Exits are central to the private equity investing process and a PE firm will consider a variety of different exit strategies to realize its return on investment. Four of the most common PE exit strategies are: trade sale, initial public offering, secondary buyout and leveraged recapitalization. A fifth exit option is also discussed below.
Trade sale
Trade sale is a commonly used exit route in which the PE sponsor sells all of its shares held in a company to a third party purchaser. The third party purchaser often operates in the same industry as the target company and has strategic advantages (i.e., accessing a new market) in acquiring the target company, for which it is willing to pay a premium. Typically, the third party purchaser is very knowledgeable about the business of the target company and this may facilitate a faster due diligence and closing process.
Initial public offering (IPO)
IPO is an exit strategy whereby the company offers its securities for sale to the general public. "Going public" may attract the highest return for PE sponsors depending on market conditions, but the transaction cost is high and the process is often long and unpredictable. PE sponsors also may not be able to make a clean exit; they will often be asked to enter into a lock-up agreement and commit not to sell shares for a period of 6 – 12 months following the IPO.
Secondary buyout
A secondary buyout is an exit route whereby the company is sold by one PE sponsor to another PE sponsor. There are a variety of different factors that may cause a PE sponsor to pick this exit strategy, such as the original PE sponsor may no longer be interested in backing the company but the company is not yet ready for trade sale or an IPO or the management of the company may wish to replace the PE sponsor. Secondary buyout allows PE sponsor to have a clean and fast exit.
Leveraged recapitalization
Leveraged recapitalization is a partial exit strategy that allows the PE sponsor to extract cash from the business without selling the company. It is usually achieved by the company borrowing more money from a bank or issue bonds, and the cash generated will be used to redeem shares held by the PE sponsor. However, it should be considered that a highly leveraged company may have a greater risk of bankruptcy and may not have enough liquidity to run the business.
Dual–track process
PE firms may also utilize a "dual-track process" to exit their investments, meaning filing a prospectus for IPO and pursuing a trade sale at the same time. Dual-track process allows the PE investors to test the water in the public market while looking for a suitable strategic third party purchaser. Although the dual-track process may provide better returns for PE sponsors, the transaction cost of running a dual-track process can be quit costly.
Aside from determining the mode of exit, PE investors may also consider the timing of exit, whether to fully or partially exit from the company, the performance of the company post-exit, exit valuation of the company and reporting valuations of unexited investments to investors.1
Footnote
1 Douglas Cumming & Sofia Johan, Venture Capital and Private Equity Contract – An International Perspective (Oxford: Academic Press, 2009).
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