The exit phase is a fundamental step for the private equity investor, as only through it does the monetization of the creation of value implemented during the investment period take place. Through divestment, the creation of value becomes from theoretical to effective, transforming the portfolio valuation into a price and consequently into a yield obtained on the market. For this reason, from the first analysis of the potential investment, private equity operators question themselves in advance about the exit possibilities and the most likely categories of potential acquirers at the time of divestment, despite being very distant in time. During the investment cycle, the prospect of exit cannot be neglected, in particular when the company must evaluate a transformational acquisition that could positively or negatively affect the success or the exit. Think of how profitable it is, for the purposes of a subsequent valorization, to have increased the scale of the company and its degree of internationalization through a build-up strategy and have placed it in a range of higher multiples. For the purpose of maximizing the capital gain inherent in the shareholding, the critical factors in the exit phase are essentially three: The choice of the time window to implement the divestment, which depends both on the performance of the company in the portfolio and on the conditions of the M&A and capital markets. Identification of the category of potential buyers (strategic and financial or public equity market). This choice will influence the adoption of the divestment process, which may result in an M&A or IPO path The decision on the sale strategy to best enhance the outgoing asset. As already mentioned, exit planning should start early, with considerable thought being given to structuring and positioning the business to make it attractive to likely buyers, as well as networking and relationship development with these buyers. A lot of preparation should go into the robustness of the management plans, the detail of due diligence, and other reports. Efforts should be made to “warp up” the market, by making potential buyers aware of the upcoming sale several months before the formal process starts. The exit thesis normally forms a key part of the investment approach for any investment contemplated by the private equity firm. GPs need to understand the exit potential of the underlying business to recognize any elements of the proposed investment strategy that may actually detract from value creation. When deciding whether to exit or keep the company in portfolio for a longer period, a private equity firm should consider several strategic factors. Most likely, a successful exit strategy balances the company’s need for additional growth capital with the need to provide returns on capital to the fund’s LPs. The possibility of obtaining a capital gain depends primarily on the performance of the company in the portfolio. The divestment decision is taken when the investment, thanks to its operating and financial results, allows for a return deemed attractive by the managers. The decision to divest, unless it is “forced” by the need to liquidate the investment quickly due to maturity of the terms of the fund, occurs at the end of a growth path. It therefore occurs when the three factors of value creation, the growth of operating profitability, deleverage and the potential arbitrage on multiples, allow a level of capital gain considered attractive. In addition to the historical series of economic and financial data, great attention must be paid to the trend of current trading, i.e., the performance of the company in the months in which the sale procedure will take place, both of the M&A or IPO, and its alignment with the budget of the current year. It is important to grasp whether the target firm is able to manage throughout the exit process by itself. Realization of an exit strategy may involve a relevant amount of time and money to pay for advisors, especially during an IPO process. Before conducting an exit strategy, a company will be subject to a stringent due diligence process to ensure that all of the proper systems and controls are in place. A company is in a position of strength if its track record shows it consistently outperforms performance targets. A fundamental element to consider while choosing the right moment to implement the divestment is the condition of the markets, both for M&A and stock exchanges, and last but not least, for acquisition financing. In difficult market situations (i.e, a crisis or a so-called “black swan”), the mortality of deals increases exponentially, and there is a rapid downward pressure on prices, resulting in a gap between buyer and seller. Also, the IPO market is heavily affected by the shocks, with a mortality that occurs very quickly and with a flow of new stakes that is interrupted and that can remain at zero for months. The investor who is preparing his exit path must foresee the conditions of the markets with a few months in advance, and not base the choice of the exit timing only on the growth of company performance. In the presence of a crisis on the markets, the reaction of the buyers is very rapid and can even endanger the deals between the signing and closing phases, if there are stringent clauses of material adverse change or “subject to financing” in the contract. In addition, deals for which a sales contract has not yet been signed may suffer a decrease in transfer prices, extended due diligence times and a high risk of abortion of the deal as a whole. In the selling procedure, starting from the choice of the right moment, the active collaboration of all partners, in particular, those operating in the company, is necessary. Asymmetrical and uncoordinated behavior and interference in the sale procedure can create disruption and jeopardize the entire process. The need for alignment and responsible attitude must naturally also be extended to advisors, in particular to the investment bank responsible for the process, called upon to provide a reliable estimate of the future sale value and to suggest the