Private equity is a term used in the finance sector to describe investments made directly into a business by some investors and private equity organizations. Institutional investors typically make private equity investments in venture capital funding or leveraged buyouts. Private equity can be used for various goals, including technology upgrades, business expansion, acquisitions, and even the revival of a failed organization.
Private equity investors often have a 5-7-year investment horizon and expect to leave after making a significant return on their investment. Private equity investors might use various exit strategies to get their money back. Private equity (PE) has been the expansion engine for a while. The primary goals of this industry are evolution and productivity. Private equity refers to capital that is not traded on a public market and is invested in a long-established industry that is not functioning well or is about to fail. Venture Capital, Growth Capital, Leveraged Buyout, Mezzanine Debt, and Distressed Debt are the five main types of PE. A venture capitalist, often known as a “venture capitalist,” comes to their aid by offering risk-bearing funds. Institutional and individual investors contribute funds to private equity, which can be used to fund innovative technology, boost working capital, or consolidate a balance sheet.
Standard Modes of Private Equity’s Exit Strategy From Portfolio Companies
Exits are of crucial importance to Private Equity investors, and they consider a variety of different exit strategies to realize their return on investment. Some of the most common Private Equity exit strategies include:
Initial Public Offer (IPO)
One frequent method is to launch a company’s public offering and sell its shares to the public as part of the IPO. Depending on the situation, shares might be sold at once. Shares assigned can also be sold when the company is listed and the shares begin trading on the exchange. Because of the required costs, stock market flotation may only be employed by giant corporations, and it must be financially sustainable.
A strategic buy or trade sale is another choice, in which the business is sold to a different suitable company and a portion of the sale earnings is received. One of the most typical methods for private equity funds to exit is this one. The buyer will typically profit strategically from purchasing this business because their strengths may compliment one another. As a result, the buyer frequently pays more to purchase such a business.
The private investors can sell the acquired stake in the company to some other private equity group in a secondary sale. The secondary sale might happen for a variety of reasons. For example, the business may demand additional funds above the current equity fund’s capability. Alternatively, the company may have reached a point where the earlier private equity investors wanted it, and additional equity investors wanted to take over.
Repurchase by the Promoters
It is another effective exit plan in which the company’s management or promoters buy back the equity position from private investors. For both investors and management, this is an appealing exit option.
It is the least desirable choice, but it may be necessary if the company’s promoters and investors have been unable to run the business successfully.
Key Considerations and Trends in Private Equity’s Exit Strategy From Portfolio Companies
Preparing the Portfolio Company for Sale
Private Equity investors, being financial investors with an investment philosophy of creating returns on their investments, typically keep a close eye on the company’s performance and engage in strategic choices that may affect valuation (especially as their investment horizon approaches). Furthermore, as part of a portfolio company’s ‘clean-up’ prior to an impending sale, another emerging trend is to refinance or repay the company’s existing debt to be able to, among other things:
-Displaying a solid balance sheet to potential incoming buyers
-If any, obtaining a release of encumbrances over shares of other shareholders that may be relevant for a bulk sale.
Retaining a majority interest or control rights in a publicly traded firm after a partial exit may expose the Private Equity investor to be classed as a promoter or “co-promoter.” Partially exiting from a private firm carries the risk of the Private Equity investor losing control and piggybacking on the founders’ or private equity’s exit strategy from portfolio companies.
Use of Insurance Product
Most Private Equity investments are made through funds with a short life expectancy and internal constraints on taking general indemnity obligations, including uncapped indemnities. As a result, using an insurance product to supplement, and in some circumstances completely replace, the indemnification structure that sellers may provide in such transactions is becoming increasingly prevalent.
Severance Payouts or Compensation Arrangements
Without the approval of the board and non-interested public shareholders, a Private Equity investor cannot enter compensation or profit-sharing arrangements (including severance payout arrangements) with the promoters, directors, or key employees as part of its exit strategy from a publicly traded company to incentivize them by sharing returns beyond a hurdle rate.
Much debate has surrounded the question of whether a foreign investor’s exit option can be at a pre-determined valuation while still guaranteeing returns. Indian courts have recently demonstrated a greater willingness to uphold indemnity and damages claims, even when the underlying contractual commitment conflicts with Indian exchange control prohibitions on guaranteed returns.
There may be different tax implications depending on the cost of buying shares and the difference between the purchase value and the final sale price. To minimize further tax implications, ensure those indemnification payments are not treated as income and are instead adjusted as capital gains. Exit structures must also be implemented to minimize tax exposure and prevent violating India’s “general anti-avoidance regulations.” In transactions involving selling shares by a non-resident private equity investor to another non-resident private equity investment, indemnities for potential indirect transfer taxes become an essential part of the share purchase agreements.
Enforceability of IPO provisions
Given that all the business’s directors sign the IPO offer documents, the directors’ fiduciary duties may prevent the company from conducting an IPO on terms dictated by Private Equity investors if the directors believe the IPO was not in the shareholders’ best interests. In addition, the corporation must have a proven record of profitability and net worth and a minimum amount of net tangible assets, among other requirements. As a result, the enforcement of IPO requirements in shareholder agreements has yet to be proven.
Locked-box vs Completion Accounts
There are two methods for making post-completion adjustments: completion accounts or a locked-box approach. A locked-box method is efficient since it ensures pricing certainty and saves management time and effort to prepare completion accounts. However, under a locked-box system, the negotiated post-signing interest that must be paid together with the purchase price may not be enough to balance the impact of intermediate activities that must be reflected into completion accounts.
Magistral’s services on Private Equity’s Exit Strategy From Portfolio Companies
Magistral’s successful exit strategy specifies existing owners’ procedures to separate themselves from the company. The extended off-shore crew also assures that no expertise is lost across firms for similar projects and that numerous projects in several companies can run simultaneously, prioritized according to board meeting schedules. Unanticipated events may necessitate the implementation of a corporate exit strategy.
About Magistral consulting
Magistral Consulting has helped multiple funds and companies in outsourcing operations activities. It has service offerings for Private Equity, Venture Capital, Family Offices, Investment Banks, Asset Managers, Hedge Funds, Financial Consultants, Real Estate, REITs, RE funds, Corporates and Portfolio companies. Its functional expertise is in Deal origination, Deal Execution, Due Diligence, Financial Modeling, Portfolio Management and Equity Research.
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