For CEOs and founders, one of the last items on their investor checklist is discussing potential private equity exit strategies. That said, ensuring that both the company and investors are on the same page in terms of how they view successful exits will reduce friction and conflict in the long term.
How likely are private equity investors to exit after 5x multiple returns? Do they care if interested buyers plan on liquidating the company after purchase, regardless of the purchase price?
At the end of the day, investors exit for two reasons:
- They have made their expected or greater returns.
- The investment was not successful or was not making enough to justify further investment.
Most investors coming from private equity firms expect to see a significant return on their investment within 5-7 years, although the actual time frame may vary from firm to firm.
The exit strategy your investor may be interested in also depends on your company’s lifecycle stage, value, and growth as well as the quality of potential buyers. Out of these factors, your company’s size and valuation take priority.
For larger organizations, initial public offerings (IPO) are a common exit strategy. IPO exits are when the founder and investors provide a public offering and sell shares of the company. An IPO is often seen as the "ideal" strategy, especially for Leveraged Buyout (LBO) sponsors.
While this is a popular option, the IPO process is expensive, and underwriting alone can cost up to 7% of IPO proceeds. Additional expenses include legal counsel, accounting, SEC registration, FINRA registration, exchange listing fees, transfer agent fees, and other indirect costs such as audits and legal counsel on M&As, intellectual property, and other items.
In some cases, a private equity firm may choose to file for an IPO and look for buyers in a strategic acquisition, one of the most common exit methods.
For many sellers, it makes sense to use trade sales as an exit strategy. Private equity funds often prefer this type of exit as strategic buyers tend to view the seller's organization as an asset. This ensures that investors and founders have more leverage during the acquisition. In this case, they can determine their individual earnings from sale valuation.
Synergy comes into play when looking at strategic acquisitions. This suggests that the target company will provide more value to certain organizations. Some examples of synergy include the buyer using the acquired company to provide a new product line, reach a new target market, or streamline their operations through the target company's suppliers and vendor network.
Secondary sale or leveraged buyout (LBO)
At some point, a company may require more investment than the private equity firm can provide, or perhaps, another set of investors would better serve the company. A secondary buyout or sale is when your investor sells to another investment firm or fund. This type of sale process is common for companies that have reached a new growth level and require more funds and different advisors.
In the repurchase exit strategy, the management team buys the ownership shares from their original investors. This strategy is beneficial to both the founders and the equity teams. While the management team gets its stake back and more control over the company, the private equity fund will get its money back.
Startups, in particular, can benefit from this strategy, especially if they have experienced rapid growth. Founders may even need additional funding down the road, but rather than dilute their ownership, buying back their stakes will allow them to provide worthwhile equity to future investors.
The least attractive option for a full exit is liquidation. Liquidation is usually only an option when a company is not profitable and there are no interested buyers who wish to run the organization.
Deciding on the right strategy
An exit strategy is critical for private equity investors, as they see this as a surefire way to reap the fruits of their investment. It also provides them with some assurance that you've completely thought through your business lifecycle.
It can be extremely difficult to pick an exit strategy years in advance; however, it’s important that management teams and investors come together to decide on their ideal exit schemes and the benchmarks to be put in place from the very beginning.