Estimated reading time: 5 minutes
Every private equity investment has a lifecycle, and eventually, it’s time to turn paper profits into tangible returns. The exit phase is crucial as it allows private equity investors to realize gains and redistribute capital to new opportunities.
In this article, we’ll explore six common exit strategies used by private equity investors. These include initial public offerings, recapitalization, and liquidation, each with its own advantages and considerations. Understanding these strategies can help investors make informed decisions about when and how to exit their investments.
Table of Contents
- Initial Public Offering (IPO)
- Trade Sale
- Secondary Sale
- Recapitalization
- Management Buyout (MBO)
- Liquidation
1. Initial Public Offering (IPO)
An IPO involves listing the portfolio company on a public stock exchange, allowing the private equity investor to sell its shares to the public. This strategy can provide significant returns if the market values the company highly.
However, the frequency of IPOs has declined substantially in recent years, with some investors citing the high costs and regulatory requirements.
One example of an incredibly lucrative IPO exit was Peter Thiel’s exit of Facebook in 2012. In 2004, Thiel invested $500,000 in Facebook for a 10.2% stake in the company. In May 2012, Facebook went public with a market capitalization of $104 billion.
Before the IPO, Thiel had already sold some of his shares. Even still, Thiel sold approximately 17 million additional shares at the offering price of $38 per share, generating $640 million from the sale. After the IPO, Thiel continued to sell, earning an additional $400 million by the time he had fully exited his position a few months later.
2. Trade Sale
In a trade sale, the private equity investor sells the portfolio company to another company, often within the same industry. The company looking to buy is typically looking to expand its market share or acquire new capabilities.
Some private equity investors look to trade sales as the acquiring company may offer strategic advantages to the portfolio company. They can achieve a quick sale at a potentially high valuation. However, it may be difficult to find a suitable buyer who values the company appropriately.
If you want an example of a successful trade sale exit, look at KKR's sale of Alliance Boots to Walgreens. In 2007, KKR acquired Alliance Boots in 2007 for $22 billion. In 2014, Walgreens bought the remaining 55% of Alliance Boots that it did not already own. The total deal valued Alliance Boots at over $27 billion, generating substantial returns for KKR.
3. Secondary Sale
A secondary sale involves selling the portfolio company to another private equity investor or financial investor. This strategy is common when the new buyer believes they can further enhance the company's value.
Private equity secondary exits can be quicker and less complicated than an IPO or trade sale. Plus, it often involves sophisticated buyers who understand the business.
However, because this exit occurs before maturity, it may not achieve as high a valuation as an IPO. Secondary sales ultimately depend on other private equity investors believing there’s still substantial upside in the investment.
4. Recapitalization
In a recapitalization, the private equity investor restructures the portfolio company's debt and equity mix, often returning capital to investors while retaining a stake in the company. This strategy allows for partial liquidity while maintaining upside potential. However, it can lead to substantial stress on the company’s debt load and requires ongoing management and oversight.
For an example of recapitalization exit, look to Carlyle Group’s Recapitalization of Acosta Sales & Marketing. Carlyle initially acquired Acosta in 2011 and executed several recapitalizations to return capital to investors. These recapitalizations provided liquidity to Carlyle’s investors while maintaining significant ownership in Acosta.
5. Management Buyout (MBO)
An MBO involves selling the portfolio company to its existing management team, often financed by debt or equity from other investors. This strategy can be attractive if the management team is highly capable and motivated.
Benefits include aligned interests between the management team and investors, and the potential for a smooth transition with minimal disruption. However, this exit strategy rarely achieves as high a valuation as other exit strategies, and often requires the management team to secure substantial financing.
One example of a positive management buyout came in 2013 when Michael Dell and Silver Lake Partners took Dell private in a near $25 billion buyout. The MBO allowed for significant restructuring, and Dell Technologies later returned to the public markets with a market capitalization significantly higher than the buyout value.
6. Liquidation
In some cases, especially when the portfolio company is not performing well, the private equity investor may choose to liquidate its assets. This involves selling off the company's assets piecemeal and returning the proceeds to investors.
Liquidation can recover some value from underperforming investments, though it typically results in low returns and can prove a lengthy, complex process.
One example of a private equity deal that ultimately led to liquidation was Toys R Us. After KKR, Bain Capital, and Vornado Realty Trust acquired the toy retailer in a $6.6 billion buyout in 2005, Toys R Us struggled financially and filed for bankruptcy in 2017. The liquidation process in 2018 aimed to sell off the company’s assets, though it resulted in significant losses for the private equity firms involved.
Practice Due Diligence on Your Private Equity Exit Opportunities
Each exit strategy has its benefits and challenges. Effective exit planning is crucial for maximizing returns and ensuring a smooth transition for the private equity investor and portfolio company alike.
When it comes to exit planning, the best option in your toolkit is comprehensive due diligence.
Asking the right questions and looking under the couch cushions could prevent significant financial losses. It’s imperative to adopt a systematic and rigorous approach to evaluating exit opportunities.
To bolster your due diligence repertoire, download our Private Equity Due Diligence Guide. This guide provides detailed checklists, red flags to watch out for, and strategies for evaluating private equity investments effectively.
Private Equity Due Diligence Guide
Reduce Capital Gains Taxes on Private Equity Exits
Lastly, imagine you've just had a successful private equity exit. Before you’ve even popped the champagne, it’s time to plan for long-term capital gains taxation.
At the federal level, this can reach as high as 20%. At the state level, capital gains taxes can crest over 14%. This means that after a successful exit, you may only be pocketing 65-70 cents out of every dollar of profit from the deal.
That is, unless you invested through a self-directed IRA (SDIRA).
Self-directed IRAs are identical to any other IRA offered by bank or brokerage, though they come with one crucial advantage: they allow you to invest in a wider range of assets, including real estate, precious metals, and private equity.
With a traditional SDIRA, investment gains grow tax-deferred until you take distributions, typically during retirement. If you invest through a Roth SDIRA, contributions are made with after-tax dollars, but investment gains can be withdrawn 100% tax-free in retirement.
For more detailed information on SDIRAs, including how to get started, download our SDIRA Basics Guide. This guide provides a comprehensive overview of these investment accounts and the IRS rules you need to follow.
Bonus: By opening an SDIRA with The Entrust Group, you gain exclusive access to Entrust Connect, our online investment marketplace. Entrust Connect features new offerings regularly, including opportunities in technology firms, real estate development projects, and more.
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