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Exit Options for Private Equity Investors

Exit Options for Private Equity Investors

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1.IPO:  This is the traditionally preferred route. Private equity investors will have a right to offer their shares for sale under an IPO and then exit. To ensure that the investor can effectively achieve this, investment documents typically specify the methods to do so.

Drawbacks with IPO:

  • Direct dependency on prevailing market conditions.
  • Transaction costs
  • Careful planning and the process takes long to implement.
  • IPO may not give large private equity investors a full clean exit.

2. Buy-back of shares:  Private equity investors could agree to exit via a buy-back of shares at a mutually agreed internal rate of return. Companies articles of association permit a buy-back of shares. A buy-back should conform to the guidelines laid down in the Companies Act, 1956 – that in a year there can only be a buy-back of 25% shares of the company (prescribed threshold), buy-back is permitted only from free reserves or from the securities premium account, a buy-back of a certain kind of shares cannot be made out of the proceeds of an earlier issue of the same kind of shares the buy-back debt-equity ratio post buy-back cannot exceed 2:1. Further since an offer for buy-back needs to be made pro rata to all shareholders, it is usual to enter into an agreement with some of the promoters/shareholders where they agree not to subscribe to the shares else there would be a risk of the buy-back exceeding the prescribed threshold and not allowing a complete exit to the PE investor.

3. Put option on promoters: An exit via this route involves a put option right with the private equity investors on shares of the promoters of the company. Considering the enforceability issues discussed under the buy-back option above applicable to public companies, investors use a private company structure to hold the promoter shares or create a promoter Owned company overseas that would hold shares in the investee company (Overseas Company Holding) and place the Overseas Company Holding in escrow. The parties must also ensure that a transfer of shares is done as per the pricing guidelines of RBI.

4. Right of first offer (ROFO), Right of first refusal (ROFR):  These are standard transfer restrictions/exit mechanisms agreed under investment documentation. Private equity investors prefer a ROFO over a ROFR since it helps them retain control over the process of price discovery. Further, investors may find it difficult to exit via a ROFR since potential acquirers may worry that even after completion of price fixing following extensive diligence, promoters may ultimately acquire the shares.

5. Sale to strategic buyers or financial buyers: The differences between strategic buyers and financial buyers are many but the most significant one is their approach to acquisitions. While strategic buyers want to buy and hold, financial buyers want to buy low and exit high. A sale is preferred because that private equity investor will have to deal only with one buyer unlike in an IPO, where multi parties are involved. Further, a sale provides payment in cash and a clean and complete exit for the private equity investor.

6. A private equity investor may also sell to another private equity buyer (secondary buyout): This type of exit appears to have developed for various reasons: one, that with private equity investors increasingly engaging in niche areas, non-specialist investors have begun to sell to more specialist firms. Further, certain private equity investors may wish to reduce their deal life in the company so they can look at more inviting projects. It is also possible that private equity investors may exit when both the management and the investors believe that a larger private equity investor will add value to a transaction.

7. Merger: That is used, but only as a back-up, is a merger of an illiquid/unlisted company with a listed company. However, this is rarely followed in view of tedious litigation processes associated with mergers, in India.

8. Break-ups: This exit route may be used by private equity investors who invested in a series of diverse non-core businesses with the intention of selling them piecemeal to various buyers who will value the business. The sale would thus involve the break-up of the business at a price that is invariably higher than the initial acquisition price.

9. Portfolio sale: This is typically used when private equity investors wish to exit from all their investee companies simultaneously. The primary reason for use of this route would be an aging private equity fund that demands an early exit.

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