LP Secondaries: Emergency Exit or Strategic Option?

Authored by Eva Hubsman

Professional investors will tell you that missing great investment opportunities is part of the job. We all have a “Facebook”, “Google” or these days, a “Wiz” story to cry about. 

What investors (professional or otherwise) don’t talk about is the missed opportunities to sell an asset at the right time for the right reasons. This is especially true for LP interests, which by nature are passive and long term, not to mention far less understood in the legal sense. 

The Lengthening Investment Horizon

Think about it: Most VC funds are structured with a 10-year timeline, but in reality, through fund life extensions, many operate for 15-20 years. This extended timeline reflects today's market realities. 

Companies are staying private longer - sometimes by choice, sometimes by necessity - with the path to liquidity often stretching beyond a decade compared to 7 years when I started in the industry, 20 years ago (Okay, 25, but I choose to round down 🙂). These extended company journeys inevitably translate to longer fund lifecycles as managers wait for portfolio exits.

This creates an interesting dynamic: LPs are essentially "married" to their investments for decades (as in plural!). While some VCs have begun using secondary transactions to enable earlier capital returns, many LPs aren't aware that secondary opportunities are also available to them directly.

Beyond the Emergency Exit

Too many LPs view secondaries as the 'fire hydrant' in their toolkit - vaguely aware of its existence and location, but only something to turn to during emergencies.

These emergencies vary: institutional investors might face the "denominator problem" when market drops force their private investments to unexpectedly take up too much of their portfolio, while individual investors confront unexpected cash flow needs, divorce proceedings, or estate planning challenges that make illiquid assets problematic despite their value.

But in today's landscape, where even the best funds often extend their lifecycle to 15-20 years, secondaries should be viewed as a strategic and accessible tool available for numerous important purposes.

In this series, I'll explore the rationale behind LP secondary transactions to address this knowledge gap and help LPs recognize this valuable option in their financial toolkit. My first piece looks into the rational behind LP secondaries, let's dig in.

LP Secondaries: The Rationale

Why might an investor consider selling their interest in a fund? The reasons vary across investor types, but all point to the strategic value of having liquidity options.

The Numbers Tell the Story

According to Q2 2024 Pitchbook Benchmark data, top-quartile 2014 vintage funds, now 10 years old, have a TVPI (Total Value to Paid-In capital) of close to 3X but a DPI ((Distributed to Paid-In capital) of just 1.85X. 

Every LP should ask themselves: is it worth waiting another 5-10 years for that extra 1X return?

Looking at 2009 vintage funds (15 years after first closing), top-quartile funds show a TVPI of 2.5X and a DPI of 1.64X. Even after 15 years, a full return remains distant in many funds.

The Opportunity Cost Factor

Smart LP strategy isn't just about evaluating returns and waiting periods—it's about opportunity cost. 

When distributions slow down (as they have over the past three years), LPs face a critical challenge: less capital returning means less capital available for new fund commitments.

This timing can be particularly costly because history shows an interesting pattern: funds raised during "down market" years tend to outperform those from "upmarket" periods. If cash constraints force LPs to miss these vintage years, the impact on long-term portfolio performance can be significant.

Secondaries offer a potential solution to this dilemma by unlocking capital from existing investments, creating liquidity that enables LPs to maintain their commitment pace through market cycles.

A Strategic Approach

Rather than viewing secondaries as a last resort, forward-thinking LPs are increasingly incorporating them as a deliberate portfolio management strategy. By selectively monetizing mature fund positions, investors can unlock capital precisely when market opportunities are most attractive, effectively turning illiquidity constraints into strategic advantages.

LPs should periodically assess their portfolios to calibrate the delicate balance between past performance, current holdings, and future investments. Secondaries are a tool that, when used strategically, can enhance an investor's performance- and in my view, belong in every sophisticated investor's toolbox.