Private Equity Fund Pricing in Secondary Markets: Effects of Taxes and Fund Structure

Abstract

Private equity (PE) funds are growing, beginning to take the lead in capital markets. In conjunction with this growth, secondary markets for PE fund ownership interests also have grown. Recent research investigates the valuation discount that sellers of PE fund interests incur in secondary markets, and suggests this discount is driven entirely by the illiquidity inherent in PE. This article describes how the legal structure of PE funds, instrumental to funds’ existence and operations but largely ignored in prior research, can impose a tax discount in addition to an illiquidity discount in the secondary market. Thus, it extends this new and important stream of research by highlighting that illiquidity may be only one attribute driving PE fund secondary market discounts and that after-tax, rather than pretax returns, warrant consideration in these markets.