Secondary Transactions: Buying Existing Positions, GP-Led and Stapled

A secondary transaction sells something that already exists rather than something newly issued. Two different things carry the name: an investor's interest in a private fund, sold on to another investor, and part or all of a fund's stake in a company, sold on to a new holder. The price is quoted against a reported value at a stated date, and the obligation still attached travels with it.

Everything here rests on one distinction that the word itself hides, and it is worth settling before any arithmetic arrives. Consider a flat in a building going up nearby. Bought from the builder, the money pays for cement, steel and wages, and one more floor gets built. Bought from the person already living in it, the identical flat takes the same money into that person's bank account, and not one extra brick is laid. Same flat, possibly the same price, completely different economics for everybody other than the buyer. A primary transaction creates something new and puts money into the thing itself; a secondary transaction moves something that already exists from one holder to the next and puts money into the seller. With that held, the two meanings of the word separate cleanly and the shapes that follow stop being confusing.

What is actually changing hands when nothing new is created?

A secondary transactionThe sale of something that already exists rather than something newly issued. is defined by what it does not do. Nothing is issued. No new instrument comes into existence, and the total amount outstanding is exactly the same after the transaction as it was before. The only change is the name written against the position. A primary transactionThe creation of a new interest, which puts new money into a fund or a business. is the other thing entirely: an interest that did not exist before now does, and the money paid for it lands in the fund or in the business rather than in a previous holder's hands.

Nilgiri Growth Partners Fund II, invented, is the vehicle worked throughout this guide. The fund is managed by Nilgiri Alternatives Advisors Private Limited, held in trust by Nilgiri Trusteeship Services Private Limited, and sponsored by Nilgiri Financial Holdings Private Limited. Its clock is counted from its own final close, so a date here is written as Year 8 Q3 and never as a calendar date. Everything quoted below stands as at the end of its Year 9 Quarter 2, or 8.50 years after that close.

Two facts about that fund before the mechanism starts. Both get used later. Nilgiri Growth Partners Fund II has nine holdings, and they cost Rs 4,00,00,00,000 between them. Four of the nine are gone entirely, being holdings 1, 2 and 3 sold and holding 5 written off in full; five are still held, being holdings 4, 6, 7, 8 and 9; and four plus five is nine, the whole portfolio. One holding has been only partly sold, and therefore sits on both sides of that line. There have been five exit events across five holdings, one more event than the number of positions that have left. So a count on a private portfolio has to say which count it means: positions gone, positions still held, or events that happened. Three different numbers describe the same nine companies, and a note that does not say which one it is using cannot be checked by anybody.

Which of the two things does the word secondary mean here?

Most confusion in the subject lives here, and it is not conceptual confusion. One word is doing two jobs. Ask somebody who works in private markets whether they did a secondary last year and the honest answer is a question back: which kind?

The first meaning is an investor's position in a fund. Twelve investors committed money to Nilgiri Growth Partners Fund II, invented, and each of them holds a fund interestAn investor's whole position in a fund: what its capital account shows and what it still has to pay in.: one line in the fund's own records recording what that investor has paid in, what it has been paid back, what share of the remaining holdings it has, and what it still has to pay when asked. Selling that line to somebody else is a secondary. The buyer becomes an investor of the same fund, in the seller's place, with the seller's number. Nothing about the nine portfolio companies changes at all. Not one of them hears about it.

The second meaning is the fund's own position in a company. Nilgiri Growth Partners Fund II holds a stake in nine businesses, and it can sell one of those stakes to somebody else, in whole or in part. When the buyer is another private fund rather than a company in the same industry, that is routinely called a secondary sale, and this fund has done exactly one of those on the whole position and one more on part of a position. The tell is the object the word points at: an investor's line in a fund's records, or a fund's shareholding in a business. An investor's line and a fund's shareholding are not two versions of the same transaction. The two transactions involve different sellers, different buyers, different documents and different prices, and only one thing joins them.

How does one of these transactions actually run?

How Private-Fund Secondary Transactions Work

Take the first meaning, an interest in a fund, and walk it end to end. Seven steps, and they are worth numbering because the order matters more than any single one of them. The thing to watch is where the price gets fixed relative to where the work gets done.

The everyday version is a resale flat again, but with a wrinkle. A price is agreed in March against a valuation struck in December. Between December and the day the keys change hands, the seller pays two months of maintenance charges and receives one month of rent from the tenant. Neither of those was in the December valuation, so somebody has to work out who they belong to and adjust the cheque. A private fund interest works the same way, except the maintenance charge is a capital call and the rent is a distribution, and both can be very large.

