Buyout firms selling minority stakes, offering shares on private exchanges, and outright going public gain competitive advantages over those that don’t.
Tradable shares, for example, become currency with which to reward staff, or to deploy to make acquisitions—much as
But it takes a lot of time to make liquidity events happen. Michael Wolitzer and Joshua Bonnie, partners at Simpson Thacher & Bartlett LLP, said in a joint interview that if you want to act opportunistically—should, say, a limited partner show fleeting interest in giving you a pile of money for a stake in your firm—best to start preparing now.
The reason becomes clear when you put yourself in the shoes of prospective institutional investors. Devotees of simplicity, they’re going to want to take a stake in a single entity, not a series of them. They’re also going to want to hold the same form of equity—pari passu in legal phraseology—that other owners do. True, a single minority shareholder can tolerate more complexity than shareholders in a public company. But the organizational charts of many buyout firms would rival the Rockefeller family tree for density of boxes and connecting lines.
Consider that every limited partnership managed by a buyout firm has its own general partner; that the general partner may or may not be the same entity as the management company; and that each limited partnership may have a different management company. Further, each of these entities can have different ownership structures. Organizing things this way ensures that management fees, carried interest and other fee income flow to partners in the fairest and most tax-efficient fashion. But Wolitzer and Bonnie describe these structures as “amalgamations” that need to be at least partially “rolled up” into singularities to pave the way for liquidity events.
Buyout firms contemplating such roll-ups face hard questions. What income streams and assets should be placed in the partnership or company whose shares are being sold? How should shares in that entity be distributed among insiders? What allocation should be held in reserve? What value do the shares have? Does the distribution of those shares have tax consequences for partners?
Such questions take time and negotiation to answer. And, needless to say, partners need to assuage their limited partners when modifying the structure and ownership of their firm. Starting early also addresses a more practical consideration. Waiting until just before a liquidity event may create a bigger tax bill for partners receiving equity in the rolled-up entity, especially those receiving equity for the first time. Once an offer is made, or an IPO is imminent, it’s tougher to argue that the valuation should be based on, say, book value.
One other reason to start early: Just like limited partners in funds, shareholders acquiring stakes in your firm will want to make sure that you have a succession plan in place for any key people past a certain age. They may even have less tolerance for uncertainty than limited partners, depending on how long they plan to hold the investment. Again, you won’t want to wait until the last minute to grapple with that elephant in the closet.
More than a half dozen buyout shops have sold minority stakes, or sold shares on public or private exchanges. The latest, as of press time, was
In other words, some buyout firms have already absorbed the advice to start early.