For all private equity investors, the final goal is to realize the return on their investment after a certain amount of time, usually after three to seven years since the original transaction took place. Exit by private equity investors is therefore an imminent aspect of every private equity transaction. Also, the number of successful exits achieved by a certain private equity house has a strong influence on its ability to attract investors and raise funds.
What investors fail to realize is that a full proof exit strategy is essentially what makes a private equity deal score over and above other similar deals. A right exit strategy ensures wealth creation and protection alongwith smooth transition. If the exit plan is weak or uncertain, a good private equity investment plan may turn into a financial ruin. To seize the real deal in private equity, exit strategy should be the foremost consideration.
Accordingly, the potential exit opportunities from an investment plays a decisive role in selection of private equity funds and proposals. This is the reason why exits strategies receive such special attention from the earliest stages of the deal.
Being a flexible financial model, private equity investment offers several exit options depending upon the fund structure and customization by fund managers. The most frequently-used and popular exits routes are presented herein below:-
Initial Public Offering
Initial public offering (“IPO”) method is whereby shares of the investment company gets listed on the stock market for the first time, so the investor is be able to sell its shares to the public. This is one of the most popular exit strategies at times of stable economic conditions as it is likely to enable the investor to realize the highest return on its investment.
However, IPOs also have serious disadvantages compared to other exit methods.
The equity share is exposed to fluctuations and other market risks for a certain amount of time after the IPO is carried out. Additionally, IPO is a cumbersome and expensive process involving compliance of strict regulatory requirements and restrictions.
Another commonly used exit route is the trade sale in which the private equity investor sells all of his/her ownership rights in the investment company to a trade buyer, i.e. a third party often operating in the same industry. This method is preferred by private equity providers mainly because it provides a complete and immediate exit from the investment. Another reason can be the quick and efficient process owing to a single person transaction with no regulatory restrictions unlike IPO. The investor is in-charge and exercises full control over the whole exit regime and may also be able to recover higher returns through negotiation process.
Trade sale comes with its own set of issues and difficulties. The management of the project may feel threatened due to change in the controlling party and act as a hurdle in completion of the exit strategy. The trader may obtain confidential information during the negotiation process and misuse it, posing a serious business risk.
Secondary Buy-Outs (SBOs) are transactions in which a private equity firm sells a portfolio company to another private equity firm. They are also known as sponsor to sponsor deals.
In this exit strategy, private equity houses appear on both sides of the deal. The private equity firm purchasing the equity investment does so with the intention of value addition to a familiar asset in another private equity firm and utilization of the excess cash available with them.
There are a number of possible reasons why an investor may choose this method as the exit route. It can be a means of shortening the life-time of a transaction in light of the current economic climate or unwillingness or inability to grant finance to the business anymore, even though the company might not yet be ready for a trade sale or IPO. In this situation, selling the company to another private equity firm can be the ideal way to move ahead.
A secondary buyout offers a swift and complete exit for investors which plays a significant role in its increasing popularity.
Leveraged recapitalization is an exit method, whereby the private equity investor is able to extract cash from a business without actually selling the company. This is achieved by changing the capital structure of the company i.e. substitution of the company’s equity with additional debt. Under this method, a private equity company borrows money from a bank or issues bonds or makes use of its own reserves, to repurchase their shares from the investor. The most important advantage associated with leveraged recapitalizations is that the control of the investment is vested in the remaining investors. On the other hand, a leveraged recapitalization may also result in imbalance of capital structure which can lead to financial difficulties and even bankruptcy. A pressure is created on the company’s operations for timely repayment and accountability to debt lending institutions and banks.
The rationale cited by the private equity firms behind preference of this method is the maintenance of control over the enterprise and wilful avoidance of uncertainty prevailing over the IPO market.
From the aforesaid paragraphs, one can understand that volatility of returns in private equity market is largely attributable to the kind of exit strategy one selects. Therefore, adopting the right exit strategy could save you from all the anxiety while going for private equity investment.
IKIA, a research based real estate portfolio management firm in Chennai, was established with the sole intention of promoting, generating and preserving wealth creation by providing competitive financial advisory services to all. They act as knowledge partners and financial guide to private equity investors throughout the deal structuring process including selection of the correct exit strategy, keeping in mind an individual’s investment goal. IKIA specializes in real estate private equity deal structuring and have been successfully advising on the real estate private equity deals since 2012. The five-member research team at IKIA evaluates and analyses primary data collected by them to provide customized solution to investors.
Every investor should approach financial advisory and portfolio management firms like IKIA for leveraging on their financial expertise and to be aware of the wealth creation opportunities in the present economic condition.