Look at what that ordering does. The buyer forms its view of the underlying businesses at step four, after the price is agreed at step three. The ordering is the reverse of the instinct most readers bring, and it is not sloppiness. There is no other anchor available. The seller will not open the fund's confidential reporting to a buyer who has not committed to a number, and the buyer has nothing to work from until it does. So the percentage is agreed first, against a figure neither side struck, and the diligence that follows either confirms the buyer's willingness or ends the transaction.

Why is the price a percentage instead of a number of rupees?

Because there is nothing else to quote it against. A listed share has a screen. An interest in a private fund has one number attached to it, the value the fund itself reports for what it still holds, struck at a stated date by a process that belongs to another part of this subject and is used here without being re-explained. The date that figure is struck at is the reference dateThe date whose reported figure the price is quoted against., and the price is said as a percentage of the figure standing at it.

Sit with how strange that is. No other way out of a private position has that feature. In every other route a business is being sold, and the two sides argue about its worth. Here, what is being sold is somebody's position, and the argument is about a percentage of a figure that the seller did not set and the buyer cannot test. The anchor in a secondary is a carrying value produced by a third process. Neither party to the transaction controls it and neither party can verify it from outside. The percentage is the whole of the negotiation.

Now put this fund's own numbers on it. No investor of Nilgiri Growth Partners Fund II has sold its interest, so the transfer priced below is one that could be done rather than one that was. Investor 1 is a domestic life insurance company, invented, and it committed Rs 1,00,00,00,000 out of the Rs 5,00,00,00,000 of total commitments, so it holds 20.0 per cent of the fund measured against total commitments. The fund still holds five businesses reported at Rs 2,82,00,00,000 between them at the end of Year 9 Q2. Investor 1's share of that reported figure is 20.0 per cent of Rs 2,82,00,00,000, or Rs 56,40,00,000.

The Rs 56,40,00,000 is the denominator for every percentage that follows. At 100 per cent of it a buyer pays Rs 56,40,00,000. At 90 per cent it pays Rs 50,76,00,000, or Rs 5,64,00,000 less. At 60 per cent it pays Rs 33,84,00,000 and at 120 per cent it pays Rs 67,68,00,000. Secondary prices are settled privately between two holders and never posted anywhere. A range like this one shows the arithmetic and not the price anybody would offer.

What else crosses over besides the value?

An obligation, and it is the half of the transaction that gets forgotten. When an investor commits money to a closed-end private fund it does not hand the money over on day one. It promises. The fund then calls what it needs, when it needs it, and the part of the promise not yet called is the unfunded commitmentThe part of a commitment promised and not yet called, which travels with the interest when it is sold.. Sell the interest and that promise goes with it. The buyer is not offered the choice.

Taking over somebody's under-construction flat halfway through has the same shape. The flat arrives with the four instalments still due to the builder, on dates the incoming owner did not pick. No invoice arrives that can be argued with; the demand simply lands and is paid. An unfunded commitment is a duty rather than an asset, it is fixed by the contract rather than by the price, and it arrives later as a call with a notice period attached.

Now derive the obligation for this interest rather than quoting it. A careless note goes wrong at exactly this step. Nilgiri Growth Partners Fund II, invented, has drawn Rs 4,80,00,00,000 of the Rs 5,00,00,00,000 committed to it. Drawing 96.0 per cent leaves the fund as a whole Rs 20,00,00,000 unfunded. Every investor is called strictly in proportion, so investor 1 has paid in 96.0 per cent of its own commitment of Rs 1,00,00,00,000. Rs 1,00,00,00,000 less Rs 96,00,00,000 is Rs 4,00,00,000. The Rs 4,00,00,000, and not the fund's Rs 20,00,00,000, is what a buyer of investor 1's interest takes on, and Rs 4,00,00,000 is 7.1 per cent of the Rs 56,40,00,000 reported share it just priced.

What happens between the reference date and the day it completes?

Life happens. A private fund does not pause because two of its investors are negotiating. The fund can call money and it can pay money out, and both of those change the value of the interest between the day the price was struck and the day the buyer pays. So the document has to say who gets what.

