LBO Exit Strategies: M&A, IPOs, and Dividends / Recapitalizations
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- Опубликовано: 4 янв 2015
- This LBO exit strategy training will cover different ways a private equity firm can exit a leveraged buyout...
By breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
... including an M&A deal - a sale to a normal company or to another private equity firm - as well as an initial public offering (IPO), and a recapitalization / perpetual dividend “non-exit.”
2:09 Exits in Real Life: M&A, IPO, and Dividends/Recaps
6:27 Standard M&A Exit in an LBO
7:21 IPO Exit in an LBO
12:44 Dividends / Recapitalization in an LBO
16:42 Recap and Summary
Exit Strategies in a Leveraged Buyout / LBO Model
There is typically VERY little thought given to the exit in a leveraged buyout (LBO) model - in 99% of models, people just assume a simple exit multiple based on EBITDA, implying that another company or another private equity firm buys the company.
But in real life, that doesn’t necessarily happen… sometimes, a portfolio company cannot be sold to another normal company or even to another private equity firm.
For example, it might be too big for another company to buy, or it might be in an unfavorable market where there’s little M&A activity.
Also, it tends to be harder to do M&A deals in emerging and frontier markets because potential buyers are also smaller and less willing to make big acquisitions.
As a result, you need to think about 2 alternative exit strategies: initial public offerings (IPOs) and recapitalizations (recaps), otherwise known as dividends / dividend recaps.
The Mechanics of an M&A Deal
A normal M&A deal is simple: you simply assume an exit multiple, calculate Enterprise Value based on that, and then back into Equity Value by subtracting Net Debt.
Then, you calculate the IRR and multiple to the private equity firm by looking at its initial investment and how much the firm receives back at the end upon exit.
There is some uncertainty around the timing of the exit and the multiple, but overall it is a very “clean” process because the firm sells 100% of its stake all at once, to another single firm.
Initial Public Offerings in an LBO
In an IPO scenario, the PE firm cannot sell its entire stake when the company goes public because it sends a big negative signal to everyone else in the market and new potential investors: if this company is so great, why are you selling your entire stake in it?
So instead, the firm has to sell off its holdings over a period of time… perhaps 20% in Year 1, 35% in Year 2, 30% in Year 3, and 15% in Year 4, as in our example.
If the share price stays the same, the MoM multiple is the same but the IRR is lower because it takes more time to get the same capital back.
But if the share price fluctuates a lot, it could work for the firm or against the firm: a higher share price over time obviously helps them, while a declining share price hurts them.
In general, though, the IRR tends to be lower in an IPO because it takes the PE firm more time to sell its holdings; the MoM multiple may be about the same, or it might be higher or lower depending on the share price movement.
Dividends / Recapitalizations in an LBO
This is not really an “exit strategy” at all: the private equity firm simply holds the company indefinitely and the firm keeps issuing dividends from its excess cash flow to the PE firm.
In some cases, the company may take on extra debt to issue these dividends (known as a “dividend recap”).
The problem here is that the company can only issue dividends with the cash flow it has available, which is typically far less than its EBITDA.
This strategy can work if the company grows very quickly and/or is a “cash cow” business with high margins and high FCF yield, but in general it is very tough to realize a high IRR solely with dividends, simply because it might take years and years just to recoup the initial investment.
The MoM multiple, over a long period, might be reasonable, but the IRR would end up being so low that many PE firms would not be interested at all.
Conclusion
The M&A sale is the preferred strategy in 99% of leveraged buyout scenarios because it tends to produce the highest IRRs and highest MoM multiples, with the least amount of uncertainty.
However, in many cases the PE firm will have to use strategies such as an IPO exit if, for example, the company is too big to be acquired; and if it really can’t figure out what to do, dividends / recapitalizations may be used.
They are especially common in emerging and frontier markets where the capital markets are smaller and less liquid and where it’s harder to find qualified buyers. Regulatory issues may also prevent these types of companies from going public in larger, developed markets.
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Absolutely love these videos. It was a no-brain er to subscribe to this Channel, and I love the emails I get from you guys. Keep up the good work, you'll make all of us rich!!!
