Achieving a successful exit in PE requires more than just focusing on acquisitions and immediate performance improvements.
Private Equity and Venture Capital (PE/VC) firms evaluate investment opportunities, focusing on market fit, scalability and financial strength. They prioritise sectors with strong growth potential by taking macroeconomic conditions and risks into consideration. Additionally, they seek investments aligned with their values and strategic goals, requiring businesses to be adaptable for collaboration and growth.
However, one paramount consideration for PE/VC firms’ potential investment that gets lost in the bunch, is the exit strategy for investing companies. This aspect affects investment decisions profoundly. This article examines exit strategies globally, delves into Nepal's investment landscape, and underlines the importance of predetermining exit strategies for PE/VC firms.
PE/VC at a Glance
Private Equity (PE) firms and Venture Capital (VC) firms are both integral players in the world of investment, specialising in providing capital to businesses at various stages of development. PE firms typically invest in more established companies, whereas VC firms focus on early-stage or high-growth startups even if they don’t have a well-proven revenue model.
What sets PE/VC firms apart from traditional investors is their multifaceted approach to investment. These firms offer more than just financial support. They provide mentorship, facilitate industry connections and offer strategic guidance to portfolio companies. Furthermore, a fundamental distinction lies in their fixed investment period as well as a predetermined exit time. Most returns generated by these funds are realised through multiples on their exit, underscoring the critical importance of a well-planned and executed exit strategy in maximising investor returns and sustaining the momentum of investment activities.
What Exactly is a PE/VC Exit?
A PE/VC exit involves the sale or divestment of an investment in a portfolio company to realise returns on investment. PE/VC firms need a robust exit strategy as it serves as the primary source of returns for their funds. Achieving favourable returns through well-executed exits validates the effectiveness of investment decisions, enhancing investor confidence and satisfaction. Moreover, well-executed exits contribute to the development of the broader PE/VC ecosystem by attracting additional investments and stimulating entrepreneurial activity by fostering confidence in the market.
Common PE/VC Strategies
It is necessary to understand the common exit strategies employed by PE/VC firms to know about the right exit strategy. These strategies represent the combination of meticulous planning, strategic execution and market insight, allowing investors to unlock value and capitalise on investment opportunities. Let’s explore the various exit strategies that PE/VC firms commonly employ to realise returns on their investments.
1. Secondary Buyouts (SBOs): In a secondary buyout, the PE/VC firm sells its stake in the investee company to another PE firm or institutional investor. This allows the original investor to exit its position while enabling the new buyer to take over the value creation process and implement its own strategies to drive growth and profitability.
Recent studies indicate a rising trend in SBOs globally over the past two decades. In 2023, Secondary Buyouts accounted for 42.2% of the total exit value in the United States. PE funds nearing maturity often opt for SBOs to avoid extending the fund's life when portfolio companies are not IPO-ready. SBOs are favoured for their lower search costs and reduced adverse selection, where sellers possess undisclosed information advantage. This information asymmetry is mitigated as PE investors are typically more sophisticated than public investors, enhancing confidence in SBO transactions.
SBOs also offer PE funds higher prices, reduced risk and faster access to proceeds compared to IPOs and trade sales. However, in Nepal, this differs significantly which will be discussed later. Additionally, capital market conditions heavily influence the choice between SBOs and other exit routes, with favourable debt markets increasing SBO likelihood through leveraged buyouts (LBOs), particularly for financially strong companies.
Researchers have noted a potential downside of SBOs, where management's loyalty can be divided. Globally, there is evidence of management receiving incentives from both selling and acquiring funds which creates a situation of conflict of interest. While the management aims to maximise the company's value for sales, they may also have incentives to keep it lower for future bonuses tied to performance. This conflict arises as it is easier to project performance improvement for underperforming companies than for already successful ones. Balancing value maximisation at exit with potential future compensation tied to lower valuations poses a conflict of interest for management and PE/VC firms.
2. Initial Public Offering (IPO): Going public through an IPO involves offering shares of the investee company to the public for subscription on a stock exchange. IPOs offer liquidity for shareholders and access to public capital markets for company expansion. They are a common exit route for mature PE/VC companies. However, for a young PE/VC firm, a successful IPO exit not only serves as an exit route, but also enhances the fund's reputation. There are plenty of evidences of young firms raising subsequent additional funds shortly after an IPO exit, due to improved reputation in global markets.
