Types of exit

All private equity transactions are structured with an exit in mind. Historically there were three exit routes: Trade sale: sale of the business to a corporate acquirer. Flotation on a stock market. Receivership and liquidation. This report does not explain these types of exit as they are well understood. It is clear that new routes to exit have emerged over the past decade: secondary buy-out/sale to another private equity fund; leveraged recapitalisation/repayment of loans and preference share; and secondary market transactions including the sale of portfolios of investments to other financial institutions.

In the early years of the buy-out market it was rare for a private equity fund to be prepared to buy a business from another private equity fund. Today it is common, accounting for about a third of larger buy-out exits. This has raised a number of issues regarding churn in the private equity market. Where a fund is approaching the end of its agreed life and has yet to exit an investment, a fund manager may face an unusual set of incentives. If the fund is extended to maximise the value of the last investment(s) there are penalties for the fund manager. Therefore it may be more rewarding to the manager to sell the asset for whatever value can be achieved today, rather than attempt to maximise the value in the longer run. In this sense there is an apparent paradox in private equity fund structures: the longer an investment has been held in a fund, the more likely it is that the private equity fund manager is incentivised to act based on shortterm considerations. In recent years, the most liquid acquirers of corporate assets have been private equity funds.

Therefore a fund seeking a quick exit will very probably approach, among others, private equity funds. One way to mitigate the potential foregoing of value in such a transaction might be for the vendor private equity fund managers to co-invest in the business alongside the new private equity fund and do this from another fund under their management. This could trigger the carry in the old fund and carry forward the asset in the new fund at the value established by a thirdparty purchaser. As the market has evolved, investors in private equity funds have had to be careful to ensure that the incentives of the fund manager and the investors in each and every fund are tightly aligned. Ultimately the constraint on fund managers is reputational: investors will not support fund managers that abuse their relationships.