Excellent stuff dude, indeed, good to have a plan B or C for that matter in the event the ideal M&A scenario exit doesn't play out. But it is good to work hard towards that scenario first then have a couple of other exit option in your arsenal just in case. Thanks for the excellent video.
Thanks for watching!
Thank you, really clear explanation of the exit strategies and the reasoning behind them!
Thanks for watching!
This is a great tutorial. Thank you!
Thanks for watching!
Well done thank you man
Thanks for watching!
Thanks for the great video and all the others! Two quick thoughts: 1) For the third situation, dividends/recap, the continuing value of the enterprise should be included in the valuation 2) Mathematically, all three ways of 'exit' should not yield different IRRs for the initial PE investor. The reasons you mention why for an IPO, the investor takes on higher risk, etc. are valid, and usually in practice lead to a lower overall IRR. Similarly, most PE shops are not the best 'long term' owners, as compared to other strategic buyers. But if a company is worth a certain amount, its intrinsic value does not change whether another PE firm buys it, a corporate strategic buyer, its shares are distributed to the public, or the original LBO firm retains ownership.
Thanks for your feedback, but I think you have the wrong idea on these points. To clarify, "IRR" or "Internal Rate of Return" corresponds to the cash invested and cash received. It is impacted by both of those as well as time. IRR depends on *realized gains* and has nothing to do with unrealized gains.
So if a company just becomes "worth more," but the PE firm does not sell any of its stake in the company, IRR is not impacted. The PE firm can't even record anything for IRR until it sells something or receives cash back from dividends or something else.
So in the third scenario, no, the company's Enterprise Value should not be included because it doesn't represent a return of cash to the investors. You would do that only if the PE firm sold the entire company recovered the proceeds.
On your second point, no, that's the whole point of IRR: the method of exit most certainly results in different IRRs. If an exit takes 1 year longer or shorter, or even 1 month more or less, the IRR will be impacted. If the PE firm's stake is worth more or less, the IRR is certainly impacted.
I'm not sure what the point about PE firms not being "long-term owners" has anything to do with this - of course they're not long-term owners, they buy and sell companies, so clearly they have to sell companies in a reasonable time frame to earn an acceptable IRR.
well done
Thanks for watching
Thanks for this video. A question that came to mind when I was watching the bit about the dividend recap - you say that the IRR decreases significantly due to the effect of small dividend payouts over a longer period of time. However, would it be possible that the PE firm takes on a lot more debt to effectively enact another 'buyout' of its own shares in the target in a lumpsum dividend recap? And if so, wouldn't the IRR be roughly commensurate to that of the typical M&A sale? Thanks again!
Potentially, yes, but the debt issuance would have to be massive for that to work... you normally only see dividend recaps as an "exit strategy" in emerging/frontier markets for that reason (because the growth rates there can be high enough to make the strategy work).
Thanks for the video! When we try to calculate the IRR to the PE firm, we assume they sell the company at the end of the projection period, use the proceeds to pay down any debt, add back any cash, and then arrive to ending equity. However, when a strategic/financial buyer buys the company, aren't they the ones responsible for paying off / refinancing the target's debt? So therefore why do we subtract debt and cash when calculating returns to the PE firm? I've read in the guides that the PE firm creates a holding company so that it is not actually responsible for paying down the debt when selling.
The issue is that even if the new acquirer repays the target's debt, it still reduces the equity proceeds to the PE firm. Yes, the acquirer pays a Purchase Enterprise Value of X, but if Debt of Y must also be repaid, then the proceeds that go to the PE firm are only X - Y rather than X. This debt is often replaced immediately after the deal closes, but now it's the responsibility of the new acquirer.
This is wonderfull. Is there a way to get these templates?
Click "Show More" and scroll to the bottom.
So for an interview question, who benefits from a dividend recap?
The PE firm benefits because they get back some of their money earlier on, which results in a higher IRR for them, assuming that the dividend recap does not cause issues or otherwise hurt the company's performance in the next few years.
can I get these excel sheet sir
Click "Show More" and scroll to the bottom and click the links.