Unlocking Private Equity Exits: Strategies For Successful Investment Offloading

Private equity firms are known for their ability to turn struggling companies around and infuse them with capital, potentially saving them from bankruptcy and preserving jobs. However, the methods they use to achieve this can be controversial. Private equity firms typically seek to exit their investments after a period of 4-7 years, during which they will have implemented strategies to increase the company's value and profitability. This is often achieved through operational improvements, market expansion, or product and service innovation. However, they may also employ more aggressive strategies such as asset liquidation, stringent cost-cutting, and imposing debt on the company. The most common exit strategies for private equity firms are Initial Public Offerings (IPOs), strategic acquisitions or trade sales, secondary sales to other private equity firms, and repurchase by the company's promoters.

Initial Public Offering (IPO)

The IPO process typically includes the following steps:

• Investment Period: Private equity investors provide funding to the company during its early stages, often when it is still privately held. They may hold various classes of shares with different rights and privileges.
• Company Growth and IPO Preparation: Over time, the company grows and develops its products, services, and revenue streams. As it reaches a certain level of maturity and fulfills the requirements set by regulatory bodies and stock exchanges, it may decide to go public through an IPO.
• IPO Process: The company makes shares available to the public for the first time on a stock exchange. The IPO price is set based on investor demand, market conditions, and the company's valuation.
• Lock-Up Period: After the IPO, early investors and company insiders are typically subject to a lock-up period during which they are not allowed to sell their shares. This period usually lasts for a few months to a year to ensure stability in the share price during the early trading period.
• Post-Lock-Up Exit: Once the lock-up period expires, private equity investors can start selling their shares on the open market. They may choose to do this gradually to avoid flooding the market with a large volume of shares, which could drive down the share price.
• Market Conditions and Timing: The timing of the exit is crucial. Private equity investors aim to sell their shares when market conditions are favourable and the share price is at its peak. This requires careful analysis of market trends, the company's performance, and overall economic conditions.

An IPO exit strategy is tailored to the needs and objectives of early investors, such as private equity firms. While going public provides opportunities for fundraising, increased visibility, and potential acquisitions for the company, it also comes with additional regulatory and reporting requirements.

The primary benefit of an IPO exit for a portfolio company is the potential for a high valuation, provided there is investor demand and stable, favourable public market conditions. However, an IPO also involves high transaction costs. Additionally, if the private equity firm intends to fully exit the investment, potential public investors might perceive this as a lack of confidence in the company's future prospects. Furthermore, the IPO terms may include a "lock-up" period, during which the private equity firm is prohibited from exiting some or all of its position. Other potential challenges include the risk associated with the overall public equity market environment and the likelihood of a discounted price for the IPO, which can impact the achievable value for the private equity firm's equity holders.

Strategic Acquisition/Trade Sale

Private equity firms can exit their investments through a strategic acquisition or trade sale, which is one of the most popular exit routes for private equity funds. This involves selling the company they have invested in to another suitable company and then taking their share of the sale value. The buyer often has a strategic advantage in acquiring the business, and the two companies may complement each other. As a result, the buyer is often willing to pay a premium for the acquisition.

A financial sponsor may realize gains through a trade sale to a strategic acquirer, allowing for an immediate liquidity event. Strategic buyers typically intend to hold the acquisition over the long term to gain a greater competitive advantage and market share in their industry. A strategic buyer is usually a non-private equity firm, and the acquisition is in the buyer's strategic interest, whether for market growth, trade secrets, new products, synergies, or other business improvements. Therefore, a trade sale usually commands the highest sale price and is the preferred exit option for investors seeking a quick return.

When preparing for an exit, private equity firms should start early and adhere to three key principles: keep it simple, tailor the messaging, and provide evidence. It is crucial to develop a clear and concise equity story that highlights the asset's potential and how it will create value under future ownership. This narrative should be backed by ample supporting evidence, including financial profiles, growth strategies, and operational improvements.

By starting the exit preparation process early, private equity firms can make meaningful corrections to the business, assemble the required evidence, and achieve alignment between the firm and the management team. A well-prepared exit strategy can help maximize exit returns and sustain long-term returns.

Secondary Sale

Private equity firms can exit their investments through a secondary sale, also known as a secondary buyout. In this scenario, the private investors sell their stake in the business to another private equity firm. There are several reasons why they might choose to do this. For example, the business may require more money than the current equity fund can provide, or it may have reached a stage where other equity investors want to take over.

A secondary sale can also occur when a financial sponsor and the current management team believe that a larger financial sponsor can add more value to the company as it moves into the next stage of its development. Alternatively, a financial sponsor may decide to sell the company to another private equity firm if it has reached its minimum investment time and has already generated a high rate of return.

Selling to another private equity firm offers increased flexibility in the structure of the sale. For example, the seller could potentially maintain a partial ownership stake and enable the company to continue operating with a focus on long-term growth. However, it is important to note that a financial sponsor is usually a sophisticated buyer and will try to purchase the asset at a minimal valuation, often at a much lower price than a strategic buyer would pay.

The decision to exit an investment through a secondary sale also depends on the macroeconomic, legal, tax, and regulatory environment. For instance, tight credit conditions may reduce the number of potential buyers as banks may be less willing to lend financing.

Repurchase by the Promoters

When a private equity firm exits an investment through a repurchase by the promoters, the promoters of the investee company will repurchase the shares owned by the private equity firm at the current market price. If the promoters decline to repurchase the shares, the private equity firm will explore other exit options.

A repurchase by the promoters can be an effective exit strategy for private equity firms, but it is important to consider the potential challenges and risks associated with this option. These may include the financial health of the company and the ability of the promoters to raise the necessary funds to repurchase the equity stake.

To ensure a successful exit through a repurchase by the promoters, private equity firms should carefully evaluate the financial position of the company and the promoters' ability to fund the repurchase. Due diligence and a comprehensive understanding of the company's financial health are crucial to mitigate potential risks.

Overall, a repurchase by the promoters can be a viable exit strategy for private equity firms, but it should be approached with careful consideration and planning to ensure a positive outcome for all parties involved.

Refinancing

In a refinancing, the private equity investor refinances the company by taking on debt and using the proceeds to buy out some or all of their equity stake. This allows the investor to cash out part of their investment while still retaining an ownership stake in the company and potentially benefiting from future growth. Refinancing can be particularly attractive if the company has a stable cash flow and the ability to service the additional debt.

For example, a private equity firm may choose to recapitalize a company by issuing dividends or raising additional debt against the company's assets. This allows the firm to distribute cash to investors while maintaining an ownership stake. Recapitalizations are effective exit strategies when the company has stable cash flows, valuable assets, and growth potential.

However, refinancing can lead to substantial stress on the company's debt load and requires ongoing management and oversight. It is important to carefully analyse the company's financial position, debt capacity, and market conditions before implementing this strategy.

Frequently asked questions