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Capital Unbound: Exploring New Liquidity Solutions in Private Markets

The demand for private market liquidity is intensifying as private equity (PE) firms and private companies grapple with evolving market dynamics and increased pressure from stakeholders.

November 06, 2024 • Estimated Reading Time: 15 minutes

In this article

The demand for private market liquidity is intensifying as private equity (PE) firms and private companies grapple with evolving market dynamics and increased pressure from stakeholders. According to a survey by JP Morgan nearly two-thirds (59%) of private company decision-makers report growing expectations for liquidity events from investors, C-suite executives, and equity-holding employees. This surge in demand reflects the critical role liquidity plays not only in portfolio management but also in talent acquisition; in fact, 93% of decision-makers consider liquidity events valuable to prospective employees when assessing job offers.

As private companies choose to stay private longer, they are redefining traditional pathways to liquidity. By delaying IPOs, companies are leveraging the flexibility of the private markets to navigate economic uncertainties while still creating liquidity through tender offers, direct secondary sales, and other means. This shift is pushing the private capital markets to adapt to new liquidity demands, fostering resilience and creating room for growth outside of public exchanges.

Furthermore, liquidity events in the private market are increasingly driven by a variety of strategic goals. Companies utilize these events not just for wealth-building but also to validate employee performance (85%), align business and employee goals (84%), and support other fiscal objectives. This complexity highlights the need for private liquidity events to evolve, addressing multifaceted business priorities that extend beyond traditional capital gains.

In this report, we delve into the mechanisms and trends shaping liquidity in the private equity landscape. Key findings include the growing role of the secondary market, where volumes have surged from $25 billion in 2012 to $112 billion by 2023. Despite this growth, the secondary market remains undercapitalized with only $171 billion in dry powder, underscoring the significant gap between private equity's $5.3 trillion AUM and its current liquidity infrastructure. We also explore how longer hold periods, increased investor demand, and evolving exit strategies are collectively shaping the future of private equity liquidity.

Private Equities Total Exits Annually

Total exits peaked in 2021, likely due to a post-pandemic surge in market activity as PE firms sought liquidity amid favorable market conditions.

Since then, there’s been a noticeable decline in the number of exits, particularly from 2022 onward, as macroeconomic uncertainties and rising interest rates have impacted exit opportunities.

  • Secondary Sales 

    • Secondary sales remained a significant portion of total exits, with a decline visible post-2021. This could be attributed to growing demand for liquidity as PE firms sought ways to extend holding periods, often facilitated by continuation funds.

    • The decline in secondary sales exits after 2021 also reflects an increased reliance on continuation funds, as PE firms seek to maintain exposure to high-value assets without fully exiting. This trend aligns with the increased use of NAV-based financing and other liquidity solutions.

  • Trade Sales:

    • Trade sales, the most prominent type of exit each year, also saw a significant drop post-2021. Trade sales are traditionally popular as they offer a clear exit path and immediate liquidity. However, the declining numbers from 2022 suggest PE firms faced challenges finding strategic buyers amid market volatility.

    • This aligns with the industry's growing preference for secondary solutions or NAV-based strategies, as trade sales have become less reliable for immediate liquidity.

  • IPOs:

    • The sharp increase in IPO exits in 2021 reflects a period of favorable market conditions, with many firms capitalizing on high valuations. However, IPOs have dropped considerably in the following years, reflecting a volatile public market environment.

    • The reliance on IPOs for liquidity has waned, making a case for alternative liquidity solutions such as secondaries and continuation funds.

Secondaries deep-dive

The secondaries market has emerged as a critical and dependable mechanism to address the growing liquidity demands within the private equity (PE) sector. This market’s expansion is indicative of its increasing importance, with total volume surging from $25 billion in 2012 to $112 billion by 2023, reflecting an impressive compound annual growth rate (CAGR) of approximately 15%.

Historically, the secondaries market provided liquidity mainly through the sale of limited partner (LP) interests. However, its evolution has brought new structures, such as continuation funds, which allow general partners (GPs) to hold onto valuable assets longer while still delivering liquidity to LPs. This flexibility has made secondaries an attractive solution in an environment where traditional exit paths like IPOs and trade sales have faced constraints.