most appropriate time window, avoiding any conflict of interest. Once the favorable exit period has been chosen, there is the need to choose the appropriate divestment channel, i.e., the type of potential buyers to turn to. For our purposes, we can identify four categories of interlocutors: strategic buyers, financial buyers, the stock market, and the original shareholders (buy back). Strategic buyers are groups active in the same sector as the target company, or in contiguous or similar sectors. Strategic buyers can operate in a diversification logic, even if the tendency to create conglomerates has faded in recent years. Theoretically they are the only ones who can benefit from operational synergies and in some sectors and historical moments they manage to pay consistent premium prices compared to other interlocutors. This disinvestment channel is defined as trade sale and is, for majority or totalitarian transactions, the most frequent at international level, even if with different weights from country to country. Unlike the secondary buy-out, which we will see later, this option almost never grants the private equity investor the possibility of a partial divestment and possible maintenance of an upside, given the buyer’s integration and rationalization needs and the absolutely different objectives between the two categories of investors. It should be remembered that for a management recovering from a successful buy-out, the trade sale, especially if towards a direct competitor, it could be the less welcome solution, and the exit procedure could be conditioned, with a probable deployment of management in favor of other buyers. The sale of minority packages, in the absence of a shareholder who at the same time alienates a stake that allows a majority to be obtained, instead, sees strategic buyers as less likely candidates, due to the reduced possibility of integration and rationalization synergies. Exceptions can be justified only for investments in companies that have an extremely interesting commercial or technological profile, and that bring to the trade buyer synergies of well-defined revenues or technological advantages. Financial buyers, on the other hand, represent a very broad category, ranging from traditional private equity funds to permanent capital operators, up to including family offices and investor clubs. This operation is commonly referred to as a “secondary buy-out” and in recent years has seen a progressive development in all advanced markets, also due to the growing endowments of private equity funds and an ever-wider, liquid, and competitive acquisition financing market. This exit channel, which is the second most important at a valorization level, strongly depends on the availability of leverage financing, as well as on the company’s ability to generate a further upside in terms of organic growth and build up. The secondary buy-out occurs more and more frequently also in serial form, with subsequent “tertiary” and even “quaternary” buy-out operations. Often, in these share transfers between investors, the company finds itself in a full path of development, and thanks to its growing scale and degree of internationalization it enters a higher category. The exit through secondary buy-out can have the advantage of allowing a partial reinvestment by the seller, who, alongside the incoming shareholder, will be able to benefit from a subsequent and further creation of value. The alignment of interests, given the homogeneity of the investors, can be easier. By secondary buy-out, in a strict sense, we mean the share transfer between financial institutions of the majority of the capital with a mixed intervention of equity and debt by the buyer. The sale of a minority package, on the other hand, is more properly defined, as we have already seen, as replacement capital. Also, for this type there is a growing market in almost all advanced countries, above all thanks to the presence of a greater number of subjects specialized in minority transactions, in particular permanent capital operators, not bound by particular deadlines as in the case of traditional private equity funds. The repurchase of the shareholding by the original shareholder who remained in the company’s capital is commonly referred to as a buy back. It is undoubtedly a more frequent case in the exit of minority investments and at least initially it remains, compared to the others, a residual way-out option for the investor who has the primary objective of creating value through a transaction with third parties. This exit channel in terms of importance stands in fourth place, with a greater frequency in the venture capital and expansion capital sector than in pure management buyout. The repurchase in fact recreates the ante status with respect to the original investment operation and becomes an obligatory channel when the other exit options are not feasible or are not appreciated by the majority shareholder. The repurchase can take place both on the basis of a put and call clause stipulated at the time of the investment and through an ad hoc M&A negotiation in the exit phase. In cases where the recipient of the sale belongs to the categories of strategic buyers and financial buyers mentioned above, and also, albeit in a very shortened form, in the case of the buy back, the divestment process is that of M&A operations. This procedure, although not regulated from a regulatory point of view unlike the IPO that will be mentioned below, is articulated and complex and usually requires a large number of subjects involved and several months of work. This is because the phases of preparation of an information base, the drafting of a partner list, the first approaches to the market and the deepening of knowledge of the project by potential buyers, the presentation of offers and subsequent due diligence, up to the negotiation and signing of the sales contract. And the process ends only on the closing date, with the endorsement of the shares or quotas and the simultaneous transfer of funds, once all the necessary authorizations have been obtained. If the exit strategy