Back to School: PE might be leaving value on the table

  • Almost 70 pct of PE firms don’t dedicate resources to exit processes
  • Almost half of GPs said last exit was either too early or too late
  • Processes could better prepare companies for turbulent economy

Private equity has been a rare bright spot for institutional investors starved for yield in recent years. But new survey data from Ernst & Young suggests general partners might be leaving value on the table through inefficient or poorly timed exit processes.

Some 47 percent of the GPs the consulting firm surveyed said their most recent exit was either too early or too late, which pared its ultimate value. The same survey of 100 PE executives found that more than 85 percent of PE firms don’t take a systemic approach to their exit process and almost 70 percent don’t consistently dedicate resources to evaluate exit opportunities.

“I live in the PE community, so none of the themes [the survey highlighted] really surprised me,” said Bill Stoffel, US private equity leader for Ernst & Young LLP. “But the numbers surprised me more than anything else.”

“A lot of times, the divestitures will happen when there’s an inbound offer,” Stoffel said. Firms would benefit by spending more time and resources preparing their portfolio companies for exit, particularly in preparing the deals’ tax structures, which “really takes 18 months. That’s not a six-month process.”

Most of the firms that lack dedicated resources for preparing portfolio companies for exit are small or mid-market, Stoffel said. As a result, many of those firms rely on third-party service providers to build runways for eventual exits. This could involve notifying executives of their roles in a sales process or establishing data to support the narrative that establishes the company’s value.

“The information dissemination is much more organic in the smaller funds, so you don’t need as many of these processes in place,” he said, noting that smaller firms have smaller teams, effectively easing the portfolio-review process. “Their Monday morning meetings are all of their partners at the table,” Stoffel said.

According to EY, exits may be complicated in the near term by uncertainty about tax reform, to say nothing of geopolitical risks in Asia, the Middle East and Europe. Firms will need to respond with “more rigorous portfolio reviews, investments in analytics to make better exit decisions and more time spent on exit planning,” the report says.

Portfolio managers appear caught in a catch-22, however, according to the survey. One of the primary reasons firms don’t prolong the process of preparing a portfolio company for exit is fear of damaging the business. Employees and customers may lose confidence if they learn their company might be for sale, which could hurt the company’s value.

“The overarching kind of concept here is it’s an evolution,” Stoffel said. “The competition, and the amount of people chasing deals, has increased significantly. The levels of dry powder are higher than they’ve ever been. … How do you squeeze out the most value of your investments?”

Action Item: More on Ernst & Young: