Canada: Buying To Sell: Private Equity Sponsor Exits

Last Updated: November 17 2016
Article by Darrell R. Peterson

According to Pitchbook Data, Inc., Canadian private equity sponsor exit activity in 2015 reflected a year-over-year jump of more than 20 percent in volume. In addition, S&P Capital IQ data for Q3 2016 shows a year-over-year increase in transaction value for both M&A and public offering exits. These trends, combined with the fact that close to 36 percent of current sponsor backed inventory dates from 2010 and earlier, suggest that the industry is set to experience a robust exit market over the next few years.

There are six principal types of private equity sponsor exits: trade sales, secondary sales/ buyouts, initial public offerings, redemptions, dividend recapitalizations and write-downs/ write-offs/ bankruptcies. The process for each of these principal types of exits is different and has distinct requirements in respect of the size and characteristics of a portfolio company, execution timing, costs, tax impacts and public disclosure requirements. In addition, the extent of exit can vary between full and partial exits, which are both theoretically possible for each of the six principal types. This paper summarizes the primary process differences and requirements and relative market importance of each principal type of exit.

Exit Alternative 1: Trade Sales

The sale of a portfolio company to a third party such as an industry peer or a competitor is the most common exit type for private equity sponsors. The sale to a third party is frequently referred to as a 'mergers or acquisitions exit' or 'M&A' exit.

The buyer of a company in a trade sale typically is a strategic acquiror. By virtue of operating in the same business, strategic acquirors are best positioned to evaluate the prospects of a business. Accordingly, strategic buyers are often able to pay a premium for companies due to strategic fit and potential synergies.

Trade sales tend to be full exits, typically effecting the sale of the entire company for cash consideration. Partial trade sale exits, although possible, tend to be rare. In such cases, the selling party would typically receive (often illiquid) shares in the acquiror company instead of cash.

From a legal structuring perspective, a sale of a portfolio company can be effected either through a 'share deal', an 'asset deal' or alternatively, a sale to a strategic acquiror could take the form of a merger. The selection of the legal structuring type will be determined by a variety of features, including timing, ease of implementation and tax considerations.

Exit Alternative 2: Secondary Sales/ Buyouts

A secondary sale is an exit whereby only the private equity sponsor sells its interest to a third party, while management and other investors retain their respective stakes in the portfolio company. Secondary sales tend to achieve lower relative purchase prices and thus often generate lower returns than trade sales. Purchasers of a secondary block usually lack the bargaining power of a 100% acquiror to obtain full inside information. Also, transaction synergies are far less likely to be achieved in the case of secondary sales compared to trade sales, mainly due to the fact that buyers are typically unable to integrate and combine the targets' assets with their own.

In contrast to a secondary sale, a secondary buyout denotes an exit transaction where a portfolio company is sold from one financial sponsor to another. Secondary buyouts are a growing phenomenon in the private equity market fuelled by the increasing volumes of assets held by private equity firms.

Secondary sales or secondary buyouts are usually full exits for the sponsors only.

Exit Alternative 3: Initial Public Offerings

In an 'Initial Public Offering' (IPO) the portfolio a company sells treasury shares to public investors with a sponsor concurrently selling pursuant to a secondary offering. IPOs are in most cases accompanied by a listing on a stock exchange. Of the different exit types, only an IPO provides a company with an infusion of fresh capital and its shareholders with a high degree of liquidity.

Sponsors often prefer an IPO exit because IPOs typically result in higher valuations for portfolio companies than other possible exits. In addition, although IPOs typically do not result in a full exit for the sponsor, the sponsor benefits from any post-IPO increases in a portfolio company's value.

In most cases, sponsors do not sell all of their shares into the public market right at the time of the public offering but rather undertake a `lock-up' agreement with the investment bank underwriting the offering in which they commit themselves not to sell shares for a period of typically 6 to 12 months following the IPO. Subsequent to the lock-up period, securities are either sold into the market or distributed to investors over a period of months or even years following the public offering.

An IPO process has several notable disadvantages including: (i) the process can be lengthy and take four to six months; (ii) an IPO can be costly and can distract management from their primary job of running the portfolio company's business; and (iii) both during and after the IPO process, the company will be subject to extensive rules and regulations under the various securities regulatory regimes. Noteworthy alternatives to the typical IPO include reverse take-overs and blind capital pool companies:

A reverse take-over (also known as a back-door listing or a reverse merger, RTO) is a type of sale transaction where the shareholders of the portfolio company sell the company to a publicly listed issuer in exchange for shares of the listed issuer, which results in an effective change of control of the public issuer. The publicly listed issuer is frequently referred to as a shell company because often it will be a company whose business has deteriorated and has few assets other than its listing. An RTO does not necessarily include an equity financing component, so it is often used where the principal goal of the transaction is liquidity for shareholders from the stock exchange listing, versus an IPO where capital raising from the public is generally the principal goal.

