TL;DR
A Secondary Buyout (SBO) occurs when one private equity firm sells its investment in a portfolio company to another private equity firm.
In this type of deal, the selling firm, which has typically held the company for a number of years, seeks to exit its investment and realize its returns.
The buying private equity firm sees potential for further value creation and growth, and thus acquires the company with the goal of generating future returns.
Secondary buyouts are often used as an alternative exit strategy when other options, such as going public or selling to a strategic buyer, are not feasible or attractive.
The buying firm usually brings new capital, operational expertise, or a fresh strategy to further grow the company and prepare it for a future exit.
How Does a Secondary Buyout Work?
The process of a secondary buyout generally follows these steps:
1. Initial Investment and Growth
In the initial phase, a private equity firm acquires a company, typically through a leveraged buyout (LBO), where the firm uses a combination of equity and debt to purchase the business.
Over the course of several years, the private equity firm works to improve the company’s operations, increase profitability, and position it for growth.
This can involve restructuring, improving management, expanding into new markets, or making strategic acquisitions.
2. Exit Planning
When the private equity firm is ready to exit the investment and return capital to its investors (Limited Partners, or LPs), it evaluates different exit options.
If the market conditions are not favorable for an IPO or a strategic sale, the firm may pursue a secondary buyout. This involves selling the company to another private equity firm that is interested in taking over the investment and continuing to grow the business.
3. Negotiation and Sale
The selling private equity firm negotiates the terms of the sale with the buying firm, including the company’s valuation, the amount of equity and debt involved, and any operational plans moving forward.
Once both parties agree on the terms, the transaction is finalized, and the buying firm acquires the company.
The selling firm exits with a return on its initial investment, while the buying firm takes control of the company and continues to manage it.
4. Further Value Creation
After the secondary buyout, the new private equity firm typically seeks to create additional value by continuing the company’s growth strategy.
This may involve expanding the company into new markets, increasing operational efficiencies, or making further acquisitions.
The goal is to enhance the company’s profitability and value before eventually pursuing another exit through an IPO, strategic sale, or potentially another secondary buyout.
Why Do Private Equity Firms Use Secondary Buyouts?
Secondary buyouts have become an increasingly common exit strategy in private equity for several reasons:
1. Alternative Exit Strategy
In some cases, traditional exit options, such as going public through an IPO or selling to a strategic buyer, may not be feasible or desirable due to market conditions or company-specific factors.
A secondary buyout offers a viable alternative, allowing the selling firm to exit its investment and return capital to its investors.
2. Continued Growth Potential
The buying private equity firm often sees untapped growth potential in the company. The company may have already been significantly improved under the previous ownership, but the new firm believes there is still room for further value creation.
This could involve operational improvements, geographic expansion, or a new strategic direction.
3. Strong Deal Flow in Private Equity
As the private equity industry has grown, the number of portfolio companies seeking exits has increased.
Secondary buyouts help private equity firms maintain deal flow and invest capital in businesses that have already been vetted and improved by another firm. This reduces some of the risk compared to investing in earlier-stage or unproven businesses.
4. Liquidity for Investors
Private equity firms are generally expected to deliver returns to their Limited Partners within a specific time frame, often between 5 and 7 years.
When market conditions or strategic factors delay an exit, a secondary buyout can provide a timely liquidity event for the selling firm, allowing it to distribute proceeds to its investors and close out the investment.
Benefits of Secondary Buyouts
Secondary buyouts offer several advantages for both the selling and buying private equity firms, as well as the portfolio company:
1. Flexibility in Exit Timing
For the selling private equity firm, a secondary buyout provides flexibility in the timing of its exit.
If an IPO or strategic sale is not possible due to unfavorable market conditions, a secondary buyout allows the firm to exit the investment and deliver returns to its investors without waiting for market conditions to improve.
2. Opportunity for Additional Growth
For the buying private equity firm, a secondary buyout offers the opportunity to acquire a company that has already been improved and is positioned for further growth.
With a new strategy, additional capital, or fresh leadership, the firm can build on the existing success of the company and create even more value.
3. Reduced Risk
Because the company has already been owned and managed by another private equity firm, it may present a lower risk to the buying firm than a typical leveraged buyout of an unproven business.
The company’s operational and financial strengths are already established, providing a clearer path for further improvements and growth.
4. Liquidity for Shareholders
Secondary buyouts also provide liquidity to shareholders of the portfolio company, including management and previous investors.
For many employees and early investors, a secondary buyout can be a significant liquidity event, allowing them to cash out part or all of their stake in the company.
Example of a Secondary Buyout
A well-known example of a secondary buyout is the sale of Gymshark, a UK-based fitness apparel company. In 2020, private equity firm General Atlantic acquired a 21% stake in Gymshark, valuing the company at over $1 billion.
After a few years of strong growth under General Atlantic’s ownership, Gymshark was sold to another private equity firm, EQT Partners, in a secondary buyout. The sale allowed General Atlantic to exit its investment with significant returns, while EQT saw the potential to further grow the business internationally.
Conclusion
A Secondary Buyout (SBO) is a popular exit strategy in the private equity industry, providing a flexible and timely way for firms to realize returns on their investments.
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