Best of LinkedIn: Private Equity: Exit Strategies CW 40/ 41

00:00:00: Provided by Thomas Allgaier and Freeness, based on the most relevant LinkedIn posts about private equity exit strategies insights in calendar weeks.

00:00:07: forty-and-forty one.

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00:00:17: Right.

00:00:17: so just a set expectations right off bat.

00:00:19: Today's deep dive is laser focused on top Private Equity Exit Strategy trends across Linkedin.

00:00:25: Yeah big ones

00:00:26: Exactly.

00:00:26: Because for professionals navigating today's M&A landscape, I mean the playbook has fundamentally shifted.

00:00:32: It really has.

00:00:33: We are unpackaging the math The liquidity crunches and just harsh realities of modern deal-making.

00:00:38: And we really need to begin by examining the macro shift in how deals are underwritten Today.

00:00:43: Right because honestly the disappearance of cheap debt is the domino that triggers every other exit strategy trained were going to discuss.

00:00:51: Oh absolutely!

00:00:52: The mathematical reality of private equity Is Just Changed Multiple expansion and, you know debt pay down.

00:00:59: They can no longer hide average operational performance.

00:01:02: No they really can't.

00:01:03: And Santy Thomas detailed the stark math facing large biots.

00:01:06: right now it is.

00:01:08: It's pretty wild to look at

00:01:09: what are the numbers?

00:01:10: Look like

00:01:11: well imagine a twenty billion dollar fund if its operating without leverage It would need its portfolio companies to grow EBITDA at seventeen percent annually.

00:01:20: wait

00:01:20: What yeah

00:01:21: Seventeen percent a year for five years straight just to hit a two X net return.

00:01:25: Hold it, let me push back on that because expecting seventeen percent annual EBITDA growth across an entire portfolio.

00:01:32: That is like expecting a mature oak tree to grow at the speed of bamboo?

00:01:36: It's

00:01:39: just not realistic.

00:01:40: I mean Thomas notes that historically only about one in eight large companies ever achieve a fifteen percent growth rate.

00:01:47: so seventeen is just well.

00:01:49: it's a pipe dream for an entire

00:01:51: which is exactly why leverage isn't doing the heavy lifting anymore.

00:01:55: Christopher Jay Conti brought some fascinating data into this, median equity checks have actually hit a ten-year high of seven point five X EBITDA.

00:02:03: Wow!

00:02:04: Seven point five x that is a massive amount of equity to put down

00:02:08: right.

00:02:09: so The thesis Isn't the capital structure any more?

00:02:12: That thesis Is basically just the management team.

00:02:15: you know it connects perfectly to Seth Marin's historical perspective on If you look back, the LBO booms of the nineteen eighties and mid-two thousands.

00:02:25: they ended in massive restructurings once that cheap debt vanished.

00:02:28: Oh right like some those legendary blow ups

00:02:31: Exactly Like RJ Arnabisco or TXU The debt goes away and suddenly whole house of cards just kinda comes down.

00:02:38: Yeah because hold.

00:02:39: periods are stretching out now And debt is so expensive.

00:02:43: Matt K had a really great tactical takeaway.

00:02:46: What was it?

00:02:47: Working capital efficiency is now totally central to value creation.

00:02:50: Oh, absolutely

00:02:51: I guess cash flows everything right?

00:02:52: Now exactly

00:02:54: i mean every dollar trapped in late receivables Is effectively borrowed at like ten percent or more.

00:02:59: it's just burning money At that point.

00:03:00: yeah you can't Just ignore a sloppy billing cycle anymore.

00:03:03: and since companies Can be easily flipped using That cheap debt Whole periods are extending, which leads directly to a massive bottleneck in returning cash to investors.

00:03:12: The liquidity crunch?

00:03:13: Exactly!

00:03:13: Yeah there is this growing really intense tension between paper valuations and actual cash returns.

00:03:20: right now

00:03:21: It's getting pretty severe.

00:03:22: Very Tom Cain pointed out that there isn't estimated four-to five trillion dollars in PE inventory.

00:03:28: Trillion

00:03:29: with a T Trillion

00:03:30: With A T. That's

00:03:30: insane.

00:03:31: it

00:03:32: represents around thirty five thousand unsold companies just

00:03:35: sitting here just strand it, which brings us to a great example from LDR Muratov.

