Secondary Funds EXPLAINED

All right. All right. Welcome back to the channel. Today, we're going to talk about what is a secondary fund? How do they work? How can some of them produce huge— I'm talking 100%, 200% IRRs for your fund. And actually a really cool offering that you could build as a fund manager where you don't have to figure out the investment thesis. You don't have to actually go and buy certain assets on the ground floor. You can buy second positions in funds or general partners and do really, really well as a fund manager. Also, I wanna explain how these work, how these coincide with fund-of-fund models, private equity, venture capital, hedge funds, how they all come together and how this is actually pretty darn cool. Now, if you're new to the channel, welcome back. My name is Bridger Pennington. I'm the founder of 3 investment funds and the founder of Investment Fund Secrets. So we help people start, launch, and scale funds. We have over 16,000 members around the globe. We just threw a 1,200-person event in Vegas a few months back, all designed around helping people start, launch, and scale their own investment funds. So with that lovely introduction, let's now go down to the whiteboard here, the whiteboard of truth and justice, and talk about secondary funds, what they are. So if you guys recall, typical fund structure looks like this. You've got a general partner and you've got a limited partnership. Okay. I'm going to do an abbreviation, limited partnership, and you have limited partners or investors that put money into the limited partnership or fund. Okay. This is your management team right here. So managers, general partner, they manage the limited partnership, the fund. Fund and limited partners or investors put money capital into that fund. Now that pool of capital can be used to go buy real estate. It can go buy companies and private equity. It can go buy public companies or public securities as a hedge fund. It can buy as a venture capital, can invest into startup companies. Okay. It's kind of crazy actually. All those are done out of the pretty much same vehicle, which is pretty cool out of this, what we call a fund structure. And we've got other videos on our channel that walk through this way more in depth and how to start one, how to build one, how to scale one, how some of our students are doing this and building $100 million funds from the ground up. It's actually really cool. So go check out those other videos. Now for today's video though, what is this concept of a secondary fund? Now the first time I was introduced to this, so one of my mentors, they had a massive fund. This was, I think, a $2 or $3 billion fund they had. And one of their investors had a very large position. It was about $40 million in this fund. Okay. Now this investor, for whatever reason, needed liquidity. They needed to get out of this fund. If you know anything about funds, they're typically, there's a lockup period. This fund for For example, I believe had a 7-year lockup period. So for 7 years, you can't get your money out. If you want your money out, it's a 50% penalty. So for example, if they wanted their money out, they could actually only get $20 million out liquid today. It'd be a massive penalty, right? And they'd be kicked out of the fund. Now, for whatever reason, this $40 million investor wanted out of this fund. So the idea came to me, hey, what if we came to this big investor, instead of them taking $20 million, we came and offered them $30 million? $35 million. Hey, we'll buy out your $40 million position for $35 million. You guys get $35 million today, take a $5 million loss. We assume this position in this fund. Now, additionally, with that, these funds are 7 years. Usually, the first couple of years of a fund, there's, you're not making much money because, you know, some of these funds are investing, they're deploying those first few years. By year, maybe 3, 4, 5, in that range, let's talk, let's say 4, 5, and 6, they start selling properties. That's where you get huge returns. Returns. So typically the first couple years it's like zero or negative five percent, and the last few years are you know they they sell a property it's forty, fifty, sixty percent, and they average over the life of seven years maybe they average a twenty-two percent return over seven years. Okay. The advantage for us as well so we would get a five million dollar discount and we were buying in right here at year three and a half. Okay. So we have a seasoned investment that the next it's only about Another 3 years, it's going to pay out really, really high returns. And our money's only been at risk for half the time of the other investors. Does that kind of make sense? Kind of cool. This is the concept of what's called a secondary position. We would be coming in and taking a secondary position on this fund. And you can see the obvious returns and gains you can get from doing this. Now, that story, we actually were trying to get money together. They found another person, they beat us out, and another fund came in and filled this. I don't know the exact terms of their deal, but filled that position. They figured it out without us, which kind of stunk. But oddly enough, about a month later, I had another group come to me and talk about secondary positions in the tech space, which I thought was pretty interesting. So they came in and they would find big tech companies. Okay, I'm gonna just draw a tech company here. And this tech company currently is worth $300 million from their last, let's call it a Series B round, was $300 million. There's no way those are worth those today with the market crashing, but let's just call it $300 million. And they plan to either IPO or do a Series C in a year and a half from now. So 18 months. And they think they'll be worth $1 billion 18 months from now. Okay. Pretty cool. Got nice trajectory. Good tech company. We vetted them out. Now, a lot of tech companies give out shares to employees. Okay. So they break up this, you know, they get a little pool here and they break it out for employees. What this entire fund was doing, and they produced, they were on fund 3 at the time, they had produced 200% returns plus to their investors. They were managing about $25 to $35 million. They would come in to the chief marketing officer that owned, maybe they owned, you know, $4 million in stock options. Now, that stock is not liquid. They've got to wait another 18 months for that. So, this group would come and say, hey, do you want to get paid out a little bit earlier? And they say, yeah, you know what? I'll sell half my shares, $2 million today. I want to sell around that mark at Maybe they sell it at the previous round, $300 million, or maybe even a smaller round. They get more of a discount. So this entire fund would come in. They would scoop up these VC plays. So maybe it's a $2 million position, but they come in and they can buy it for $1.5 million today. So they get a $500,000 delta and they get a really great position in this tech company that's currently not liquid. Kind of cool, right? Closer timeline to an IPO. They get to come in at a later round and compress the time of deployment. Now, you guys are smart investors, but you understand IRRs and most investing metrics are based on a yearly APY, IRR, all— pretty much all investing metrics are done on an annual schedule. Because it doesn't matter what return you get, it matters what return you get and in what timeline. This shortens your timelines, hence boosting your IRR or APY calculation for your fund return back to investors. Now, a lot of you that follow our stuff, you guys know we talk about the 3 circles of a fund all the time. These are the 3 people that you need in a fund, 3 different types of people. We have our expert investor, fund manager, and your money raiser. Okay? You can have 3 people, you can have hundreds of people, you can have 2 people, but these 3 roles need to be filled. And it's usually good to become really good at one of these 3 and find partners for the other one is what we talk about typically. What's cool about secondary funds is it makes this job, in my opinion, a little bit easier. You are finding really good positions, whether it's in tech companies, Whether it's taking out limited partners, or I didn't mention this earlier, you are taking positions in general partners. General partners just like this that want liquidity, you can come and carve out a slice to give a general partner liquidity on their funds, which is kind of cool, right? Again, this is all called secondary funds, and you aren't the person on the ground floor building the tech. You're not the person on the ground floor buying the real estate or investing into startups. You just invest in the managers who are doing that. And your thesis comes down— sorry, I'm scrolling up and down here— comes to the ability of vetting really good companies or really good operators. Additionally, you get to diversify across a lot of different funds or companies and fields. That's one of the biggest benefits of a secondary fund model, or what I would call a fund of funds model. We also have other videos on how to— what a fund of funds is, how to build them, but they're also similar to this. So I hope that helps give you an idea of how secondary funds work. There are billion-dollar funds doing this right now and grabbing positions and producing very, very high returns for their investors. If you guys can comment, subscribe, like this video, thank you all so much. Check out the other videos on our channel about starting and scaling a fund, about fund of funds, how they all work together. You guys are amazing, and I'll see you on the next video. Bye.