What exit options private equity firms have for their portfolio companies? 

What exit options private equity firms have for their portfolio companies?

As a private equity firm, you have multiple options on how to sell your portfolio company.

You could sell to the public market, through an IPO (which is costly, but doable), you can sell to a strategic buyer, you can sell to management, or you can sell to another private equity firm.

If you sell to a strategic buyer, you have to be conscious of the fact that through the process of the sale, the strategic buyer is going to become aware of your strategies (your trade secrets).  If the potential strategic buyer walks away from the deal, they may have a competitive advantage over you. If you are looking to sell to a strategic buyer, my recommendation is, before you disclose your trade secrets, have the potential buyer put down a good-sized deposit.

You can also sell to management through a management buyout. Remember the example we gave of Michael Dell’s management buyout of Dell computers? (Video #2)

Another option is to sell to another private equity firm. If you’re getting close to the end of the term of your fund, (i.e. in your ninth or tenth year) and you want to exit, there may be another private equity firm that’s close to the beginning of the term of its fund. Your portfolio company might still be amazing, you just have to divest.

Finally, there’s a dividend recapitalization, where you can take on debt and pay out a dividend.

As an example of a business that goes from inception until exit, we’re going to look at Alice. Alice is a third year university student who has an eye for fashion. Looking at what her fellow students were wearing, Alice realized something – students were either wearing attractive clothes that were not comfortable or comfortable clothes that were not attractive. Alice began to design clothes that were both attractive and comfortable.

As Alice and her friends started wearing the clothes that she designed, other students on campus noticed, asking Alice to design clothes for them as well. Soon students across campus were wearing these attractive, comfortable clothes.  Other students, from universities across the country, started to take notice and began contacting Alice for these attractive, comfortable clothes.

There was such a demand that Alice had to open a large manufacturing facility. Now, students across Canada were wearing Alison’s clothes. When these students from Canada visited the U.S., American students looked at these Canadian students and said, “Wow, they look so good and so comfortable. We need to get a hold of some of these clothes!” So, more students started to order clothes from Alice. Word spread across the U.S., and before long, Alice had a company with sales across North America. Then, along came a private equity firm and this private equity firm loved Alice’s company.

The private equity firm recognized that Alice’s company had no debt and had successfully penetrated the North American market.  The private equity firm had a lot of contacts in the European clothing industry, where it wanted Alice to expand. The private equity company bought a majority stake in Alice’s company and then expanded it to Europe. Years later, the private equity firm and Alice had developed a huge clothing company that had penetrated both North America and Europe.

The private equity firm now has a few options on how to exit its investment in Alice’s company.

It could bring the company public through an IPO, it could sell the company to a strategic buyer (such as a big clothing company), or it could sell the company to Alice through a management buyout (depending on how much debt the company has on the books). The company can sell to another private equity firm, potentially one that has experience in markets that the company is currently not in, such as Asia or Australia. The company could also do a dividend recap (depending on how much debt that they have on the books, they could take out some more debt and pay a special dividend).

These are just a few options that the private equity firm has to exit.