involves an IPO, the stock market is the buyer of the fund’s holding. The IPOs put in place by private equity entities certainly have an advantage in terms of certification effect, knowledge of the markets and credibility of the assignors, but they are also subject to the contingent conditions of the capital markets and do not present the same degree of attractiveness and feasibility. This sales channel requires specific qualitative characteristics (for example organization, transparency, reporting and dialogue with the market) from the companies that are going to be listed, as well as quantitative characteristics such as size, profit margins and income prospects. From a geographical point of view, it is emphasized that they are more frequent, as exits of financial investors, in Anglo-Saxon markets than in southern Europe. Sometimes, especially in majority transactions, the IPO allows the selling financial investor only a partial divestment, with relative advantages and disadvantages. Among the advantages, those of retaining a part of the upside linked to the appreciation of the stock market. Among the disadvantages, those of postponing the monetization of a part of the investment, with the risk of not keeping the price obtained during the IPO. This valorization opportunity for the exit of financial investors, the IPO remains, in order of importance, only the third option after the trade sale and the secondary buy-out, both for the eligibility requirements that only a minority of the companies in the portfolio can represent and for the frequent objective of the transferors to implement a total disinvestment of the shareholding. The IPO involves an absolutely different and more regulated process than the M&A, with lower degrees of flexibility, a series of standard features and a well-defined authorization process. The duration of the preparation phase varies greatly from company to company and at the end of it the target must present certain requirements in terms of governance, management control and adoption of accounting principles. It is known that many companies are more ready than others to face the stock market, and the decision of the private equity investor to implement an exit through IPO will depend on an objective diagnosis on the degree of the actual preparation and suitability of the company and of the management for landing on the markets. In this regard, the possibility of implementing a dual track in which a listing process and an M&A process coexist is emphasized. The choice of the double track arises, in addition to the need to maximize the price, from the need to reduce the risk of execution and final pricing inherent in stock exchange listing projects, generally more exposed to exogenous factors and sudden changes in the market mood. Note how, although the processes are completely different in terms of structure and interlocutors, they can be reconciled from a timing point of view and benefit from each other, also because the huge processing of historical and prospective data carried out by the company creates in both cases a useful information base. As a rule, the sequence takes place with the announcement and start of a listing project and then, in front of offers judged to be more attractive or signs of weakening of the stock market, resorting to the hypothesis of trade sale or secondary buy-out. The sequence can also be reversed, especially in the presence of broken auctions, after which, after a certain period of time, the IPO project is the priority option. In general, private equity investors, compared to corporates or family businesses, appear better prepared to manage a “double track”, due to the familiarity and the consolidated track record in both markets. Instead of the conventional IPO procedure, there is the possibility for the outgoing fund to go public through SPAC, an instrument aimed at facilitating and accelerating the listing of SMEs on the stock exchange. In this case, the listing takes place through a private M&A negotiation between the promoters of the listed vehicle and the shareholders of the target company. Once the business combination has been approved by the shareholders’ meeting, the merger by incorporation will take place, after which the target company will acquire the status of listed. For the financial investor, the listing through SPAC of an investee company presents, compared to the conventional IPO, various advantages in terms of greater agility in the procedure, greater confidentiality in the preparation phases and greater certainty on the final exit price. In conclusion, it is considered appropriate to mention two other forms of exit operations even if they do not consist in the sale of a shareholding. The first is the dividend recap, for which we mean the collection of dividends in an extraordinary form through the use of additional financial leverage, through a change in the capital structure, but not in the shareholding structure, an early monetization is made possible. The dividend recap is a valorization method strictly linked to the conditions of the leverage financing market and shows a marked cyclical nature, with substantial volumes during positive phases and vice versa almost absent in the phases of market contraction. The write off of the investment, on the other hand, has opposite sign compared to the previous case. It is a total or partial reduction of the value of the equity owned by the financial investor. More than an exit method, it turns out to be a reduction in value with consequent capital sacrifice. Write off is also closely linked to the economic phase and tends to increase in times of crisis. However, even in the most difficult phases of the global economic and financial situation, it recorded an non-significant weight on the total investments in venture capital and private equity, also because the financial investor has often exploited the possibility of recapitalizing the company to avoid the hypothesis liquidation or bankruptcy and to negotiate an agreement with creditors at the same time.
Giuseppe Incarnato
Chairman & CEO IGI INVESTIMENTI GROUP
