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The New York Times reported that Harvard University's endowment lost 22 percent in the second half of 2008. As a result of the market turmoil and problems in the private equity market, Harvard is seeking to sell $1.5 billion of its private equity holdings. And this is just one institution. For years the private equity market seemed invincible - values would forever increase, investors would always clamor to get a piece of a fund, and investors would never default on future commitments. But the recent upheaval in the financial markets has changed all of these assumptions. Many institutions are now seeking to liquidate interests in private equity funds in an effort to rebalance their assets and reduce their unfunded liabilities. This rush to liquidate is creating a massive supply in interests and is likely to result in a robust secondary market for private equity interests.
Why Does a Secondary Market Exist?
Typically, investors in private equity funds acquire their interests directly from a fund, in a "primary" transaction. In a private equity "secondary" transaction, an existing investor in a fund seeks to sell the interest to a buyer, thereby creating a secondary market for that interest. Over the past several years, this market has grown tremendously and, for reasons discussed below, is expected to continue to grow at an accelerated pace in the coming months as many investors look to reduce their private equity exposure.
Private equity fund investments, by their nature, are illiquid. State and federal securities laws and the fund's governing agreements impose significant restrictions on transfer. The life of a fund is typically 10 years or more, and investors do not have redemption, withdrawal, or other rights to cash out their investment. Investors are obligated to contribute capital in installments over the life of the fund, and there are significant penalties for default on these contribution obligations. Thus, an investment in a fund represents a longterm commitment. Secondary buyers, however, can, with the consent of the relevant funds, offer liquidity for investors looking to sell an individual interest in a fund, or a portfolio of fund interests.
The buyer in a secondary transaction assumes the obligations (including obligations to make capital contributions) of the seller under the fund's governing document (typically...