When it comes to private equity investments, exit control is an important but rarely talked about part of the value creation journey. It refers to the systems, procedures, and checks and balances that the private equity firm and the board of the portfolio company set up to make sure that the change from ownership to a successful sale or selling goes smoothly. This isn’t just a routine task; it’s a strategic role that has a direct effect on the end valuation multiple, the speed of the deal, and the certainty of closing. A good exit governance system makes sure that the selling process is carried out with accuracy, openness, and strategic alignment.
The board’s changing job description
When a private equity investment gets close to the end of its expected holding period, the board of directors of the client company’s job changes in a big way. At first, the main goal was to improve operations, grow organically, and make smart acquisitions. Now, the main goal is to be ready to leave the business. The board, which is usually made up of the financial sponsor’s representatives, independent directors, and key management staff, needs to change from a steering group for growth to a dedicated oversight body for a complicated transaction. Because of this change, the company needs to be open and honest about how mature it is, how it positions itself in the market, and whether it is ready for tough due diligence from potential buyers or public markets.
One important part of governing is either creating a separate Exit Committee or making it clear what the current board’s duties are when it comes to exits. This committee, which oversees the hiring of advisors like investment banks, lawyers, and accounting firms, is like the brains of the sale process. It gives strategic advice on the possible ways out, like a trade sale, a secondary buy-out, or an initial public offering (IPO). The governance system needs to make sure that all possible conflicts of interest are found and dealt with. This is especially important when it comes to management incentives and different shareholders’ deadlines. For a high-pressure sales process to stay on track and stay honest, communication between the board, the financial backer, and management must be clear at all times.
Two Requirements for Management
The top management team of the portfolio company has a lot of work to do to make sure that exit governance works well. They are expected to keep their full attention on day-to-day activities and meeting key performance indicators (KPIs) to keep the business moving forward, while also spending a lot of time and money getting the business ready to sell. This dual mandate is naturally hard, and the board needs to give clear direction and support. Ned Capital are a leader in governance for PE, visit their website to fond out more.
The governance system must give the management team the tools, data, and protection against process fatigue they need to do their job. This includes putting together a Data Room planning team whose job it is to gather and check all the operational, financial, and legal paperwork that a buyer will look at. At this point, a governance failure like missing or inconsistent data can make buyers lose faith, which can cause big delays or a drop in the final deal price.
Also, the governance system needs to include the important part of giving managers incentives. Keeping employees and keeping them motivated are very important because losing key employees during the exit phase can be very bad for deal security. The board and the financial sponsor must carefully plan structured reward programs. These programs usually come in the form of exit bonuses or shares of the company that become fully paid for when the business is sold. These plans need to make sure that the selling shareholders’ interests are aligned with those of the management team. This way, the management team will be paid for both running the business well and making the deal go smoothly.
Clean-up of operations and finances
Good exit planning calls for a time of proactive operational and financial de-risking to happen long before the sale process starts. The board is responsible for making sure that the business is offered in the strongest and most transferable way possible. This means getting rid of any “skeletons”—possible liabilities, unresolved legal problems, or complicated, non-standard contracts—that a smart buyer might not want to buy.
In terms of money, the focus of government is on getting ready for Quality of Earnings (QoE). It’s not enough for the portfolio company’s financial reports to just be legal; they need to be fully ready for audit and carefully looked over by buyers. The board needs to make sure that add-backs—one-time or non-recurring costs that are put back to earnings to show the “true” profitability—are reasonable, well-documented, and safe. Add-backs that are too aggressive or not backed up are a common source of disagreement and can hurt trust during due diligence. As part of good governance, the seller’s QoE report must be reviewed first by a vendor due diligence (VDD) team, which is supervised by the board. This gives a clear, unbiased picture of the business’s finances, making the process much more efficient and lowering the lack of information.
Maintaining the exit route and the integrity of the process
Another important decision that exit governance makes is which exit method to use. This could be a competitive auction, a strategic bilateral sale, or an IPO. Each route needs a different set of plans and board control. Setting up Sarbanes-Oxley compliance at the public business level and hiring non-executive directors with experience in the public market are two things that must be done before an IPO. In a competitive trade sale, the board has to carefully control how much information is given to different bidders. This keeps the playing field fair and protects confidential information.
The board is in charge of making sure the process is honest no matter what path is picked. This includes setting the reserve prices, accepting the short list of bidders, and, most importantly, telling the shareholders what they should do. During this time, the board has to balance its duty to increase shareholder value with its responsibility to make sure the business stays open and profitable.
The goal of good exit governance is to make sure that the deal goes smoothly and maximises value. It needs foresight, discipline, and a change in the way the board and managers think. The governance framework turns the naturally complicated process of a private equity divestment into a managed, successful, and profitable last chapter of ownership. It does this by setting clear roles and responsibilities, controlling the flow of information, aggressively lowering the business’s risk, and making sure that everyone has the same goals.