00:03:40: Family office is really feeling this pinch.

00:03:42: Oh I bet

00:03:43: they're seeing reports of a fifteen percent IRR in this massive net asset.

00:03:47: value right looks

00:03:48: great.

00:03:48: on the spreadsheet look

00:03:49: fantastic.

00:03:50: but then we experience DPI distributions to payday and capital up.

00:03:54: just point one zero X.

00:03:57: oh man

00:03:58: yeah.

00:03:59: so when actually needs say thirty million dollars for new acquisition They realize that a fifteen percent return on paper is totally meaningless without an actual liquidity plan.

00:04:09: That's brutal, but you know even the general partners are feeling this squeeze.

00:04:13: Really?

00:04:14: GPs too!

00:04:15: Nicola Vukovic noted European PE executives increasingly taking out expensive

00:04:22: personal loans

00:04:23: against their unpaid carried interest

00:04:26: just to fund capital calls or secure day-to-day liquidity because exits aren't happening.

00:04:31: So they are basically taking out high interest payday loans against their own stuck performance bonuses.

00:04:36: Pretty much.

00:04:37: And it's wild!

00:04:39: I mean, historically dividend recapitalizations were the release valve for this exact kind of pressure.

00:04:44: Right you'd just borrow more against a company and payout the LPs

00:04:47: Exactly.

00:04:48: but Isaac T reports that recap volume actually fell fifty percent year over year through July due to elevated interest rates.

00:04:56: The math doesn't work right now.

00:04:58: But i do have question about When a sponsor actually does manage to pull off a dividend recap in this high-rate environment, who actually bears the risk?

00:05:06: That is The Million Dollar Question.

00:05:08: And Mitchell Ozak's analysis of rollups shed some light on it.

00:05:12: He cited the NBER which found that A typical dividend recap increases affirms debt by eighty four percent.

00:05:18: Eighty Four Yeah

00:05:19: Wow yeah and it spikes the probability of bankruptcy within six years By thirty one percent.

00:05:24: So they just saddle the company with debt and walk away

00:05:27: pretty much.

00:05:28: It often leaves the target shareholders holding the bag while this sponsor extracts cash.

00:05:32: That is a tough pill to swallow for founders!

00:05:35: By the way, if you're finding that deep dive into the mechanics of PE useful make sure to subscribe so catch all our future additions.

00:05:41: Absolutely

00:05:43: So.

00:05:43: with buyers being so incredibly picky and capital constrained how a company organizes its financials in technology long before sale dictates whether it can exit at all.

00:05:53: Yeah...you really have to re-architect everything.

00:05:56: Exit optionality isn't a strategy.

00:05:58: You can just pivot to in year four.

00:06:00: It's a fundamental architectural decision that has to be made on day

00:06:04: one.

00:06:04: Brad Wolf made an excellent point about this.

00:06:07: keeping multiple exit paths open is at its core purely A finance decision.

00:06:11: now how so

00:06:12: well.

00:06:12: strategic buyers want synergies, right?

00:06:15: They want mapped charts of accounts

00:06:16: sure for easy integration.

00:06:18: But financial sponsors they want unarguable working capital.

00:06:21: pigs and IPOs require heavily tested controls.

00:06:25: you can't fake that at the last minute.

00:06:27: Which perfectly reinforces what Natalie Townsend cited from an EY study, over sixty percent of PE firms view financial data and KPI readiness as their single biggest challenge heading into

00:06:47: And it highlights the danger of capital structure mismatches too.

00:06:51: Su-Yi Tan shared this crazy story about the firmest IPO collapse.

00:06:54: Oh, I saw that.

00:06:55: Yeah That was massive.

00:06:57: They tried to float on ASX at a valuation of forty four billion Australian dollars Billion But they only had forty six megawatts of live AI capacity and this massive unfunded capex pipeline.

00:07:10: So...they were trying price construction project like finish software product.

00:07:15: Exactly Public markets outright rejected pricing heavy infrastructure on high-margin SaaS multiples.

00:07:21: The market just said, no

00:07:23: I mean you can't just wave your hands and say AI to justify that kind of valuation anymore.

00:07:28: Though speaking of technology Chandan Mahajan argues that diligence teams must ask if a company owns or rents its AI.

00:07:36: Oh That's really interesting distinction.

00:07:38: It is

00:07:38: critical.

00:07:40: A one million dollar annual AI bill If You're Just Renting it actually reduces your exit valuation by fifteen million dollars at a fifteen X multiple.

00:07:48: That is the direct hit to the exit value,

00:07:51: though I'd

00:07:51: push back on that bit using Asif Rahman's logic.

00:07:54: Okay what's his take?

00:07:56: Even if you own the AI productivity doesn't automatically equal EBITDA.

00:08:00: Why not?

00:08:01: If you're working faster shouldn't margins go up?

00:08:03: You think so but if AI makes your engineers code twice as fast Your sales team doesn't magically sell twice as much.

00:08:10: Oh i see The bottleneck just moves Right.

00:08:12: Instead, your customer support queue just blows up because you're shipping so much code.

00:08:17: It's like putting a Ferrari engine in a golf cart!

00:08:20: I love that analogy...

00:08:21: Yeah the bottleneck just ships to the axles and they eventually snap.

00:08:24: You haven't actually made this business more profitable.

00:08:27: That makes total sense.

00:08:29: Having explored these strict demands of modern buyers we really need turn the lens to founders and target companies themselves.

00:08:35: The human element of all this.

00:08:37: Exactly Because navigating these intense PE environments is whole different ball game.

00:08:42: We have to look at sector-specific treadmills in preparation.

00:08:45: There is this realization now that, In many sectors a PE exit isn't the final destination.

00:08:50: What is it then?

00:08:51: It's just a ticket To another larger PE funds holding period.

00:08:56: I'm Jed Mahmoud had A staggering statistic on this.

00:08:59: Ninety seven point eight percent Of physician practice exits Simply sell to Another PE firm.

00:09:04: Almost ninety eight percent.

00:09:06: Yeah

00:09:07: It's a total mismatch of long-term healthcare assets being financed by short term, five year capital.

00:09:12: Just flips and flips

00:09:13: And this happens in Background Screening too.

00:09:15: Jason Morris pointed out that companies change hands four or five times.

00:09:20: Wow That sounds exhausting for the management team.

00:09:23: it is Every time there's closing dinner.

00:09:26: it resets strategy and delays integrations.

00:09:29: We just probably why Preston Alexander argues independent medical practices often out earn PE acquired ones.

00:09:35: Oh really?

00:09:36: How does the math on that work?

00:09:37: Well,

00:09:37: the rollover equity.

00:09:38: The founders have to take gets trapped in a stagnant secondary market.

00:09:42: if the company keeps getting flipped or delayed they never actually see that cash.

00:09:45: so there better off just staying independent and taking the cash flow.

00:09:48: often yes And Adam coffee brings up a great warning about survivorship bias here.

00:09:53: Oh people only looking at the winners

00:09:55: exactly Founders Only study the peers who successfully exited got that second bite of the apple.

00:10:01: They completely ignore the seventy three percent Who fail.

00:10:05: Seventy-three percent fail.

00:10:07: Yeah,

00:10:07: because they just weren't ready for the brutal reporting cadence and the hundred day playbook of a PE board.

00:10:13: Which is why Alexis Sikorsky's framing is so brilliant.

00:10:16: He says PE firms subject founders to a quote unquote six month colonoscopy Of diligence.

00:10:22: that

00:10:22: paints quite a picture.

00:10:23: it does but its true.

00:10:25: yet Founders rarely scrutinize The buyers who they will actually be reporting two four years.

00:10:30: They don't diligence the sponsor.

00:10:32: That's a massive mistake.

00:10:34: If you are taking their money, You need to know who is driving

00:10:37: the bus.

00:10:38: Absolutely

00:10:39: So.

00:10:39: To wrap things up I want to leave you with a final provocative thought to

00:10:43: mull over.

00:10:43: let's hear it.

00:10:44: if The ultimate exit for so many of these assets from health care practices to software companies It's just passing them to a larger private equity fund At what point does the private market definition?

00:10:55: Of an exit stop meaning a true realization of value and start meeting Just a routine refinancing event?

00:11:02: If you enjoyed this episode, new episodes drop every two weeks.

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00:11:15: Huge thanks for tuning into This Deep Dive.

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