As shown in the figures above, the market experienced a dip in 2020, with volume decreasing to $60 billion. This decline was largely driven by the economic uncertainty and volatility caused by the COVID-19 pandemic, which temporarily hampered transaction activity across the private equity landscape. However, the market quickly rebounded, demonstrating its resilience and adaptability. By 2021, the secondaries market volume had surged to $132 billion, driven by pent-up demand, favorable economic conditions, and an influx of capital seeking exposure to private equity assets.

This boom in 2021 underscored the secondaries market’s role as a reliable liquidity provider during periods of market instability. With the ability to offload assets or restructure portfolios through continuation funds, PE firms have gained the flexibility needed to navigate complex market conditions. The sustained growth of the secondaries market highlights its critical role in offering liquidity solutions that traditional exit channels may not consistently provide, especially in times of economic turbulence.

Secondaries compared with PE AUM

The comparison of Private Equity Assets Under Management (PE AUM) and the secondaries market volume underscores the secondary market's growing relevance within the PE ecosystem. While PE AUM has steadily increased from $1.9 trillion in 2012 to $5.3 trillion in 2023, marking a 10% CAGR, the secondary market's expansion has outpaced this growth with a CAGR of 15%. 

This discrepancy signals that while PE funds have accumulated vast amounts of capital, they increasingly rely on the secondary market to manage liquidity demands, particularly as traditional exit avenues fluctuate.

The data reveals that although the secondary market volume remains a small fraction of total PE AUM, its growth trajectory reflects a heightened focus on alternative liquidity solutions. The peak in 2021, where secondary volumes reached $132 billion, coincides with record levels of PE AUM, suggesting that the industry is leveraging secondary transactions to enhance flexibility and optimize portfolio management.

This trend underscores how critical the secondary market has become in sustaining liquidity and mitigating risk amid evolving economic conditions.

Secondary Dry Powder levels

The chart presents the Secondary Dry Powder Levels compared to the Aggregate Secondary Capital Raised from 2017 to 2023. Dry powder refers to the unspent capital that private equity firms have available for deployment, while the aggregate capital raised represents the total funds raised during the same period. This chart is critical for understanding the liquidity dynamics in the secondaries market, a key segment within private equity that offers an alternative liquidity solution, especially during periods when traditional exit routes like IPOs and trade sales are less favorable.

Insights from the chart

  • Growing Dry Powder with Fluctuating Capital Raised: From 2017 to 2023, dry powder in the secondaries market has been on a steady upward trajectory, increasing from $76B in 2017 to $171B in 2023. 

    This reflects an accumulation of uninvested capital, which may indicate that firms are holding back on deployments, possibly waiting for more favorable market conditions or better investment opportunities.

  • Variability in Capital Raised: The aggregate secondary capital raised, on the other hand, shows significant fluctuations. After peaking at $78B in 2020, fundraising declined to $38B in 2021 and dropped further to $31B in 2022 before rebounding to $91B in 2023. This volatility can be linked to market uncertainty caused by macroeconomic factors such as COVID-19, inflationary pressures, and interest rate hikes. 

    The drop in capital raised during 2021 and 2022, coupled with sustained high levels of dry powder, suggests that secondaries firms were more cautious during these years, likely due to valuation concerns and uncertainty around deal flow.

  • 2023 Surge in Capital Raised: The sharp rise in capital raised in 2023, jumping to $91B, could signal a renewed confidence in the market and a growing appetite for secondary transactions as firms look to deploy the dry powder accumulated over previous years. 

    This suggests that liquidity events and market conditions have improved, leading to a more favorable environment for deploying capital.

Secondaries Dry Powder to Deployment Ratio

The following Dry Powder to Deployment Ratio chart illustrates the ratio between secondary dry powder (capital reserved for deployment) and the aggregate secondary capital raised from 2017 to 2023. This ratio is calculated by dividing the total dry powder by the amount of capital raised in a given year. 

