% 100%

Average age of fund purchased (years) 0 0.10 0.30 0.80 1.50 1.20 0.70 0.40 0.00 0.00 5.00

3. Historical turnover

Probability 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

1990 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1991 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1992 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1993 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1994 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1995 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1996 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1997 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1998 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

1999 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

2000 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

2001 0% 5% 10% 20% 30% 20% 10% 5% 0%

2002 0% 5% 10% 20% 30% 20% 10% 5%

2003 0% 5% 10% 20% 30% 20% 10%

2004 0% 5% 10% 20% 30% 20%

2005 0% 5% 10% 20% 30%

2006 0% 5% 10% 20%

2007 0% 5% 10%

2008 0% 5%

2009 0%

Primary fundraising (Thomson Reuters; AVCJ; EVCA;

Asia Private Equity; NVCA; Dow Jones PE Analyst;

Preqin (2009))

Secondary transaction volume Dow Jones Guide to

Sec. Market Buyers(1996-2008)/ UBS (2009)

Appendix - 183 -


Vintage funds potentially brought to market

Primary raised 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

1990 21.1 - 1.06 2.11 4.22 6.33 4.22 2.11 1.06 - - - - - - - - - - - -

1991 13.9 - - 0.70 1.39 2.78 4.17 2.78 1.39 0.70 - - - - - - - - - - -

1992 17.4 - - - 0.87 1.74 3.48 5.22 3.48 1.74 0.87 - - - - - - - - - -

1993 17.8 - - - - 0.89 1.78 3.56 5.34 3.56 1.78 0.89 - - - - - - - - -

1994 33.3 - - - - - 1.67 3.33 6.66 9.99 6.66 3.33 1.67 - - - - - - - -

1995 38.6 - - - - - - 1.93 3.86 7.72 11.58 7.72 3.86 1.93 - - - - - - -

1996 49.5 - - - - - - - 2.48 4.95 9.90 14.85 9.90 4.95 2.48 - - - - - -

1997 80.5 - - - - - - - - 4.03 8.05 16.10 24.15 16.10 8.05 4.03 - - - - -

1998 117.2 - - - - - - - - - 5.86 11.72 23.44 35.16 23.44 11.72 5.86 - - - -

1999 132.7 - - - - - - - - - - 6.64 13.27 26.54 39.81 26.54 13.27 6.64 - - -

2000 250 - - - - - - - - - - - 12.50 25.00 50.00 75.00 50.00 25.00 12.50 - -

2001 140 - - - - - - - - - - - - 7.00 14.00 28.00 42.00 28.00 14.00 7.00 -

2002 70 - - - - - - - - - - - - - 3.50 7.00 14.00 21.00 14.00 7.00 3.50

2003 80 - - - - - - - - - - - - - - 4.00 8.00 16.00 24.00 16.00 8.00

2004 120 - - - - - - - - - - - - - - - 6.00 12.00 24.00 36.00 24.00

2005 255 - - - - - - - - - - - - - - - - 12.75 25.50 51.00 76.50

2006 370 - - - - - - - - - - - - - - - - - 18.50 37.00 74.00

2007 455 - - - - - - - - - - - - - - - - - - 22.75 45.50

2008 375 - - - - - - - - - - - - - - - - - - - 18.75

2009 246 - - - - - - - - - - - - - - - - - - - -

Historical turnover rate

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Total Potential - 1 3 6 12 15 19 24 33 45 61 89 117 141 156 139 121 133 177 250

Effective Secondary transactions 0.2 0.4 0.4 0.8 0.5 1 0.579 0.71 1.494 2.35 3.09 2.278 2.092 6.904 8.38 7.468 10.268 13.35 16.116 9.1

Effective Turnover rate 6.5% 3.1% 2.9% 4.6% 5.3% 5.0% 2.6% 1.8% 4.9% 5.4% 5.4% 8.5% 10.1% 9.1% 3.6%

