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Why strategic buyers are key for private equity exits - Neeraj Agrawal

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We all know the importance of making a good entrance. In the private equity (PE) investment process, getting the exit right is as critical. However well you have managed your investment in the preceding years, your final return will depend on how well you execute the exit. Neeraj Agrawal, Executive Director at Crescent Enterprises, shares his thoughts on routes to a successful exit. 

Among the most popular exit strategies is finding a strategic buyer who will often operate in the same industry as the target company, and recognises strategic value in the acquisition. It will therefore pay the substantial premium for future realisation of value accretion.

Advantages may include expansion into new geographic markets, access to new customers or suppliers, and acquisition of technology or product lines that complement their existing portfolio. Further benefits include, and are not limited to, enhancing aspects of their operations, sales and marketing, and research and development.

A purchase may also enable the buyer to absorb a competitor - Uber’s acquisition this year of Careem for $3.1 billion will help the former company consolidate its market position in a region of 400 million people, ending a costly battle for dominance in ride-hailing.

Rapid technological changes are making it more challenging than ever to assess value and risk –potential buyers and sellers may have very different observations on an industry’s direction, business strategies and the level of investments.

In a trade sale, the purchaser is knowledgeable about the business of the target company, easing the due diligence and closing process. They are also likely to be able to realise synergies quickly, such as early product development due to acquisition of technology, elimination of duplicate functions, and greater purchasing power thanks to leveraged economies of scale.

On the flip side, if a prospective buyer knows that there isn’t much competition for the purchase of the target company, then they may be conservative in their decision to pay a premium, making a deal less attractive. Also, while trade sales can achieve good returns for investors, entrepreneurs may be reluctant to cede control of their business to a larger company – which may well be a direct competitor.

Rapid technological changes are making it more challenging than ever to assess value and risk –potential buyers and sellers may have very different observations on an industry’s direction, business strategies and the level of investments required to support technology development in portfolio companies. Logistics companies for example may face challenges of integrating blockchain into their operations, while manufacturing organisations will need to factor in Internet of Things-type solutions.

In such cases, an initial public offering (IPO) may be a more attractive exit strategy – given favourable market conditions. Fluctuating oil prices and geopolitical tensions have contributed to a slowdown in market activity in the region, emphasising the importance of identifying a strategic buyer.

Preparing and positioning the business for a sale and evaluating potential buyers in the market is critical. When identifying, exploring and assessing a strategic fit for an organisation, it is important to have a good understanding of exactly what options are available on the market and an overview of sector activity. Exploring the types of companies being sold, potential buyers and their strategic direction should not be overlooked.

While a direct competitor can often be the most straightforward option – as with Uber and Careem – this strategy is dependent on market conditions and timings, so flexibility and a wider view of the market is critical.

By understanding what companies are looking for, you can better identify the value a potential purchaser will see in your business – and then maximise that value so as to get the best possible premium. Conversely, that may not mean taking all the value yourself – since a buyer doesn’t want to acquire a business with flat or declining financials, owners may want to leave some value-creation options “on the table” for the future owners.

Investors need to have an idea of their intended time of exit – and be prepared to leave earlier if an attractive offer is tabled.

Traditionally, PE investors have focused mostly on EBITDA (earnings before interest, taxes, depreciation and amortisation), as the most important financial number they want to boost – which will most likely enable them to sell the investment for more than they paid for it.

According to advisory service EY, while 41% of PE firms still cite the importance of achieving EBITDA goals on divestment timing, 74% would accept an unsolicited bid for a company, stressing the need to be prepared and to move quickly.

Achieving all these objectives requires careful planning, so investors need to have an idea of their intended time of exit – and be prepared to leave earlier if an attractive offer is tabled. Owners should look to create value through performance improvements throughout the holding period, and ensure that the company demonstrates a proven track record, creating future value.

There’s a saying in show business that you need to stick the landing: however good a film or TV show is during its duration, a bad ending will spoil the impression created with the viewer. For PE investors, getting the right strategic buyer in place will help you “stick the landing” - but you have to work on it.

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Neeraj Agrawal spoke at SuperReturn Middle East in 2019. Looking to find out more? Visit our website >> 

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