In my previous article, the application of the Private Equity Industry in the growth and expansion of companies has been highlighted and explained in simple terms. The firms in the Industry, operate with aims to acquire companies at a relatively low cost, oversee the growth or expansion, and exit with profits, when the time is right. The manner to which the firms choose to exit a certain investment, ofcourse is dependent on a number of variables that have a direct or indirect impact. Some PE firms choose to take the company public through an IPO process, others choose to offer it up for acquisition by a corporate buyer, a write-off, and while others choose to go for a secondary buy-out. In the end, they choose a route that is in direct alignment to the interests of their limited partners, aiming to provide substantial returns to them.
To understand what factors determine the choice of an exit of a Private Equity firm, it is important to break down in detail, the exit choices available for some firms;
Initial Public Offering (IPO)
Commonly referred to as “IPO”, it is a process by which company raise capital, through offering part of it’s equity stake (shares) for public subscription, hence the term often used “company goes public”. The company is then listed in a particular exchange, and it’s shares begin trading publicly on a daily basis. In the past, it has often signified a symbol for success, a sign for officially making it, in the world of connoisseurs.
After the PE firm is satisfied with the value it has created from the company it acquired years before, it can decide it is time to leave that particular investment, by taking the company public through an IPO. This is common for companies that have proven to be highly profitable and needing less control of the PE fund managers.
An IPO is considered favorable also when the stock market is bullish and looking strong. This assures the fund managers that once they put on a roadshow, they can value the company high in accordance to how the market value permits, hence pocketting substantial returns once they sell the equity stake they hold of the company.
It has happened that some companies have seeked an IPO, due to the pressure of paying a high debt they amassed, when the PE firm acquired them through a Leveraged Buy-Out (LBO). This is because, LBO requires borrowed capital to finance an acquisition of the company, for which that borrowed capital is then assumed as a loan by the acquired company, which is then dumped in it’s balance sheet, and the company is then forced to service it indefinitely. So when the acquired company is struggling to create value, the PE is backed into a corner of having to offer returns of any kind to the Limited Partners (LPs) who are the investors. Due to such pressure, the PE firm may take the company public prematurely, in order to exit the investment and be able to create value to return atleast principal amounts invested.
On March 16th, 2020, The Carlyle Group sold a 10% stake in its SBI Cards & Payment Services Ltd (SBI Card), which is the second largest credit card issuer in India, through an IPO, while still holding the remaining 16% stake, hence making it a partial exit.
This type of exit is realized once the Private Equity firm sells the acquired company to another corporate buyer. In such cases, the Corporate Buyer normally is a company that can easily identify as a platform company, for which the acquired company can serve as an extended subsidiary or line that can compliment it’s ecosystem to offer their customers or clients a diversified portfolio of products and services.
This choice of an exit, costs less to the Private Equity, and regulations involved, are less compared to those required to be taken into consideration for an IPO. It also offers a buy back, whereas the acquired company can choose to buy back it’s shares, and regain full control and ownership of it’s company.
It is an easy exit route, as most PE firms can agree on the terms of the sale and excute on it. While for an IPO, there is a lockout period of one year after going public, during which, the PE firm is required to still hold on to it’s shares befor selling them at a profit to earn their returns.
In June of 2012, Walgreens took step in acquiring a 45% stake in Switzerland’s Alliance Boots, for $6.7 billion in cash and shares, with a promise to acquire the remaining 55% of shares and outstanding debt of £7 billion. This transaction deal was an exit made by KKR and its partners, with which they pocketted majority of their initial investment of about $2.45 billion in equity investment because they received $1.8 billion in cash and seven million Walgreens shares that is equivalent to $200 million.
A trade sale is a strategic acquisition that most corporate buyers use to facilitate Mergers & Acquistions (M&A’s) deals. The acquiring company in this case, normally acts as a platform company, for which the acquired companies can serve as a line of extended services, or a company that will provide a new line of products to be able to gain new markets and clients.
Sometimes the acquired company is sold to another Private Equity Fund, as a means of exiting a particular Investment. It is a favorable means of exit during the time when the IPO Market is not favorable (bearish even), when the credit conditions are favorable and when there is ample dry powder accessible to PE firms to make an acqusition with.
It is a much faster exit route, than an IPO or a trade sale, and offers no choice of buyback to the acquired company. Normally PE firms prefer this choice, when there are exists a clash of management between the former and the acquired company management. In such instances, the PE Firm can choose to sell the company to another PE fund and exit early.
In 2017, Blackstone sold Logicor to China Investment Corporation a sovereign wealth fund, for €12.25 billion.
When the acquired company go bankrupt, the Private Equity firm can choose to exit the firm through writing off it’s equity, either totally or partially depending on a capital reduction level. The acquired company can call upon (redeem) it’s shares from the PE firm at a price less than it’s face value, hence reducing ownership stake of that of a PE firm either totally (calling back all their shares) or partically (redeeming some of the shares), forcing the firm to an exit.
The decision to write off happens when a PE firm seek the court to declare the company has defaulted, or when creditors asks the court to initiate the filing of bankruptcy proceedings. A write off comes at a cost of ensuring with certainty, that a company is in no position to be profitable now or in the near future and that it’s assets can be sold to the market, to pay it’s obligations to creditors and for investors to realize their returns.
The decision of what choice of an exit a Private Equity can be an easy one or rather, a complicated one, depending on what side of an exit, the respective party belongs to. In regions such as Asia, older Private Equity firms tend to be more suited and financially capable of taking companies rather than the younger firms. Also their strong legal systems have created a strong stock market which is favorable to IPOs, hence attributing to the high valuations attached to the companies going public.
In Europe however, the Internal Rate of Return (IRR) for IPOs is much higher than that attained from Acquistion Exits, and most high profitable companies require less control, which then contribute to an IPO being a more preferrable exit choice than others.
United States of America (USA) choice of an exit vehicle depends on the finances of the acquired company, the stage that the acquired company is in, whether or not the company is a best performer, whether the company needs more work, quality of the company, type of an industry the company belongs to or even a duration of an investment. High Quality Companies prefer an IPO first, then a trade sale, secondary sale then a buy-back or a write-off.
Some firms employ more than one exit strategy, and pursue both an IPO and also a trade sale on the side. In some cases, firms choose to partially exit from the investment through an IPO first, and then years later, sell of the remaining stake they hold through a trade sale.
Firms take into consideration how long they have held their investment, for which maximum holding period is normally ten (10) years. It is highly unlikely for a PE firm to take exit a premature investment (normally of less than 3 years), as most fund managers prefer to exit after they have created enough value for the company and for their investors.
Recently, the firms have bought into an idea of building long term funds that will last for a periof of 15 years, or even longer. Large PE titans such as The Carlyle Group, Blackstone, CVC all have been on the front line launching buyout funds whose life is longer than other traditional PE funds. These funds will target companies with low risk and low returns over a long period of time. They aim to charge lower fees, while enjoying an internal rate of return (IRR) of about 12% to 14%. With over $2 trillion in dry powder, it is no question that this trend, marks the new horizon of private equity, as most limited partners (LPs) who are institutional investors or high networth individuals, are comfortable with putting their investments with PE firms for a long time, and also holding an investment for a long time gives room for more expansion and growth rather than exiting after only a few years