Size that with this fund's own last two movements. No interest changed hands, so the two figures give the scale of what lands in such a gap rather than the terms of any transfer. The fourth distribution of Nilgiri Growth Partners Fund II, invented, was Rs 22,00,00,000 at Year 8 Q4, of which investor 1's 20.0 per cent share is Rs 4,40,00,000. The seventeenth capital call was Rs 2,20,00,000 at Year 9 Q1, of which investor 1's share is Rs 44,00,000. Drop one of each into the gap between a reference date and a completion and the payment moves twice. Cash out of the fund to the seller reduces what the buyer should pay, and cash into the fund from the seller increases it, and Rs 56,40,00,000 less Rs 4,40,00,000 plus Rs 44,00,000 is Rs 52,44,00,000.

Who has to agree before an interest can change hands?

The manager, in almost every case. An interest in a closed-end private fund is not a bearer instrument that can be handed to anybody at will. The fund's own documents govern whether it may move at all, to whom, and on what conditions, and the agreement the manager gives is the transfer consentThe manager's written agreement, needed before an investor's interest can pass to somebody else.. There are good reasons for the gate. The fund has to know who its investors are, has to be able to call money from them, and has to satisfy itself about the incoming holder before it stands in somebody else's place.

The detail of that gate belongs to its source. Alternative Investment Fund categories, registration, reporting and conduct are set by the Securities and Exchange Board of India at sebi.gov.in, and the conditions attaching to a transfer sit there and in the fund's own trust deed and contribution agreement. Transfer conditions change, and the current text at sebi.gov.in is the only authority on them. Where the second meaning of the word is in play and shares in a portfolio company are moving instead, a company's share transfers, its board and its filings are matters for the Ministry of Corporate Affairs at mca.gov.in.

One artefact in this invented fund shows a consent that was settled before anybody wanted it. Nilgiri Growth Partners Fund II has six side lettersSeparate written agreements giving one investor terms that differ from the standard ones., each a separate written agreement with one investor. The third of them belongs to investor 4, the treasury of a domestic bank, invented, and it carries a transfer right to any entity under the same control. The side letter gave that consent once, in writing, at the fund's formation, years before there was any transfer to consent to, and a consent given that early converts a negotiation into a filing.

Who is asking, when the manager starts the transaction?

GP-Led Secondary

Everything so far assumed an investor woke up wanting out. Turn that around. The manager can start a secondary too, over the fund's own holdings rather than over anybody's interest, and when it does, almost every feature of the transaction changes. A secondary the manager starts is called a GP-led secondary, after the general partner who leads it.

The name does not describe the legal shape of this fund. Nilgiri Growth Partners Fund II, invented, is settled as a trust under an indenture of trust; there is no limited partnership and there is no general partner as a matter of Indian law. The role a general partner plays elsewhere is discharged here by Nilgiri Alternatives Advisors Private Limited as investment manager and Nilgiri Trusteeship Services Private Limited as trustee, between them, and the contract is a trust deed and a contribution agreement rather than a partnership agreement. The global vocabulary still arrives with the documents and the investors use it, so both sets of terms appear here, each identified as what it is.

Here is the household version of what changes. Ten cousins jointly hold a plot of land, and one of them wants out; that cousin finds a buyer, the others barely notice, and the only question is whether the group agrees to the new name. Now imagine instead that the cousin who has been managing the land proposes to sell it, at a price that same cousin worked out, to a buyer that same cousin found, and then goes on managing it afterwards. Nothing about that is improper. But the party proposing the price is now also the party that produced the figure the price is quoted against, and everybody in the room can see it.

One shape of a manager-initiated secondary has a name of its own. A continuation vehicle, where a holding moves into a new vehicle the same manager runs and investors choose between cash and rolling on, is one of these transactions and not the whole of them; what moves inside it, who stands on each side, the conflict it carries and the process that answers it are covered separately.

What exactly is stapled to what?

Stapled Secondary

A stapled secondary is one of these transactions with a second thing attached. The buyer takes an existing interest, and at the same time, in the same negotiation, commits new money to a fund the same manager is raising. The staple is that the second is a condition of the first. The seasoned position is not available on its own.

Nilgiri Alternatives Advisors Private Limited has raised no successor vehicle, so no staple could be offered on any interest in Nilgiri Growth Partners Fund II. The asymmetry inside the shape is worth following anyway, and it survives whether or not anybody ever signs one.

