As the company matures, private equity investors will be looking to liquidate their investment if the returns are attractive and meet their return targets. The process of evaluating the various liquidation options is called the 'Exit Strategy'.
There are three main ways a PE investors can exit:
Sell the investment fully to another party in one shot
Sell the investment in the public markets through an Initial Public Offering (IPO)
Sell the investment to interested parties over a period of time in stages
If the company is outright owned by one private equity fund, the sale process and the exit strategy can be relatively straightforward. Life is generally never that simple. Many private companies have multiple private equity investors who would have invested at different stages of the company's life cycle. Therefore, not all the private equity investors in a company may be willing to sell their stake at the same time, making the sale process more complicated.
Buyers
When a company or a private equity investor's stake in a company is up for sale, there may be many potential buyers. Generally, when the buyer falls into one of the following buckets, there is immediate synergy to expedite the sale process:
GPs who were previously invested in the company through the LP (PE investor who is now looking to sell)
Another PE investor who has an investment in a company that is a direct competitor (or an indirect competitor with significant synergy) to the seller's company in the marketplace
One of the company's customers who does a lot of business with the company and sees value/synergy in buying out the company
Some buyer use cases are:
Case 1: Say a pension fund (GP) who was invested through an LP in a company really likes a particular business because it fits very well with their overall portfolio. They can choose to make a direct investment in the company instead of an indirect investment through the LP.
Case 2: Some of the major deals in recent years have included one PE fund buying out another. Affiliate Managers Group bought out Pantheon Ventures in 2010. Carlyle Group bought out Alpinvest for $14bn in 2011. Consolidation in the private equity investments can happen if the market is mature and if the combined diversity of LP profiles and investment appetites makes more strategic sense.
Case 3: In the technology / media / telecommunications / infrastructure space, if the investment company is a key service provider to one of the big hyperscalers like Microsoft, Google, Facebook, Amazon and Apple, it is likely that one of the hyperscalers can buy out the company from the private equity fund. The tech giants have sizeable cash piles that they can put to work by acquiring the investment company in an all cash deal.
Sellers
Let us assume the following situation:
The company for sale is owned by a consortium of investors who made their investments at different points in the life cycle of the company.
The 'Early Investors' are looking to sell their investment for a return as they may now want to visit other profitable opportunities in the market to deploy their capital
The 'Late Investors' may not be ready to sell yet as their return targets and expectations may be different to that of the Early Investor
The Management team who may have some equity stake in the company want to continue to grow the business. As the company grows, the absolute value of their stake in the company grows as well.
In this scenario, the exit considerations may look like the following:
The most returns for a PE investor are generated when the exit leads to an IPO. However, the management team may not be entirely happy with an IPO. Post an IPO and formation of a new Board and Chairman, the management team will need to rebuild relationships and reformulate a business strategy and direction that works for the new shareholders. Also, the public markets may look through a more short term lens to generate more immediate profits than focus on long term value that the management team may have been previously focusing on when the company was held private. The Late Investors can choose to hold their investment even in an IPO, but the future value/returns maybe impacted due to involvement of parties from the public markets in decision making.
So, overall the exit outcomes have different impacts on the parties involved:
For Early Investors - Trade Sale in one transaction either through an IPO to public markets or to strategic investor/buyers
For Late Investors - Trade Sale in stages allowing them to hold on to their investment for longer. Stages of sale preferred to private parties and not to public markets
For Management - Trade Sale in either stages or in one transaction to private parties is preferable as they will continue to have the incentive to grow the business, increase value of the company and the absolute value of their share of the pie
Middle Men - Investment Bankers
Bankers do the following as part of a sale process
Design, Develop and Articulate the Exit Strategy: This includes evaluating mergers and acquisitions criteria, trends in the markets, potential synergies with potential buyers etc.
Connect the buyer to the seller: Investment Bankers match funding demand with funding supply. They know the parties with capital and they know the parties who are seeking an investment. Investment Bankers are match makers and they will guide meaningful conversation with the parties on both sides of the deal.
Conduct a valuation analysis: Once a connection has been made between the parties, the investment bankers will lead and participate in a valuation exercise.
Begin negotiations. If working for the buy-side, the investment banker will help the buyer develop and deliver an appropriate offer. If working for the sell side, the banker will assist with review of term sheets and negotiations with the buyer
Assist with due diligence. During diligence, investment bankers continue to dive deeply into the financials and often will serve as one of the major sources of communication between the buy-side and the sell-side.
Lead the closing and settlement of final terms. Investment bankers are largely responsible for negotiating the final terms of the deal.
Investment Banks can also choose to underwrite the public offering themselves. This means the investment bank also does the following in the case of an IPO:
pledges to buy all the unsold shares in an issue of new shares
signs and accepts liability under an insurance policy, thus guaranteeing payment in case loss or damage occurs
Therefore, to complete a successful exit strategy, we require the Buyers, Sellers, Management Teams and Investment Bankers to come together.
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