At some point, a Private Equity Fund Manager (Fund Managers) would often find out that, indeed, every aspect of the fund raising and investment cycle is a disciplined process and that the degree of discipline that is brought to bear on each process may be directly proportional to the success of a Fund Manager. Exit Planning is a fundamental discipline for Fund Managers and perhaps, the most understated. In our experience, most times, it’s the quality of the Exit Plan and of the execution of that Plan that makes all the difference in the quest for alpha. Regardless of the investment thesis or legal structure or domicile of a private equity/venture capital funds, Exits are a constant event that must happen because they serve the function of validating your investment thesis, the basis upon which you convinced LPs to commit to your fund. Given the limited exit options available in frontier markets, Exit Planning probably, more than other aspects of the investment cycle, requires the most innovation and originality at this time.
This resource is for Private Equity Fund Managers at all levels, specifically, local and foreign accelerators/incubators, angel/early-stage investors, venture capital investors and the traditional private equity investors who may be looking to invest in or sell a portfolio company in Nigeria.
It does help, to think about Exit Planning, from two ends of the same spectrum: The legal, on the one hand, and the strategic, on the other. Perhaps, the most important point to note here, is that “Alpha” Exits, if we measure Alpha, strictly, in terms of “multiples”, are an “early-oners” game. And so, the point where a shrewd Fund Manager should start considering a documented Exit Plan is just before entry. The seeds of a great Exit Strategy are sown at entry and preparation for sale, should ideally start from purchase. Fund Managers who miss it at this point may struggle later. An Exit Plan is definitely not something to keep in mind as an abstract.
Take for instance a key entry control document – The Term Sheet -. From a structuring point of view, there are a number of control provisioning that need to go into a Term Sheet and by extension, the Definitive Agreements. Typically, depending on local laws, these may include redemption rights, registration rights, board control/veto right drag or tag-alongs and very likely, the amendment of key constitutional documents. There are a number of structuring considerations to note here. Firstly, there is no default limit to the number and type of ‘control’ provisioning that is possible as these can be highly, transaction-specific and dependent on the strategic objectives of the Exit Plan. Secondly, it’s not exactly in knowing that such or certain controlling provisions exist and that such provisioning must go into a Term Sheet but, in the extent to which the structure of that provisioning aligns with or serves to deliver the strategic objectives of the Exit Plan. In specific regard to the last point, it typically helps for Fund Managers to see, from the beginning, how each ‘control’ provisioning would play out in a practical Exit scenario.
Other than alignment with the Exit Plan, the inclusion and/or negotiation of these rights would also serve to communicate with and manage the expectations of one of the most important stakeholders in every Exit Plan – Management -.
The Management of the portfolio company can often be critical to the Exit Plan. Alignment on this level, is also therefore key, especially, in terms of ensuring that Management understands the criticality of the Exit Plan, preferred exit routes, preferred exit buyers, and timelines. Having open discussions around these are generally advisable for a Fund Manager.
In achieving alignment with Management, it helps to think in terms of the appropriate level of Management incentives necessary to execute an Exit Plan. Equity sweeteners are one ideal way to deliver alignment, especially, in the case of a highly sophisticated management team. It bears noting, that buyer types will often drive the scope and structure of such equity sweeteners. For instance, whilst secondary buyers may place a valuation premium on current management for a portfolio company that is doing well, a strategic may necessary not, to the extent that such buyer would have its own management team. In the latter case, any such employee equity plans should typically vest in a “change of control” event. The overall objective for the Fund Manager should be too maximize exit price, whilst also keeping a good management in place, especially in the case of a secondary buyer.
Generally, and as far as legal strategy goes, it is important for the Fund Manager to (a) have sufficient control over the form and timing of the exit from the outset; (b) ensure that the Exit Plan is flexible enough to recognize all possible exit options (whether these be, trade exits, leveraged recapitalizations, IPOs or secondaries) and detailed enough to articulate the legal, political, regulatory and contractual requirements necessary to deliver on each option seamlessly.
For the Fund Manager, understanding the legal, regulatory and political requirements necessary to deliver on an Exit pathway can provide very useful perspective in regard to the type of relationships that a Fund Manager needs to build and invest in, strategically, at the beginning of the holding period.
“Strategic” considerations should ideally capture all economic (both micro/macro) variables that are relevant to an Exit Plan. It is always advisable to start with an ideal exit Scenario Analysis with details of the – ideal Exit buyer, ideal economic conditions, ideal Exit pathway etc., ranging from a best case scenario to the worst case scenario. It does help to complement this with a Sensitivity Analysis using key economic indicators and trends, that may include, the extent to which an Exit Plan may be affected in a recession or in a growing economy, political/election cycles, where the portfolio’s business is generally in the economic cycle, the portfolio company’s attainment of certain financial and operational benchmarks and how close a fund is to dissolution. Any one of these variables can drive the the timing and/or scale (partial or full)of an exit. For instance, the proximity of a Fund to dissolution can drive an exit decision, even though market conditions may not be very ideal. Also, it may be strategic to sell a portfolio that is doing well in an industry that is experiencing a downturn. Indeed, the number of outcomes are varied and it is always useful for the Fund Manager to have these in its line of sight as much as it is reasonably possible.
Staying focused on other key stakeholders (the portfolio company, likely/preferred buyers and key regulators) during the holding period of an investment is also a key strategic component of Exit Planning. An Exit Plan should have an unfailing requirement to closely monitor these stakeholders. For a portfolio company, it is important for its performance to match a Fund Manager’s strategic plan and projections and where not, for the Fund Manager to re-route as appropriate. Facing a preferred/likely buyer, it is important to key an eye on such buyers’ preferences and needs as this may change over time for strategic reasons, during the holding period of a Fund Manager’s investment. Its also always important to understand the key valuation metrics and considerations of an ideal buyer, facing a portfolio company and to ensure that the Exit Plan is flexible enough to adapt.
For further guidance on selling a portfolio company, building an exit plan or reviewing a Term Sheet/other definitive documentation, please reach out to your Balogun Harold contact or to our Private Equity/Alternative Assets Team lead via email@example.com