The speed at which IPOs can return capital to their investors is pivotal in maintaining a healthy pipeline of deals, but the recently pulled IPOs of Skrill and Edwards have shown just how fragile the market is for private equity firms hoping to exit their portfolio companies.
‘I think it’s still open for the right business but you now need a pretty good story behind the IPO,’ says Richard Babington, investment director at NBGI private equity.
Private equity exits took a hit at the start of 2011, in stark contrast to the strong showing that the industry displayed at the end of last year. In the first quarter of 2011, the European exit market was valued at just €7.4 billion, a fall of 61 per cent from the €19.8 billion in the first quarter of 2010.
Data produced by Lyceum Capital and Cass Business School’s UK Growth Buyout Dashboard shows that there were 12 exits from private equity investments in the UK in the first three months of the year, with the majority of sales being achieved through secondary exits (see chart 1 below).
Advent Venture Partners recently completed the exit of The Foundry, a supplier of digital visual effects, in a secondary buy-out by The Carlyle Group only 20 months after it had initially been subject to an MBO.
Mike Chalfen, general partner at Advent Venture Partners, says that the success of the exit was down to developing the sale early on in proceedings: ‘We always wanted to develop the option of selling without actually selling. So from last summer, when the company was approached by various potential buyers, the CEO was able to build up a small number of relationships, and that was what triggered the exit process.’
Despite the fact that The Foundry was attractive because it is highly differentiated and has a unique technology position, Chalfen says it’s always important to make sure that any company is functioning well enough to let the top couple of executives focus on the exit strategy.
‘We are finding it easier to [discover] unique businesses in Europe that are achieving some scale and I think that is why exits are easier: it’s not buyer driven, it’s that there are interesting things happening in the exit market,’ he adds.
Karen Slatford, chairman of The Foundry, says that part of the success in achieving the exit was leaving something in reserve for future growth: ‘As well as the existing solid foundation, there are a number of new products to take to market that would increase the growth trajectory of The Foundry. I think that in any market, in any phase, you can’t afford to rest on your laurels. The fact we have an opportunity for new market potential is definitely one of the reasons that attracted Carlyle.’
It is a sentiment echoed by Rod Richards, managing partner at Graphite Capital: ‘One of the things you should be doing as a private equity firm is investing in the growth prospects that will attract the buyer in the future.’
Richards believes that there is a trend developing, with exits being spoken about right now being private equity firms’ most successful investments. He senses that there is also a feeling that if private equity firms are going to sell one of their better-performing assets then they are really holding out for a good price.
One company at the beginning of its journey through the private equity investment cycle is accountancy
software business Access. It recently underwent a £50 million MBO backed by Lycecum Capital as part of a ‘rapid expansion strategy’.
CEO Chris Bayne, who led the MBO, says that part of a successful marriage with a private equity firm is having a clear approach to where the business is going: ‘You have to be visibly part way through your voyage. There is no point in us having plans that leave us with no growth indicators or opportunities going forward.’
Another way for private equity companies to return capital is through debt refinancings, a strategy that Jeremy Furniss, partner at Livingstone Partners, believes is on the increase.
‘There has been a relatively busy period of debt refinancings where the existing investor has seen the business grow successfully,’ he explains. ‘They have paid down the debt from the earlier transaction and as a result the opportunity occurs to go back to the bank and refinance it.’
Livingstone Partners was involved in the recent sale of ZEAG Group, a Swiss-based provider of parking revenue management systems, to Italian business FAAC Group.
Furniss believes that an exit to overseas investors is a growing sale channel: ‘If you look back over the past 12 to 18 months, I think that all but one of the businesses that Livingtone in London has sold have been to a foreign buyer.’
From the perspective of NBGI’s Richard Babington, securing exits is all about accessing the global networks. ‘We are seeing potential buyers popping up from really leftfield locations. It’s about pulling in potential buyers from China and India – the more cash-rich countries.’
‘Part of a successful marriage with a private equity firm is having a celar approach to where the business is going’
Based on his recent experience, Advent Venture Partners’ Mike Chalfen sees exits as coming from a wider base: ‘Buyers are more and more global; fewer and fewer locations are scary to them.’
Explaining the rationale behind Advent’s exits, Chalfen says, ‘We are finding it easier to find unique businesses in Europe that are achieving some scale.’
Sean Whelan, managing director of ECI, argues that for exits to be achieved, a more observational approach is necessary to ascertain when and where a potential sale might occur.
Richard Babington of NBGI believes that key to achieving an exit is not cutting off any possible route, seeing both private equity and trade buyers as rather fickle and partial to changing their views from one minute to the next.
However, with risk assessment at an all-time high in the market, he is seeing deals taking longer and longer to complete. ‘Businesses that were marketed at the start of last year are only just getting exited now, whereas before you would see more of a three- to four-month process,’ he says.
‘It’s a very tactical thing; they know that the longer the business drags on, the higher the chance something won’t add up and they’ll be able to buy the company more competitively.’
This assessment is mirrored by Andrew Aylwin, partner at Lyceum Capital, who says that with prices on the rise, managers of the lower mid-market are working hard to understand investment risk, meaning that deal processes are drawn out as a result.
Only four exits through trade buyers were made in the first quarter of 2011, the lowest level since the first quarter of 2009. Within this environment, Silverfleet Capital is using a buy-and-build process to build up the market value of its portfolio companies.
Research compiled by the private equity firm shows that during in 2010 the volume of add-ons or builds increased by 33 per cent, to 305 from 230 in 2009 (see chart 2 below). The findings also reveal that where a transaction value was available, the value increased by 7 per cent, from £14.3 million to £15.3 million.
Following six buy-and-build acquisitions in seven years, Silverfleet exited European Dental Partners in April in a deal worth €170 million, a healthy return on the initial €110 million that the private equity firm paid for the business in 2004.
Silverfleet’s Neil MacDougall reveals, ‘We believe that as the trends in the M&A market and debt market appear favourable for buy-and-build, and with many sponsors still needing to exit their older investments, it is likely that buy-and-build activity will continue to rise in 2011.
‘I think what is true is that you can’t be too descriptive in terms of exit timing as you need to keep a close eye on what is happening in the external environment and whether they are more or less aggressive.’
See also: The balancing act of partial exits