The decision to exit via IPO is influenced by market conditions and company traits. IPO exits tend to increase during periods of strong stock market growth, as companies capitalise on favourable market conditions, known as “windows of opportunity”. There is a phenomenon of “Hot Issue Markets” as well, when there are a number of highly anticipated IPOs popular among investors. PE/VC firms can take advantage of these hot markets when exiting through IPO to get the most attractive valuations. Besides the market condition, the size of the company plays a significant role as well, with smaller companies in the fund’s portfolio being less likely to exit through IPO.
There are, however, disadvantages of IPO exit as well. In an IPO exit, shares held by a PE fund usually face a lock-up period - one year in Nepal for alternative funds under SIF regulation) - limiting the ability to sell stakes swiftly, compared to SBOs or trade sales. Additionally, the considerable costs associated with IPOs, including underwriting and registration fees, along with the need for extensive information disclosure, present challenges.
3. Trade Sale (Strategic Sale): Another common exit route involves selling the investee company to a strategic buyer who sees value in the acquisition, often paying a premium for synergies. Trade sales, including share deals, asset deals, mergers or management/founder buyouts, have historically been popular exit routes for PE/VC funds worldwide.
The preference for Strategic Sales can be attributed to their ability to offer streamlined liquidity pathways, opportunities for strategic collaboration, and greater control over timing and execution compared to IPOs. They offer confidentiality, lower business disruption risks and fewer regulatory hurdles compared to IPOs. Strategic buyers often offer better valuations, paying premiums for synergies or market entry. Additionally, trade sales feature faster execution and lower transaction costs than IPOs, also enabling the sale of specific business parts to potentially enhance overall valuation. A drawback of trade sales, however, is the limited buyer pool, which reduces competition and possibly lowers the company's valuation. With fewer potential buyers, sellers may lack options for driving up prices through bidding competition and have less negotiation leverage.
4. Other Exit Strategies: Another exit option available is Dividend Recapitalisation which enables PE/VC firms to make a partial exit without affecting the company’s overall structure. This exit strategy, though it does not provide a full exit, provides a backup option in case other exit strategies fail. Recapitalisations are usually funded by cash balances of portfolio companies or by leverage.
Global PE/VC Exit Scenario
Strategic sales have consistently dominated as the preferred exit strategy in the global PE/VC landscape over the past two decades. According to the Global Private Equity Report of 2024, strategic sales accounted for a remarkable 80% of the total exit value of global PE firms in 2023, far surpassing IPO exits, which constituted a mere 3% of the total volume. Thomas Bravo’s announcement of the sale of data security software developer Imperva to Thales group was one of the largest strategic sales in 2023, amounting to $3.6 billion.
Regardless of the methods of exits, the overall exit activities in the last two years have seen a declining trend. Buyout-backed exits came in at $345 billion globally, which is a 44% decline from 2022. The underperformance of exit activity in 2023 can be attributed to the adverse impact of rising interest rates and macroeconomic uncertainty on buyer-seller dynamics. Rising interest rates increased financing costs, prompting more cautious valuation assessments, while macroeconomic uncertainties heightened risk aversion among buyers and sellers, fostering apprehension and indecision. PE firms typically avoid being forced sellers. Instead, they opt to hold on to promising assets until exit conditions improve.
But compared to other exit strategies, IPO exit saw massive improvement, increasing by 72% in 2023. Thrift store operator Savers Value Village fetched a market capitalisation of nearly $4 billion in a strong debut on NYSE in June 2023. Savers Value was primarily owned by PE firm Ares Management in the US.
In Europe, however, the exit scenario was better in 2023 than in the previous year. There were eight mega exits worth over one billion euros in just the third quarter of 2023. The positive exit scenario was heavily skewed by very large exits, most notably the Arm IPO, achieving an exit value of 43.9 billion euros. ARM Holdings PLC is a British semiconductor company that designs mainly microprocessors and has major holdings of SoftBank Group, which has the world’s largest technology-focused venture capital fund, named Vision Fund. Looking at secondary buyouts, financial data provider, Macrobond, was sold by Nordic Capital to US-based Francisco Partners in 2023, attaining a 6x return from its initial investment. Secondary buyouts accounted for 24.8% of total exit value in Europe in 2023 up to September as PE sponsors deployed their dry powder.