Weighted average turnover rate from 1995-2002 3.38%




Appendix - 184 -

Projections

Assuming constant fundraising in 2010E/2011E/2012E as of 2009 246

Probability of future transaction distribution

Fund raised 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

1999 132.7 20% 10% 5% 0% 0%

2000 250 30% 20% 10% 5% 0% 0%

2001 140 20% 30% 20% 10% 5% 0% 0%

2002 70 10% 20% 30% 20% 10% 5% 0% 0%

2003 80 5% 10% 20% 30% 20% 10% 5% 0% 0%

2004 120 0% 5% 10% 20% 30% 20% 10% 5% 0% 0%

2005 255 0% 5% 10% 20% 30% 20% 10% 5% 0%

2006 370 0% 5% 10% 20% 30% 20% 10% 5%

2007 455 0% 5% 10% 20% 30% 20% 10%

2008 375 0% 5% 10% 20% 30% 20%

2009 246 0% 5% 10% 20% 30%

2010E 246 0% 5% 10% 20%

2011E 246 0% 5% 10%

2012E 246 0% 5%

2013E 246 0%

Appendix - 185 -


Commitments available to transact on the secondary market

2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

1999 26.5 13.3 6.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0

2000 75.0 50.0 25.0 12.5 0.0 0.0 0.0 0.0 0.0 0.0

2001 28.0 42.0 28.0 14.0 7.0 0.0 0.0 0.0 0.0 0.0

2002 7.0 14.0 21.0 14.0 7.0 3.5 0.0 0.0 0.0 0.0

2003 4.0 8.0 16.0 24.0 16.0 8.0 4.0 0.0 0.0 0.0

2004 0.0 6.0 12.0 24.0 36.0 24.0 12.0 6.0 0.0 0.0

2005 0.0 0.0 12.8 25.5 51.0 76.5 51.0 25.5 12.8 0.0

2006 0.0 0.0 0.0 18.5 37.0 74.0 111.0 74.0 37.0 18.5

2007 0.0 0.0 0.0 0.0 22.8 45.5 91.0 136.5 91.0 45.5

2008 0.0 0.0 0.0 0.0 0.0 18.8 37.5 75.0 112.5 75.0

2009 0.0 0.0 0.0 0.0 0.0 0.0 12.3 24.6 49.2 73.8

2010E 0.0 0.0 0.0 0.0 0.0 0.0 0.0 12.3 24.6 49.2

2011E 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 12.3 24.6

2012E 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 12.3

2013E 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0

TOTAL 140.5 133.3 121.4 132.5 176.8 250.3 318.8 353.9 339.4 298.9

Projections

Years 2005 2006 2007 2008 2009 2010E 2011E 2012E 2013E 2014E

Downside case (5.6%) 5.60% 7.5 10.3 13.4 16.1 9.1 14.0 17.9 19.8 19.0 16.7

Average 17.5

Base case (6.4%) 6.41% 7.5 10.3 13.4 16.1 9.1 16.0 20.4 22.7 21.7 19.1

Average 20.0

Upside case (7.2%) 7.20% 7.5 10.3 13.4 16.1 9.1 18.0 23.0 25.5 24.4 21.5

Average 22.5

Appendix - 186 -

10. Historical valuations in the Private Equity secondary market

10.1 LBO funds

Secondary bids for LBO funds over time (in % of NAV):

Source: Author’s own based on data from Cogent Partners pricing analysis (2007-2008-2009-2010).

10.2 Venture capital funds

Secondary bids for venture capital funds over time (in % of NAV):

Source: Author’s own based on data from Cogent Partners pricing analysis (2007-2008-2009).

20%

30%

40%

50%

60%

70%

80%

90%

100%

110%

120%

2005 2006 2007 H108 H208 H1 09 H2 09 H1 10

Average

High

Average

Median

Average

Low

30%

40%

50%

60%

70%

80%

90%

100%

110%

2005 2006 2007 H108 H208 H1 09 H2 09

Average

high

Average

median

Average low

Appendix - 187 -

10.3 Other funds (real estate- infrastructure- distressed)

Secondary bids for real estate, infrastructure and distressed funds over time (in % of NAV):

Source: Author’s own based on data from Cogent Partners pricing analysis (2007-2008-2009).

30%

40%

50%

60%

70%

80%

90%

100%

110%

2005 2006 2007 H108 H208 H1 09 H2 09

Average

high

Average

median

Average

low

Appendix - 188 -

11. Structure of listed Private Equity funds

11.1 Structure of listed direct Private Equity fund

Source: Website of LPX Group

Appendix - 189 -

11.2 Structure of listed indirect Private Equity fund (listed fund of funds)

Source: Website of LPX Group