When should Private Equity players exit businesses?

A billion-dollar question indeed but not easy to answer. There is no one formula that can be applied unequivocally to exits, for if there was one, every private equity (PE) firm in the world today would be generating insane IRRs. Exiting a business is a complex decision based on various factors, internal as well as external. While there are numerous options on how to exit – IPO, third-party sale, merger, etc. – the more difficult question is deciding on ‘when’. Here are some key points PE firms could consider when evaluating an exit scenario.

The most obvious is external market conditions. Due to the uncertain economic environment over the last 18 months globally, the number of PE exits declined from 580 in 2017 to 378 in 2019. This year, a further slowdown in exits is noticeable, with the count declining from just 59 in Q1 to 30 in Q2, mainly due to the pandemic. This clearly indicates that economic and market conditions are probably the biggest determinants in arriving at the decision on when to exit. A sizeable number of PE exits happens through the IPO route. PEs must understand and factor in how the market and economy may behave in future. If the impact on the public market is likely to persist over the long term, it is advisable to realign the exit strategy and consider a private market exit.

There are other considerations as well. First, as exit is a process, it should be carefully planned and decided months or maybe years in advance. Most firms have a target of the multiple they want to derive on the exit, but a good and successful exit also necessitates constant monitoring of KPIs. Creating a relevant dashboard to track the level of preparedness for an exit and constantly evaluating with the ‘target date’ in mind can help the firm correctly time the exit. Once the target parameters defined earlier are met, the next step is to prepare for the exit by reaching out to potential buyers.

Second, a PE firm should be able to analyze internally and honestly ascertain the value it can add for a company. If it feels that it has done all it could financially and strategically to take the company to a certain level, and any further involvement will not add much, it is time to take the decision to maximize returns and move on to another buyer.

Third, a PE firm should know when to cut losses. Best bets rarely play out the way as planned. Rather than being adamant on pulling through, the firm should analyze and if it finds that turning this around could be a challenge, it is time to minimize damage. Though the PE firm may not get the required return or valuation, it would still be better than to stick around when things go further south. To make this decision, it is important to get a pulse or know that the current levels of earning and profitability are probably the best the firm could help the company realize.

There are other factors that come into play too – for example, the relationship with the portfolio company’s management. A PE firm may want the business to take a certain direction, but the company itself may want to charter a different strategic course. Instead of being at loggerheads, as this would not be good for the business, it is best to part ways. Imposing strategies on an unwilling management will only dilute performance and future valuation. Regulatory norms and taxation-related laws are also important and must be checked while deciding exits. The firm should not be caught unaware or be in a tight spot due to sudden regulatory changes.

There is no exact science to planning an exit. It can be affected by several macroeconomic, interpersonal, industry-specific and other factors. All a PE firm can do is prepare in advance, track the relevant metrics, and formulate and communicate a powerful story to ensure they look back with no regrets!