In contrast to the global trend, India predominantly favours IPOs as exit routes, followed by strategic sales, due to ample access to capital in both international and domestic public markets. In 2023, Indian PE/VC exit values surged by approximately 15% to around $29 billion, with Public Market Sale exits, including Block Trades and IPOs, constituting nearly 50% of the total exit value. This trend benefited from India's increasingly deep public markets, although IPOs were primarily prevalent in traditional sectors.
Delhivery, an ecommerce logistics provider, raised $674 million through a domestic Indian IPO in May 2022, offering a significant exit channel for PE investors such as Vision Fund and The Carlyle Group. Similarly, Nykaa, a beauty e-commerce platform, raised $719 million through an IPO, enabling PE investors TPG Growth and Lighthouse Funds to make partial exits. However, post-IPO share price performance is crucial for PE/VC exits. This is an important consideration because early investors like PE/VC firms are typically subject to a certain lock-up period. Delhivery's share price dropped from Indian Rupees (INR) 541.55 to INR 331.7 within six months of its May 2022 debut, while Nykaa's price plummeted by approximately 44% in the same period. This trend, common in IT sector exits in India, significantly impacts exit valuations for PE firms, particularly as they typically only achieve partial exits through Offer for Sale in IPOs. Additionally, stringent lock-up period provisions, as seen in Nepal, exacerbate these implications.
Exit Scenario in Nepal
In Nepal, like India, IPOs and trade sales are the predominant exit strategies, while the PE/VC sector is still emerging. With just 16 PE/VC funds operating in Nepal as of 2023 (with no investments made by SIF to date), opportunities for exit through secondary buyouts are limited. The preferred exit strategy for PE funds in Nepal involves IPOs, particularly due to the tendency for IPOs to be oversubscribed, regardless of company financials and growth prospects. According to Nepal Private Equity Association (NPEA), PE/VC firms have either implemented or considered exiting 13 of their portfolio companies (which accounts for 35% of total exits) through IPOs to date, reflecting the significance of this strategy. Notable examples include Upper Syange Hydropower Limited (USHL) and Nepal Warehousing Company Limited (NWCL), both backed by Team Ventures. Additionally, one of Dolma Impact Fund’s portfolios, Solar Farm, is also in the process of listing on Nepal Stock Exchange (Nepse).
A PE/VC exit involves the sale or divestment of an investment in a portfolio company to realise returns on investment. PE/VC firms need a robust exit strategy as it serves as the primary source of returns for their funds.
With globalisation, strategic sales are poised to gain traction as PE firms seize opportunities for regional consolidation, exemplified by Daraz's acquisition by Alibaba. In Nepal, PE/VC firms are also opting for strategic sales, with five portfolio companies already having undergone or considered such exits. This trend reflects a strategic shift towards leveraging merger-acquisition opportunities. For example, the funding received by Sastodeal from the Dolma Impact Fund facilitated initial significant growth, supported by Dolma's strategic guidance and cross-border partnerships with industry leaders Myntra and Flipkart. This growth ultimately enabled a partial exit of Sastodeal to the IME Group at a premium. However, it is important to recognise that Sastodeal is no longer operational, highlighting that every private equity investment does not guarantee success. Alongside strategic sales, the promoters' buyback strategy is another commonly utilised exit route under trade sales. To date, PE/VC firms have implemented or considered exiting eight of their portfolio companies through founder buyouts, enabling PE funds to realise returns on their investments.
Dividend recapitalisation is also prominent in Nepal's PE/VC landscape, enabling firms to extract cash from companies and serving as a useful partial exit strategy. Team Ventures exemplifies this approach with its real estate investments. The firm successfully exited Team Brihat Developers, a joint venture with Brihat Investments, after completing the Dharahara Tower Apartments project, which was a project financing done through a mix of debt and equity. They are in the final stages of completion and handing over ownership of Himalayan Luxury Homes. Additionally, there are many ongoing real estate projects in various parts of Nepal. Despite not fully exiting, Team Ventures continues to receive cash flow from Team Real Estate in the form of dividends, demonstrating the practicality of dividend recapitalisation in maintaining cash flow without a full exit in Nepal's PE/VC sector.
