Exits are the lifeblood of private equity: for private equity houses, the top of their list of priorities when making an investment is an understanding of when and how they will realise that in due course. There is no point making an investment unless it results in a (successful) exit.
This is why investors plan their exit strategy at the time they invest, and why private equity investors have developed sophisticated contractual mechanisms to give their investors the best chance of exiting an investment at a time and on terms of their choosing.
The methods of exiting private equity investments have developed over the years, and particularly in the more challenging economic environment of recent times. To the usual trade sales and initial public offerings have been added secondary, tertiary (and more) buy-outs, refinancings, partial sales and liquidation, or indeed a combination of these, known as dual or multi-track processes. Such multi-track processes are becoming more common as they keep ultimate exit route optionality for as long as possible in any process without adding incrementally to the transaction costs (so for example much of the diligence work required for an IPO can be used for a sale process). In 2010 the aggregate amount of investments divested by private equity houses in the United Kingdom, according to British Venture Capital Association statistics, increased by over 150 percent on 2009, and this significant growth is reflected across Europe and globally.
The trend had appeared to be continuing in 2011 at least for the first three quarters, although the BVCA statistics have not yet been published to confirm this. Private equity houses looked to raise new funds to invest in the perceived upturn and cash-rich trade buyers flexed their financial muscle; although by about Q4 2011, the opportunities for exits started to decline quite quickly.
If the economic environment improves, exits ought to become easier to achieve; but in these uncertain times, private equity houses will continue to put a significant focus on what options might be available to them to realise their portfolio investments, being mindful of not just the economic risks, but also the legal, tax, regulatory and reputational issues at stake. It is likely we will see more bilateral deals with strong trade buyers, as the IPO market is still not looking very healthy and for many the disruption and uncertainty that can be caused by large secondary auctions may not be attractive.
It is likely we will see more bilateral deals with strong trade buyers, as the IPO market is still not looking very healthy
Portfolio company management teams are key to the exit process and their economic, commercial and personal priorities cannot be underestimated in what is a very complex environment of often conflicting aspirations. Management teams have their own personal interests to contend with and will of course wish to minimise their own exposures while maximising their gains. The portfolio company itself will be looking to the future and the ongoing success of the business for shareholders, employees and other current and future stakeholders.
A private equity house acting as fund manager/adviser wants to create a strong track record to raise new funds and to reward its staff, while protecting itself and its portfolio company directors from legal, regulatory and reputational risk. A private equity fund also needs to return cash to its investors in as tax efficient a manner as possible and free from contingent liabilities. It is these potentially conflicting perspectives that make private equity exits so intricate and interesting.
David Walker is Clifford Chance's global head of private equity. This edited article originally appeared in Private Equity Exits, A Practical Analysis, published by Globe Law and Business and edited by Walker.