A buyer can do a private equity exit from an investment in many ways. It can be done through a sponsor-to-sponsor deal or a sale to a corporate buyer. Here are some strategies that a private equity buyer can utilize.
Alternatives to Private Equity Exit Strategies
Sale to Corporate Buyer
Private equity buyers may sell to another corporate buyer that sees the acquisition of the company as complementary to its overall business strategies. They are also known as strategic buyers and they are the mainstay of private equity exit. But just like the Great Recession of 2008 to 2009, when the company is weak and the recovery isn’t great. These kinds of buyers are difficult to find. It is during these times that they are not looking to expand and aggressively pursue their strategic growth plan. This is because they are more risk-averse when their sales growth and economic growth are weak. Now that the US corporate treasuries are growing, strategic buyers are returning to the M&A market.
Sponsor-to-Sponsor Deal
This second option is where one private equity firm sells a prior acquisition to another private equity firm. This kind of transaction is well-known in a market where there are many private equity capitals in funds seeking deals while there are also famous equity firms trying to generate returns from previous acquisitions
Public Offering
In a public offering, the private equity firm sponsors an offer in the public in the stock that it owns before the acquisition. Is this viable? The answer depends on the vitality of equities markets and the IPO markets in particular. In 2013, private equity firms made roughly half of all IPOs.
Dividend Recapitalizations
Generating returns from portfolio companies of private equity firms is something else. It is more than just cashing out the investment when it sells. Private equity firms have been recently engaging in so-called dividend recapitalizations. This is when private equity firms that have acquired companies take on more debt. Issuing bonds and using proceeds to pay a dividend to the fund investors can help acquire this debt. This was the case in September 2004, when KKR had PanAmSat issue $250 million in notes that were used to pay the investors who bought the firm just one month prior for $4.3 billion.
When private equity investors purchased Burger King, the buyers paid a $400 million special dividend in 2006. Burger King financed this through the assumption of approximately $350 million in debt. In May 2006, Burger King did a $425 million IPO which prepared the substantial debt that the company had taken on to pay the dividend. This combo of the dividend and their share of the private equity proceeds provided the private equity investors with a whopping 115% return on their three-year-plus investment.
Debt Financing and Use of “Covenant-Lite” Loans
From 2003 to 2007, during the era of private equity exit, the firms were able to negotiate very big conditions with the lender and banks that they had great connections with and to which they brought a lot of business. Aside from that, the banks were confident due to the very positive economic environment and how they were not able to understand how a business cycle works.
One of the favorable conditions here was the granting of covenant-lite loans. These kinds of loans had less restrictive covenants that require specific financial performance. This financial performance may include the maintenance of specific financial ratios. The loan agreements are liberal that they can accept in advance certain violations of the agreement by the borrower.
\But they may allow the GP to “cure” transgressions in return. This is by adding more equity to the target. Although enders were flexible during the 2003-2007 private equity boom times, they are much more strict when the economy collapsed after the subprime crisis.
Bridge Financing
Bridge financing in the context of private equity transactions is the capital offered to allow the GPs to complete the deal as they wait for long-term financing to be worked out. For this to be possible, the private equity firm secures a commitment from an investment bank. The private equity GPs and the bank typically hope the bridge financing will not be a requirement, since they will be able to syndicate a bank credit facility or simply float an offering of junk bonds.
Bridge financing is riskier than longer-term financing that is related to a closed deal. Because of this, private equity firms try to avoid using bridge financing. Once there is an agreed-upon debt availability, the private equity firm is in a position to make a commitment to the seller. They must commit to the the deal’s equity, too. It is one of the things that need to commit to.
If the private equity firm does not have immediate access to the total amount of equity capital needed to complete the deal, it may go to a bank and ask it to temporarily provide the additional needed equity, called bridge equity. Obviously, the recipient has to pay the bank the necessary fees to make this equity capital available. A commitment for the total acquisition amount to the seller once the bank makes the commitment.
Delaware General Corporation Law Rule 251H
When it comes to tender offers, private equity buyers have long been in a disadvantageous position relative to strategic buyers. These private equity buyers face several risks. Risks such as that the deal would or not be approved by selling stockholders in a closing-out second-step transaction.
Bridge financing must be secured by private equity bidders without the benefit of the assets of the target for collateral support. This is because they do not get such access and sport until the deal is done. This bridge financing can be expensive, and this caused many private equity firms to avoid the tender offer.
The Rule 251h grant buyers that get a simple majority of a target’s shared in a tender offer. This is so to quickly close rather than wait for a shareholder vote. This contributed to the competitive feature of financial buyers. Examples of these are private equity firms or strategic buyers who are using debt financing. As opposed to compared to strategic buyers who may be using their own cash or stock. It also reduced the possibility of expensive time delays that make it more expensive and uncertain in the takeover process.
We hope that this article about the private equity exit has helped you a lot! See you on the next one.
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