PE/VC firms in Nepal have also explored secondary buyouts for exiting portfolio companies, with only three out of 37 exits reported by NPEA being through this route. A standout example is Foodmandu which expanded significantly with series A funding from True North Associates and series B funding from Team Ventures. Team Ventures achieved a partial exit and achieved a 2x return by selling shares to Himalayan Capital. This was one of the major highlighting events in the PE/VC exit scenario of Nepal and was well documented in international media, most notably, in Deal Street Asia. Cloudfactory, a major data labelling solution provider in Nepal, received a series of investments from BO2 and Dolma Impact Fund. In 2019, the company raised a series C investment round totaling $60 million, with FTV Capital leading the funding round, facilitating a partial exit for Dolma along with demonstrating the impact of secondary buyout strategies in Nepal's investment landscape.
But these examples cannot hide the fact that exit strategies have posed significant challenges for PE/VC funds in Nepal, with many funds lacking clearly defined plans at the outset of their investments. Despite exits being crucial for realising returns, a notable portion of PE/VC investments do not have a clearly defined exit strategy. As many as 35 companies invested by PE/VC funds, accounting for 48.6% of portfolio companies, lack an established exit strategy. This lack of foresight complicates the exit process and can hinder the ability of funds to achieve optimal returns on their investments.
In Nepal, secondary buyouts represent only 4.2% of total exits which highlights the fledgling nature of the PE/VC ecosystem compared to global standards. Developed economies boast a well-established investment continuum from seed financing, angel investors, VC/PE, and funds of funds, facilitating secondary buyouts. This structured progression facilitates secondary buyouts, as startups are initially financed by angel investors, followed by VC funding, and subsequently acquired by PE firms, with Funds of Funds acting as exit channels for larger PE investments. However, Nepal's ecosystem lacks this robust continuum property of a global investment ecosystem which complicates exits for PE/VC funds and makes secondary buyouts rare.
Getting the Exit Right
A strategic approach is necessary for optimising exits within Nepal's PE/VC landscape. While the IPO route remains a sought-after exit strategy, careful considerations are necessary in this route. Not all portfolio companies are suited for IPO exits, as inherent disadvantages may deter favourable outcomes. Furthermore, success with IPO exits is not guaranteed. Timing, leveraging a "Window of Opportunity" or capitalising on a “Hot Issue Market”, can prove effective. Yet, the Indian IPO cases of the IT sector and their after-performance underscore the importance of market behaviour post-listing.
In Nepal, the absence of offer-for-sale practice and a mandated lock-up period accentuates the imperative for sustained investee company performance well beyond the expiry of the lock-up period. Also, exiting in bulk immediately post-lock-up expiry risks adverse market sentiment and depreciated stock performance. Instead, several partial trades by recognising opportunity windows in the market can be a viable option. Prudent market analysis is also a requisite because exiting amidst a bearish market or sectoral downturn may yield subpar exit multiples. In such scenarios, deferring exit plans, albeit potentially, necessitating fund period extension, offers an alternative. However, this decision needs careful evaluation, balancing potential upsides of probable good market scenarios against compounded hurdle rate from extension.
It is crucial to recognise that the current trend of consistently oversubscribed IPOs in our primary market will not last indefinitely. While IPOs remain a favoured exit route, strategic sales also offer a compelling alternative, especially for companies not yet prepared for an IPO exit. In addition to IPOs and strategic sales, secondary buyouts are emerging as another viable exit strategy. However, the overall development of the investment ecosystem is essential for the success of secondary buyouts. Despite these options, it is necessary to analyse and identify potential exit strategies before investing in the target company.
Additionally, achieving a successful exit in PE requires more than just focusing on acquisitions and immediate performance improvements; it demands careful preparation and the crafting of a compelling narrative throughout the ownership period. PE investors can lay the groundwork for a successful exit by constantly refining a well-articulated view of why an asset represents an exciting investment opportunity. This involves honing a narrative that articulates the investee company’s strength, potential for improvement and strategic significance to potential buyers. Successful exit preparation entails starting early, well before the exit window approaches, to assemble the necessary evidence and align business and exit strategies. By adhering to principles of simplicity, early planning, and tailored messaging, PE investors can proactively shape the narrative of their portfolio companies, increasing the likelihood of a smooth and lucrative exit when the time comes.
TEAM Ventures, is an industry-agnostic alternative investment firm with a diverse portfolio spanning the energy, technology, real-estate, manufacturing, financial institutions, agro-infrastructure, and electric-vehicles sectors.)