Alternatively, the publically listed issuer could be a blind capital pool company like a special purpose acquisition company (SPAC). A SPAC is an investment vehicle allowing the public to invest in companies or industry sectors normally sought by private equity firms. The SPAC program of the Toronto Stock Exchange enables seasoned directors and officers to form a corporation that initially contains no commercial operations or assets other than cash. The SPAC is then listed via an IPO, raising a minimum of $30 million. 90% of the funds raised are placed in escrow, and must then be used toward the acquisition of an operating company or assets within 36 months of listing.

Exit Alternative 4: Redemptions

Sponsors may achieve at least partial liquidity (and possibly complete liquidity) by exercising redemption rights hard-wired into the share terms of the portfolio company. At the time of the initial investment, sponsors can negotiate for redemption rights that allow the fund, at its discretion, to return their shares to the company in exchange for an immediate payout of cash or some other consideration.

Redemption rights give sponsors the ability to get an immediate return of at least a portion of the fund's at-risk capital. In addition, redemption rights typically are priced at a premium providing a return for the sponsor even in a transaction where the fair market value of the equity at the time of redemption is about the same price the fund paid for its initial investment.

However, exercising redemption rights is typically only used in an underperforming investment because the price at which a sponsor can redeem its stock typically provides the fund with lower returns than what were originally expected by the sponsor and promised to the fund's investors; and a sponsor's ability to exercise redemption rights is limited by how much cash the portfolio company has on hand, how much additional debt it can borrow and its ability to pay for the redeemed shares.

In contrast to a redemption, in a buy-back transaction, a sponsor sells its shares back to the company or shareholder group that sold the shares originally. Buy-backs are of greater relevance for early stage investments with relatively low valuations.

Exit Alternative 5: Dividend Recapitalizations

Sponsors may achieve a partial exit from their investment in a portfolio company through a special dividend issued by either the portfolio company to its parent holding company or by the parent holding company itself. The type of dividend is defined by the source the company (or the parent holding company) uses to finance it: a non-leveraged dividend is financed by the company using cash that it already has on hand; a leveraged dividend is financed by the company incurring additional debt.

Although recapitalizations only provide for an exposure reduction of an investor's originally contributed equity capital, such transactions are often undertaken either as a 'prelude' to a later exit or as a temporary alternative to a divestment. Recapitalizations are a popular method to extract some cash from investments, leaving the flexibility to wait and prepare for a potentially more attractive exit later on.

Exit Alternative 6: Write-downs/ Write-offs/ Bankruptcy

A write-down is effected as a form of partial value-correction, where the sponsor recognizes that the investment still has some value, but lacks the originally anticipated upside potential that inspired the initial acquisition. When a write-down occurs, the sponsor will in all likelihood spend very limited or no further effort in restructuring or enhancing the investment.

A write-off occurs when a sponsor walks away from its investment not able to realize its expected returns. This is the exit of last resort and most sponsors will prefer instead to pursue a restructuring through bankruptcy proceeding. A sponsor may be able to recapitalize a distressed portfolio company using the bankruptcy process – wiping out debt and unfavourable contracts and leases – all for a modest additional investment.

Dual- or Multi-Track Exit Processes

In certain circumstances, sponsors may choose to pursue two or more potential exit routes at the same time. The most frequent dual-track exit process involves the undertaking of an M&A exit auction and an IPO process in parallel. Additionally, private equity sponsors could pursue a dividend recapitalization process at the outset, should a 'real' exit option be unattractive at that time, to still be able to retrieve cash proceeds from an investment.

It is believed that dual- or multi-track exit processes have the potential to generate extra value for the vendors of a company, as they can enhance the competitive dynamics in an auction process. Interested bidders in an auction, knowing about a credible public listing alternative, may be motivated to submit a more attractive offer in order to remain in the auction process.

Furthermore, pursuing more than one exit route maintains the flexibility to execute the alternative that generates the highest value until just before a transaction completion. Particularly in the context of volatile public equity markets, where windows for attractive new issuances open and close quickly, having the option to sell a company at a reasonable price through a trade sale can be valuable.

However, notwithstanding the advantages of a dual- or multi-track exit process, several potential drawbacks and pitfalls exist:

  • conflicts of interest of investment banks
  • higher transaction costs
  • high workload imposed on management and risk of a time delay
  • complexity of legal structuring
  • IPO track limiting the flexibility of M&A process
  • excessive disclosure and publicity

These drawbacks need to be carefully weighed against the potential advantages to a dual- or multi-track exit process.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Darrell R. Peterson
Similar Articles
Relevancy Powered by MondaqAI
Norton Rose Fulbright Canada LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Norton Rose Fulbright Canada LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions