Private Equity Exits 

What is a Private Equity Exit?

Private equity firms invest or acquire companies that they can take active ownership of, instigate improvements and then sell for a profit. This alternative investment market is typically financed with debt to enhance the equity returns. During the pre-investment due diligence phase, the investment team will have identified a target return that it is seeking from the investment and a planned timeframe to sell the company stake – this sale is the private equity exit.

Preparing for Exit

Preparing the investment for its planned sale is mainly driven by the private equity deal team involved rather than the incumbent management team. This will begin early in the investment’s life and essentially involves the private equity firm making sure that value creation milestones in the agreed business plan are being met by management. They will be keen to see that any opportunistic value creation opportunities are grabbed, and to keep the investment attractive and on the map for potential future buyers.

The private equity firm will play its roles in the following way:

• The limited partners (LPs) will receive monitoring reports on a regular basis from the PE firm – these will include financials and material developments at the portfolio company.
• The PE firm will control the board, which will provide governance over management so that they can execute and drive operations to achieve the business plan set by the board.
• The PE firm will control its deal team and any external advisors who will work together with management to drive specific investment-related value creation initiatives such as hundred-day plans, refinancing, M&A, and exit.

Exiting the Investment

A PE firm’s ability to achieve timely and profitable exits is its key measure of success. It allows the private equity firm to return capital to its investors and raise follow-on funds successfully.

There are three main paths to exit:

1. Sale to a strategic or financial buyer
2. An IPO (initial public offering)
3. Dividend recapitalization

Strategic or Financial Buyer

A sale to a strategic buyer is a sale to another business, whereas a sale to a financial buyer is normally to another private equity firm. Often, sales will happen through an organized auction process and might include a mix of private equity, financial, and strategic bidders.

A strategic buyer will be looking for an opportunity to integrate or align the target company with its own operations: it may have a complementary or similar business or be looking to acquire something to ramp up its own sales.

A financial buyer could be another private equity firm which has identified the company as one that it could add further value to and generate an attractive return for its investors. For example, a loss-making retail company may have been initially purchased by a PE fund which specializes in distressed assets. Once the business has been reorganized and generating positive cash flows in line with the PE fund’s targets, it may become an attractive purchase for another PE fund. The new fund may offer expertise in distribution, digitalization or global expansion, and see the company as an exciting opportunity to create further value.

An Initial Public Offering (IPO)

An IPO would entail listing the company on a public stock exchange and the private equity firm selling its equity in the public markets over time. This can generate high returns but takes up a lot of management time in the long administrative process.

To list a company, it has to meet the stock exchange’s exact requirements in terms of size, scale and reporting capabilities. To successfully list, a corporate finance team would likely be brought in to ensure the ‘float’ is successful. This process involves gauging market interest in the new shares and finding a listing price that would ensure both investor interest and a healthy exit for the current owners (the PE fund and anyone else with a stake in the company). An IPO would depend on the market conditions and are more common during times of economic growth.

Dividend Recapitalization

A dividend recapitalization involves raising more debt on the company’s balance sheet in order to pay dividends to the shareholders. This is done using banks to provide the debt and is a lower profile route to liquidity. In this particular exit scenario, there is no equity dilution and no new equity holder.

Which PE Exit is Most Common?

The most common route to an exit is typically the sale process. However, each process has its own merits and risks based on macroeconomic conditions and the specificities of the business being exited. Private equity investors regularly fine-tune their exit plans throughout the holding period to work out the most financially rewarding option. This is done while monitoring company performance versus its ongoing business plan.

Special consideration is given to the potential impact of value-accretive projects on a company’s value at exit. For example, how much recurring profit will the project deliver around exit time, what multiple can be assumed for this profit stream, and how does this compare to the cost of the project? Additional emphasis may be put on enhancing processes and governance not only to improve and de-risk the company’s performance but also to boost exit prospects. This is especially relevant when planning to exit to large strategic buyers and through a public listing.

Lastly, the exit environment is monitored from overall market conditions such as liquidity, debt multiples, and initial public offering activity to industry-specific dynamics such as capital expenditure cycles, M&A activity, and purchase price multiples paid, all to optimize exit timing.

Preparing for Sale

Once the private equity firm selects the timing of an exit, deal teams must prepare the portfolio company for sale. The sales process is by no means standardized, and the path chosen and parties driving the sale will depend on a number of variables, including the internal capabilities of the portfolio company, the resources the private equity firm can commit, and the complexity of the operating business.

At a minimum, the seller will prepare historic and projected financial information and key operating, financial, and legal information. These will normally be in the form of an information memorandum. Vendor due diligence on the financial, legal, and commercial standing of the company may also be considered to facilitate the sale process. The PE firm will hire service providers to help them do this work. In addition, sometimes banks will be used to provide financing options to potential bidders in the form of staple financing to make an acquisition more attractive and feasible.

Lastly, PE firms often hire sell-side advisors, normally an investment bank, to manage the sales process. This tends to be the standard for larger and more complex transactions with multiple parties. A sell-side advisor will free up valuable time that the senior management and private equity firm would otherwise have to allocate to the sale and will be able to assist in sourcing and negotiating with bidders.

Distribution of Proceeds

Once the investment is exited, capital received from the sale transaction, net of any transaction-related fees, will be distributed in line with the LP agreement to the investors and, if relevant, to eligible private equity firm and management team members. At this point, the deal’s life cycle has come to an end with no more work needed from the private equity firm.

Conclusion

Private equity exits mark the end of an investment in a portfolio company. It is the culmination of significant efforts by both the management and the investment team to rigorously overhaul the business to make sure it is profitable, generating cash and able to attract interest from new investors. Ensuring a profitable exit will be a key component of the overall investment strategy.

Generating high returns to the PE funds investors is the primary goal so ensuring an exit that is highly profitable, and on-time will ensure the private equity fund will continue to attract interest and capital from its own investors.

If you’re considering a career in the buy-side, the private equity micro-degree will teach you the key technical skills, from in-depth financial statement analysis to structuring complex add-on acquisitions in a leveraged buyout.

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Learn More About PE

• Learn about the private equity transaction timeline
• Discover the fundamentals of private equity
• What is a PE fund and how does it work?