Question

Describe common strategies LBO firms use to exit their investment. Discuss the circumstances under which some methods of “cashing out” are preferred to others.

Answer 1

Solution:

Comprising about 13% of total transactions since 1970s, initial public offerings (i.e., IPOs) have declined in importance as an exit strategy. At 39% of all exists, the most common ways of exiting buyouts is through a sale to a strategic buyer; the second most common method at 24% is a sale to another buyout firm. Selling to a strategic buyer usually results in the best price as a buyer may be able to generate significant synergies by combining the firm with its existing business. If the original buyout firm’s investment fund is coming to an end, the firm may be able to sell the LBO to another buyout firm that is looking for new investment opportunities. This option is best used when the LBO’s management is still enthusiastic about growing the firm rather than cashing out. Consequently, the LBO may be attractive to another buyout firm. An IPO is often less attractive due to the massive amount of public disclosure required, the substantial commitment of management time, the difficulty in timing the market, and the potential for incorrectly valuing the IPO. The original investors also can cash out while management remains in charge of the business through a leveraged recapitalisation. This strategy may be employed once the firm has been paid down its original debt level. The firm may borrow additional monies to repurchase stock from other shareholders, leaving the firm with a more conventional capital structure.