There are four ways to exit out of a PE investment once the horizon period is met, or otherwise by management decision.
(i) IPO (initial public offer): This represents a highly successful exit strategy, riding on a strong business model. The payback can be instantaneous through selling the own shares immediately on listing on the stock exchange.
(ii) Strategic Acquisition: The share of the PE is acquired by a larger company usually in the same business segment. Thus, a small IT company into a niche testing technology line may get acquired by a bigger IT company, which is often seen in India. Another example can be the acquisition of Instagram by Facebook. This is perhaps the most commonly used exit route, and is usually a win-win situation for both the exiting investor as well as the management of the enterprise.
(i) Secondary Sale: The investor PE exits by transferring its share to another PE. Such an exchange is seen either when a larger PE finds value in the venture thereby giving a sweetened deal to the smaller PE, or, where the business may require more money which is not in the capacity of the current equity fund.
(ii) Repurchase by existing management (founder members): This is an ideal scenario type where the founders get back to owning the majority stake in their entity, and a golden hand-shake to the exiting PE. This is also referred to as ‘Management Buyout’ (MBO). The exiting PE may, in rare cases, also get to earn a trail fee for the next n years as may be mutually agreed to by the parties, usually a % of EBIT, or a multiple based terminal value.
(iii) Liquidation: This is the least preferred method of exit, where the investor leaves out at a cash loss on capital invested. This usually happens where the investor cannot take further losses, or had made an over-estimate of expected returns, or a particular idea behind the venture hasn’t really taken off, or well received in the market. The term sheet usually provides financial safeguards to the VC against drastic losses.
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