The two halves are of different kinds. One of them exists: an interest with a reported figure behind it, five businesses somebody has been running for years, a track of calls and distributions that can be read. The other has not been raised yet: a fund with no holdings, no reported figure and nothing to diligence. A commitment to that fund is a primary commitment, and a primary commitment is the exact opposite of a secondary. Two objects sit inside one signature and only one of them can be priced against anything. The asymmetry is the whole of what makes the shape awkward.

What did this fund actually sell, and to whom?

Enough counterfactuals. Nilgiri Growth Partners Fund II, invented, has done two transactions of the second kind, and they are different from each other in the one way that matters, so put them side by side.

Holding 2 is Konark Polymers Private Limited, invented. The fund entered at Year 1 Q4 for Rs 45,00,00,000 and at Year 6 Q3 sold the entire position to another fund for Rs 63,00,00,000. Rs 63,00,00,000 on Rs 45,00,00,000 is 1.40 times, a profit of Rs 18,00,00,000 over 4.75 years. The cash reached investors as the first distribution of the fund's whole life, at Year 6 Q4, one quarter later. Nothing was retained: the position left the portfolio completely, and holding 2 is one of the four holdings that are gone entirely.

Holding 9 is Indravati Packaging Private Limited, invented, and it is the more interesting of the two. The fund entered at Year 5 Q3 for Rs 25,00,00,000. At Year 8 Q3 it sold 40 per cent of the position for Rs 22,00,00,000, releasing Rs 10,00,00,000 of cost, being 40 per cent of Rs 25,00,00,000. Rs 22,00,00,000 on Rs 10,00,00,000 is 2.20 times. The remaining 60 per cent of the position, carrying the other Rs 15,00,00,000 of cost, is reported at Rs 33,00,00,000, and Rs 33,00,00,000 on Rs 15,00,00,000 is 2.20 times as well. Add the two and Rs 55,00,00,000 on Rs 25,00,00,000 is 2.20 times across the whole thing. The cash reached investors as the fourth distribution at Year 8 Q4.

Now look at what that does to the counting. Holding 9 is the only position in this portfolio that sits on both sides of the line between sold and still held. Four holdings gone plus five holdings still held is therefore nine while the number of exit events is five. A note that said five sold and five still held would be describing ten positions in a portfolio of nine, and that is the kind of arithmetic error a partial secondary quietly produces in anybody who is counting carelessly.

There is a reason the figure on the unsold 60 per cent deserves a second look, and it is the most useful point in this guide for anybody reading a private fund's report. Most reported figures in a private portfolio are estimates: nobody has tested them, and the businesses behind them have no price. The figure on the unsold 60 per cent is different. A buyer paid cash for part of the very same position three quarters before the record date, and the part that was not sold is carried at the price that buyer paid. A real transaction in the same asset is the strongest support a carrying figure can have, and it is available only where a position was sold in part rather than whole. That is a by-product of the partial secondary, not a reason to do one.

Where does a reader of these transactions usually go wrong?

If one of these landed on an analyst's desk, what would the first question be?

The practical end of the subject matters for more people than it looks. An analyst at an insurance company or a pension pool may be handed an offer to buy somebody's interest. A person at a fund of funds may be asked to approve selling one. And any reader of a private fund's report will meet the word in a paragraph explaining what happened during the year. Four questions, in this order.

First, which meaning? Ask whether an interest in the fund moved or a stake in a company moved, and refuse to go further until somebody answers. Everything else depends on the answer. The seller, the buyer, the documents and the way the price is said all change with it.

Second, what is the denominator? A price of 90 per cent is 90 per cent of a specific figure struck on a specific date. Ask which figure, ask which date, and ask who struck it. On this invented fund the figure would be Rs 56,40,00,000, being 20.0 per cent of the Rs 2,82,00,00,000 reported at the end of Year 9 Q2, and it describes five businesses nobody has sold.

Third, what is the obligation, and whose? Ask for the unfunded commitment of the specific interest, derived by subtraction, rather than a number lifted off the fund's own summary. For investor 1 that is Rs 1,00,00,00,000 less Rs 96,00,00,000, being Rs 4,00,00,000. An analyst who asks those three questions in that order has already avoided the two mistakes this subject reliably produces, and none of the three needs any information the seller could reasonably withhold.

Fourth, who started it? If the manager did, ask where the manager stands on the price, what process the documents set for answering that, and what choice the investors were given. The answer may be entirely satisfactory. The question is not an accusation, and asking it is not a view about the transaction, the manager or the fund.