The Private Equity Fund Exit Strategy

As the last critical step of the private equity (PE) investment process, the exit can significantly affect the final return to investment.  The primary goal of fund managers is to receive a return which is in excess of the price paid for the companies in the portfolio at the time of exit. This article discusses the various exit strategies available to fund managers.

Trade Sale

This is a commonly used exit strategy in which the private equity sponsor sells all its shares held in a company to a purchaser, typically a third party. It is important to note that the third party is usually operating in the same industry as the target company, which obviously has strategic advantages. The third-party purchaser is usually very knowledgeable about the business of the target company. The advantage is that the experience of the third-party purchase may facilitate a faster due diligence as well as closing process.

Initial Public Offering

The initial public offering is an exit strategy where the company offers its securities for sale to the general public. The advantage is that going public tends to attract the highest returns for private equities sponsors and is dependent on the conditions of the market. However, the transaction costs are higher, and the process is usually unpredictable and longer. Notably, the private equity sponsors may not have a clean exit as they may often be asked to enter into lock-up agreements.

Secondary Buyout

This is an exit strategy in which the company is sold by one private equity investor to another private equity investor.  In other words, private investors will sell their stake in the business to another private equity firm. Some of the reasons that lead to private equity sponsors deciding to use this strategy are that the original sponsor may no longer be interested in backing the company even though the company is not yet ready for a trade sale. Another reason is that the management of the company may want to replace the private equity sponsor. A secondary buyout would, therefore, allow a private equity sponsor to have a fast exit.

Leveraged Recapitalization

This is a partial exit strategy in which the private equity sponsor extracts cash from the business without selling the company. This is achieved by the company having to borrow more money from the bank or issue bonds. The cash generated is then used to redeem the shares held by the private equity investor. Notably, highly leveraged companies have greater risks of running into bankruptcy and they may not always have enough liquidity to keep the business running.

Dual Track Process

The dual track exit process is an exit strategy by filing an IPO prospectus and pursuing a trade sale at the same time. This exit strategy allows private equity investors to test waters in the public while looking for a suitable third-party purchase at the same time. Even though the returns for investors using this strategy are high, the costs of running it can be costly.

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