March 22, 2018
During the past several years, owners and companies have increased the use of creative exit strategies to provide themselves additional flexibility. We see companies using a wide variety of strategies — minority interests, joint ventures (JVs), Initial Public Offerings (IPO) and outright sales — to monetize their investments. Most commonly, we see a dual-track strategy by private equity (PE) sponsors and venture capital firms, which involves pursuing an IPO while simultaneously exploring the sale of portfolio companies through a private auction.
We see variations in how dual-track strategies are executed, depending on factors such as market conditions, sponsor motivations, and resources available. Firms may choose to be proactive or reactive in their approach — either openly pursuing willing buyers while moving closer to an IPO, or only considering purchase offers they receive.
When to be proactive
Some circumstances dictate a more proactive approach to implementing a dual-track strategy. The key considerations have to do with market volatility, holding periods, and the desire for more control over the exit value:
- Market volatility – If public markets are volatile and a desired IPO market cap is not assured, selling to a third party may be a viable option. Although the IPO market and acquisition valuations are often correlated, a potential bidder may be inclined to pay a premium to the IPO market due to perceived synergies, desired growth through acquisition, or high perceived intrinsic value. Volatility can be measured in terms of the number of cancelled IPOs, mixed after-market trading performance, or pricings below an anticipated midpoint. Political and economic uncertainty can add to market volatility. Annual dollar IPO values have fluctuated in recent years, reaching a high of $86.6 billion in 2014, dropping to lows of $32.6 and $21.6 billion in 2015 and 2016, respectively, then rising again, to a high of $44.2 billion in 2017.¹ When market volatility is high, PE firms may want to adopt a proactive strategy, actively pursuing potential buyers in an attempt to reach an exit price within a more predictable range. It should be noted that high market volatility inherently also provides additional uncertainty around the completion of a successful IPO and/or sale.
- Holding period – In an IPO, the PE firm must retain a significant stake in the company, which would prolong the holding period for an investment. With that in mind, if the end of the planned holding period is approaching or has passed, or an exit must be assured to meet fund return targets, a trade sale can be used as a backup option to potentially expedite the exit process and receive the full proceeds from a sale. The median holding period has increased steadily since the economic crisis in 2008, reaching just over five years in 2016—significantly higher than pre-crisis holding periods of 3-4 years.² In this environment, proactively searching for a buyer could improve the internal rate of return (IRR) for PE firms.
- Control over exit value – If a PE firm wants more control over the exit value, an IPO filing will help to establish a price floor, and the additional competitive pressure of a viable IPO process can drive bidders to submit higher offers. Research confirms the wisdom of this strategy: A study published in the Journal of Business Venturing examined 679 exits from 1995-2004 and found that PE firms following an active dual-track exit strategy earned a 22-26% higher premium over those which pursued a single-track exit approach.³
When to be reactive
In certain circumstances, a reactive posture may be warranted — specifically, if resources are limited or the firm doesn’t want to fully divest its investment:
- Resources and energy – It takes significant resources and energy for company management to prepare for an IPO and trade sale exit simultaneously. Sponsors will have to make an honest assessment about whether management has sufficient bandwidth to sustain both tracks while running the daily business. If resources are limited, a more reactive posture may be appropriate.
- Liquidity concerns – The firm will need to determine in advance whether it wants to dispose of its entire ownership percentage for a lump sum or receive payments over time. In an IPO, sellers are required to retain a significant stake in the business, which may expose them to future public market risk, which in turn can affect their IRR. This sensitivity to public market risk can be heightened during times of high market volatility as noted above. If a firm only wants to achieve initial liquidity and continue to participate in the upside of the business, an IPO may be more appropriate. In that case, the firm would be reactive and would not openly pursue a trade sale.
A proactive or reactive stance
Whether to adopt a proactive or reactive stance also depends on the sponsored company’s financial situation. If the credibility of the company’s private financial information (e.g. inventory levels, sales trends, investment valuations, etc.) needs to be conveyed to potential bidders or the market as a whole, but the sponsor wants to maintain confidentiality, this can be achieved through the rigorous disclosures and marketing efforts required in order to go public. Depending on the strength of the company financials, the sponsor may decide to be either proactive or reactive in its pursuit of a concurrent trade sale.
A dual-track exit strategy can be both rewarding and demanding. Given the trade-offs of the two tracks in terms of complexity and cost, the viewpoints of multiple stakeholders must be considered, including board members, fund investors, buyers, co-sponsors, and company management. Likewise, the importance of selecting the right advisor must also be stressed.
How PwC can help
PwC employs an integrated service approach that leverages our private equity experience to provide timely identification and resolution of common issues encountered throughout the transaction and portfolio company lifecycle as well as issues unique to the private equity fund. Our professionals assist with many of today’s largest, most challenging issues.
¹PwC, “2017 Annual US Capital Markets Watch.”
²Hugh MacArthur, Graham Elton and Suvir Varma, “Exits Settle At A New Normal In Private Equity,” Forbes, March 9, 2017.
³James C. Brau, Ninon K. Sutton, Nile W. Hatch, “Dual-track versus single-track sell-outs: An empirical analysis of competing harvest strategies,” Journal of Business Venturing, 2008.