How private equity exits: trade sale, IPO, SPAC and more

How does a private equity fund get its money back?

A private equity fund buys a business, improves it and sells it at a higher value. It holds a company for about five years on average, though the holding period can run from under six months to more than ten. Before choosing an exit, managers look at conditions in the company’s industry, the economic cycle, interest rates and the company’s own performance.

There are two main routes, a trade sale and a public listing. Three further routes are secondary sale, recapitalization and write-off. They can be combined or used for part of a company: sell a division to a competitor and the rest to another private equity firm, for example. Distributing shares straight to the fund’s investors is possible but unusual.

Ways a private equity fund exitsalone or in combination, in whole or in part

• Trade sale Memorize to a strategic buyer, by direct sale or auction
• Public listing Memorize the second main route
  • Initial public offering (IPO) Memorize underwritten; highest price potential
  • Direct listing Use it shares float without underwriters
  • SPAC merger Memorize sold to a listed blank check company
• Other exits also tested
  • Secondary sale Use it to another private equity firm or financial buyers
  • Recapitalization Memorize new debt pays the fund a dividend; NOT a true exit
  • Write-off / liquidation Know the idea a deal that went wrong

What are the pros and cons of a trade sale?

In a trade sale the company, or a division of it, is sold by direct negotiation or auction to a strategic buyer: a business that wants more scale and scope in the same line of work.

• Advantages. The buyer expects synergies with its own business and pays a premium for them. Cash arrives at once. The process is relatively fast and simple, and cheaper than an IPO. Only a few parties are involved, so it is confidential and avoids public disclosure. The strategic buyer can judge the fit without outside scrutiny.
• Disadvantages. Existing managers may resist, fearing for their jobs or ownership by a competitor. Employees may dislike forgoing the chance to cash in shares after a listing. The pool of buyers is limited, which can reduce the price, and the deal may face competition review.

How do IPOs, direct listings and SPACs compare?

A public listing puts the company on an exchange in one of three ways.

An initial public offering (IPO) sells shares to public investors through underwriting banks. The company sells shares, including some or all of the fund’s.

• Advantages. It may realize the highest price, raises the profile of the company and sponsor, and the fund keeps upside through any shares it still holds. Management usually backs it and is likely to be retained.
• Disadvantages. Fees to banks and lawyers are high, the timeline is long and disclosure is onerous. Stock market volatility creates value uncertainty. A lockup period can require the fund to keep its shares for a time after the IPO, which delays cashing out. It suits mainly large, fast-growing firms, not smaller companies, out-of-favor industries or firms with short histories or unstable finances.

A direct listing floats the existing shares on the public market without underwriters. That removes some of the complexity and cost, but also the price support that underwriters give, and in its classic form raises no new capital. It is used less often.

A special purpose acquisition company (SPAC) is a blank check company that exists only to acquire an unspecified private company within a set period, or else return its capital to investors. Companies that suit an IPO suit a SPAC, but the valuation works differently: a single counterparty negotiates the terms.

• Advantages. The valuation is fixed in advance, which reduces uncertainty and share price volatility. There is more time for public disclosure to build investor interest, and a SPAC can give more forward guidance than an IPO allows. The structure is flexible, and the sponsors are often high-profile with large investor networks.
• Disadvantages. Warrants, fees and other instruments dilute shareholders and raise the cost of capital. The announced equity value can differ from the true value after dilution. There is deal risk, including redemptions. Regulators are reconsidering how SPACs are classified. After the merger, heavy trading can produce stockholder overhang : downward pressure on the share price as large blocks of shares are sold.

What are the other exits?

• A secondary sale is a sale to another private equity firm or group of financial buyers. It becomes a clean exit when there is no strategic buyer or open IPO window. The price comes from financial rather than strategic buyers, and as private equity funds have raised more capital, secondary sales have become more common.
• A recapitalization adds or increases debt in the portfolio company and pays the fund a dividend from the new capital structure. The fund typically keeps control, so it is not a true exit. It does let the fund return money to its investors and improves its internal rate of return (IRR), but it leaves the company with more debt.
• A write-off / liquidation happens when a deal has gone badly. The fund writes the investment down or liquidates the company and moves on. The loss is realized.

Which exit fits which situation?

Situation	Best fit
A regional bakery chain with an interested national rival	trade sale: synergies and confidentiality
A fast-growing software firm in a hot market	IPO: the highest price potential
The fund wants cash but has no buyer yet	recapitalization: cash out, control kept
The deal went wrong	write-off or liquidation

Exam tip For “which exit?” questions, find the keyword: synergies means trade sale, growth and visibility means IPO, fixed valuation means SPAC, cash without selling means recapitalization.

Go deeper Partial exits and combinations

A fund does not have to sell everything in one move. It can sell a self-contained product line or division to a competitor in a trade sale and then sell the rest to another private equity firm in a secondary sale. It can also list part of the business and keep a stake, as in an IPO where the fund sells some shares and holds the rest, which is why an IPO preserves upside but also exposes the fund to the lockup.

Go deeper Why SPACs drew regulatory scrutiny

A SPAC lets a company go public by merger rather than by the full registration process of an IPO, and it can publish forward-looking projections that an IPO prospectus could not. Warrants and sponsor fees transfer value away from ordinary shareholders, and heavy redemptions can leave a deal short of cash. Because of these features, securities regulators have been reconsidering how SPACs are classified, which could bring them closer to the rules that govern IPOs.