It serves as a useful metric to gauge the balance between unspent capital and newly raised funds, providing insights into liquidity trends and investment activity in the secondary market.

Dry Powder Figure insights

  • 2018 Peak in Ratio (4.63): In 2018, the ratio reached its highest point at 4.63. This indicates that for every dollar raised in aggregate secondary capital, over four dollars remained unspent in dry powder. This imbalance suggests a cautious approach to deal-making, possibly due to uncertainty in market conditions or the inability to find suitable investment opportunities at favorable valuations.

  • 2019 and 2020 Dip in Ratio: In 2019 and 2020, the ratio decreased to 4.09 and further to 1.59, respectively. This trend points to a more aggressive deployment of dry powder relative to the capital raised, with firms making use of their existing reserves to pursue secondary deals. The significant drop in 2020 could also be attributed to market disruption caused by the COVID-19 pandemic, where valuations may have become more attractive, leading to quicker deployment of funds.

  • 2021 Rebound (3.68): By 2021, the ratio climbed back up to 3.68, signifying a renewed accumulation of dry powder relative to capital raised. This rise suggests that firms were once again hesitant to deploy capital as quickly as they raised it, possibly due to concerns over pricing, competition, or economic uncertainty following the initial pandemic shock.

  • 2023 Decline (1.87): The ratio in 2023 dropped to 1.87, reflecting a notable increase in capital deployment. This decline suggests that firms were more active in investing their dry powder, likely responding to improved market conditions and a rise in secondary deal activity. The lower ratio signals that dry powder is being deployed at a higher rate relative to new capital raised, which may indicate increased confidence in deal flow and opportunities.

Continuation Funds

The evolution of the PE secondary market can also be explained by the growth in GP-led transactions, particularly through continuation funds, playing a growing role in delivering liquidity options to investors. Continuation funds allow General Partners (GPs) to extend their hold on valuable assets by facilitating exits that roll them into new funds, giving investors the option to exit or continue their participation. This structure has become increasingly vital as traditional exit routes, such as IPOs or trade sales, have faced delays or uncertainty.

According to recent data, exits through continuation funds are projected to reach $9 billion in 2024, signaling a strong upward trend in their usage. The total number of continuation funds is also expected to reach 100 this year, further solidifying their role in the PE ecosystem.

Insights on the chart

  • Steady Growth in Value: The chart illustrates a notable rise in the value of exits through continuation funds, starting from just $0.2 billion in 2014 to a projected $9 billion in 2024. This exponential growth reflects a clear shift toward this exit strategy as a viable solution for liquidity, driven by PE firms' desire to extend their hold on high-performing assets.

  • Increasing Fund Count: The number of continuation funds has seen significant growth, increasing from a modest 5 funds in 2014 to a projected 100 in 2024. This jump highlights the increasing reliance on continuation funds as an essential tool for PE firms to manage liquidity, prolong asset life cycles, and ensure smoother capital reallocation.

  • Liquidity Flexibility: As the market continues to mature, the ability to offer flexible liquidity options via continuation funds becomes crucial, especially in an environment where external exit routes are volatile. Bankers and PE executives can view this trend as a way to provide both liquidity to investors and operational continuity for assets.

Conclusion

To summarize, the growing demand for liquidity in private markets is reshaping how private equity firms navigate capital management and investor expectations. The rise of continuation funds and the expansion of the secondaries market have emerged as vital tools in this evolving landscape, offering flexible liquidity solutions where traditional exit routes like IPOs and trade sales have become less predictable. 

As PE firms increasingly rely on continuation funds to extend the lifecycle of high-performing assets, investors gain opportunities for liquidity without full exits, allowing firms to optimize capital reallocation while mitigating risks.

The significant growth in both the value and number of continuation funds, alongside the increasing dry powder available for deployment, reflects the strategic importance of secondary transactions in maintaining liquidity. 

While challenges remain, particularly around the deployment of dry powder and market volatility, the continued rise of secondaries and GP-led transactions points to a more resilient liquidity infrastructure. Understanding these trends is essential for capitalizing on emerging opportunities in private markets and aligning investment strategies with the shifting dynamics of liquidity.

Sources & References