6 Exit Strategies for Private Equity Investors

Knowing when and how to exit a private equity investment can make the difference between realizing substantial gains or facing significant losses. Private equity investments are usually long-term commitments, and while they have the potential to give investors lucrative returns, they're also riskier than many other investments. Part of managing that risk effectively is choosing the best way to cash out on a deal using the appropriate exit strategy.

If you're interested in private equity and want to know how it can fit specifically into your portfolio, consider working with a financial advisor .

Private Equity and Exit Strategies

Private equity involves investing in privately held companies. This makes it distinct from investing in publicly held companies whose shares trade on major exchanges. Private equity also often involves greater involvement with the investment. Rather than simply owning a piece of a company, a private equity investor may participate in high-level management and strategy decisions at the business, often with the goal of improving its value before selling it at a profit.

Another difference is that, unlike stocks, private equity investments are illiquid, meaning they cannot be sold or exchanged on the open market. Because of this lack of liquidity, it's important for private equity investors to have an exit strategy.

An exit strategy is a plan for turning the equity ownership in a company into cash. It's an essential component of private equity investing. Without a clear exit strategy, an investor risks being locked into the investment for longer than expected or perhaps having to sell at an inopportune time for a diminished return.

6 Private Equity Exit Strategies

There are several exit strategies for private equity investors to consider, each with its own advantages and considerations:

Initial Public Offering (IPO)

An IPO is one of the most well-known exit strategies for private equity investments. In an IPO, a privately held company goes public by listing its shares on a stock exchange where they can be purchased and traded by other investors. This allows private equity investors to sell their shares to the public, transforming equity into cash.

An iPO can be complex and time-consuming. The company has to meet strict regulatory requirements before mounting one. Market conditions at the time of the IPO are central to  strategy's success. So, while an IPO can provide substantial returns, it also exposes the company and investors to market volatility.

Trade Sale

A trade sale involves selling all or part of the private equity-owned company to another company, often within the same industry. The upside to this strategy is that the buyer may be willing to pay a high price for the business in order to enhance its market position or gain access to patents, trademarks or similar valuables that complement its own assets.

Trade sales can provide a quicker and more straightforward exit than IPOs. However, finding the right buyer and negotiating favorable terms can be challenging. The sale price isn't always higher, either, and may be influenced by the buyer’s strategic objectives rather than the company’s market value.

Secondary Sale

In a secondary sale, private equity investors sell all or a portion of their stake in the company to another private equity firm or institutional investor. This strategy allows the original investors to gain liquidity while secondary investors add a privately held asset to their portfolios.

Secondary sales can be attractive for investors seeking liquidity without the complexities of an IPO or trade sale. However, the valuation and terms of the sale may be less favorable than other exit strategies, depending on market conditions and the interest of potential buyers.

Recapitalization

Recapitalization involves restructuring a company’s capital structure, which may be accomplished by replacing equity with debt or issuing new equity to a new investor. This strategy allows private equity investors to realize some returns while retaining a stake in the company for future growth.

Recapitalization can provide immediate liquidity and reduce risk by diversifying the investor’s portfolio. However, it can also increase the company’s debt burden, potentially affecting its long-term financial health and growth prospects. If original investors sell majority ownership as part of restructuring, they may lose their influence over its operation.

Management Buyout (MBO)

In an MBO, the company’s management team is the buyer. The purchase is often accomplished with the help of financing from banks or other investors. This strategy can benefit all parties because the management team is already familiar with the company’s operations and has a vested interest in its success.

MBOs can provide a smooth transition and continuity for the company, but they may also require significant financing, which can be challenging to secure. The sale price may also be lower than other exit strategies due to the management team’s limited financial resources.

Liquidation

Liquidation is the process of selling all of a company’s assets to pay off its debts, with any remaining proceeds distributed to shareholders. This strategy is typically considered a last resort used when a company is struggling or unable to find a buyer.

While liquidation can provide a clear and final exit, it typically results in lower returns for investors when compared with other strategies. Liquidation may also have negative implications for the company’s employees, customers and other stakeholders.

Regularly Examine Your Private Equity Investments

Just as important as having an exit strategy for a private equity investment is regularly examining your private equity investments.

Market conditions, economic factors and company performance can all impact investment value, so investors aim to be proactive and stay informed. Regular reviews offer a chance to assess whether the current exit strategy remains viable, or if adjustments are indicated.

A review may also identify any potential red flags, such as declining financial performance or changes in management, that could affect the investment’s success. Engaging with your financial advisor or investment team to review your portfolio periodically can give you valuable insights and guidance, helping you ensure that your exit strategy is well-timed and your investment remains aligned with your long-term objectives .

Bottom Line

Private equity investors have many exit strategies to choose from, including IPOs, trade sales, management buyouts and liquidation. Ideally, exit strategies are considered when the investment is made. Doing so helps an investment realize its full potential while reducing overall risk.

Tips for Investing

• A financial advisor can help you analyze and manage investments for your portfolio. Finding a financial advisor doesn't have to be hard. SmartAsset's free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you're ready to find an advisor who can help you achieve your financial goals, get started now .
• If you want to know how much an investment could earn, SmartAsset's investment return calculator can help you get an estimate.

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