If public markets are volatile and a desired IPO market cap is not assured, selling to a third party may be a viable option. Although the IPO market and acquisition valuations are often correlated, a potential bidder may be inclined to pay a premium to the IPO market due to perceived synergies, desired growth through acquisition, or high perceived intrinsic value.
Volatility can be measured in terms of the number of cancelled IPOs; mixed after-market trading performance; or pricings below an anticipated midpoint. Political and economic uncertainty can add to market volatility. Annual dollar IPO values have fluctuated in recent years, reaching a high of $86.6 billion in 2014, dropping to lows of $32.6 and $21.6 billion in 2015 and 2016, respectively, then rising again, to a high of $44.2 billion in 2017.¹
When market volatility is high, PE firms may want to adopt a proactive strategy, actively pursuing potential buyers in an attempt to reach an exit price within a more predictable range. It should be noted that high market volatility inherently also provides additional uncertainty around the completion of a successful IPO and/or sale.
¹ PwC, “2017 Annual US Capital Watch.” - https://www.pwc.com/us/en/deals/publications/us-capital-markets-watch.html?elq_mid=9680&elq_cid=951823
In an IPO, the PE firm must retain a significant stake in the company, which would prolong the holding period for an investment. With that in mind, if the end of the planned holding period is approaching or has passed, or an exit must be assured to meet fund return targets, a trade sale can be used as a backup option to potentially expedite the exit process and receive the full proceeds from a sale.
The median holding period has increased steadily since the economic crisis in 2008, reaching just over five years in 2016—significantly higher than pre-crisis holding periods of 3-4 years.² In this environment, proactively searching for a buyer could improve the internal rate of return (IRR) for PE firms.
² Hugh MacArthur, Graham Elton and Suvir Varma, “Exits Settle At A New Normal In Private Equity,” Forbes, March 9, 2017. - https://www.forbes.com/sites/baininsights/2017/03/09/exits-settle-at-a-new-normal-in-private-equity/#2f7561616b37
Control over exit value
If a PE firm wants more control over the exit value, an IPO filing will help to establish a price floor, and the additional competitive pressure of a viable IPO process can drive bidders to submit higher offers. Research confirms the wisdom of this strategy: A study published in the Journal of Business Venturing examined 679 exits from 1995-2004 and found that PE firms following an active dual-track exit strategy earned a 22-26% higher premium over those which pursued a single-track exit approach.³
³ James C. Brau, Ninon K. Sutton, Nile W. Hatch, “Dual-track versus single-track sell-outs: An empirical analysis of competing harvest strategies,” Journal of Business Venturing, 2008. - https://www.sciencedirect.com/science/article/pii/S0883902608001122?via%3Dihub