Best of LinkedIn: Private Equity: Exit Strategies CW 42/ 43

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

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00:00:19: And today we are looking at something that is basically dominating conversation across industry right now.

00:00:24: Yeah We're taking a deep dive into absolute top trends in PE exit strategy because Honestly, the old playbook it's completely broken.

00:00:33: It really is.

00:00:34: I mean if you manage a portfolio today You are feeling this friction in every single board meeting.

00:00:39: just to set the stage for you We're currently looking at roughly thirty two thousand private equity backed companies sitting unsold.

00:00:47: Wow Thirty-two thousand.

00:00:49: Yeah, thirty two thousand.

00:00:50: and if you aggregate that You're looking at three point eight trillion dollars in value.

00:00:55: That is just trapped.

00:00:56: It's a massive systemic traffic jam At the exit door.

00:01:00: it's staggering And you know The scale of that backlog Is forcing everyone to fundamentally rethink what hold period even means right.

00:01:07: like If you look at the Bain data this going around average holds are now pushing past seven years.

00:01:12: Seven years I mean the instinct across the market is just to blame this entirely on the interest rate environment, right?

00:01:18: Yeah exactly.

00:01:19: The assumption is just oh debt got expensive so the M&A engine stalled.

00:01:23: but Wayne Markowski actually makes us really compelling argument that the root cause traces back to fund economics not twenty nineteen

00:01:32: to twenty-twenty one.

00:01:37: Right because performance was attracting massive amounts of capital and LPs were just rewarding scale.

00:01:44: so funds got bigger which meant they had put more capital to work at a much faster pace.

00:01:48: yeah, when you combine that intense deployment mandate with incredibly cheap credit it's structurally forced entry multiples to twelve X or even higher Which

00:01:57: is just wild

00:01:58: It Is.

00:01:59: The system basically incentivized GPs to prioritize velocity over discipline

00:02:05: Totally.

00:02:05: The underwriting models just assume the exit window would always remain wide open, you know?

00:02:10: Like they could just flip assets to the next buyer in this seamless chain.

00:02:14: But now that those vintage buyouts are stuck on the balance sheet it completely alters the operational reality for the underlying companies.

00:02:21: Mark Janssen highlighted this perfectly.

00:02:23: Oh yeah his post was fascinating.

00:02:24: Right, he points out that the old playbook for platform leadership is just defunct now.

00:02:29: His argument in a standard three-year sprint?

00:02:32: A sponsor can essentially fake operational excellence.

00:02:36: Yeah you ride multiple expansion

00:02:38: Exactly!

00:02:38: You ride the multiple.

00:02:39: maybe you bolt on a few acquisitions slash some SGNA and you just sprint to a recap before core engine actually blows up.

00:02:47: But when that hold stretches past six years The cracks really start to show Oh...the

00:02:52: wheels come off.

00:02:53: The unintegrated ERP systems, the mismatched cultures.

00:02:56: The neglected cat-backs.

00:02:57: it all catches up with you

00:02:59: Because by year four All of low hanging fruit on the cost side has already been harvested.

00:03:03: And your five You start seeing critical talent attrition The equity narrative that promise everyone is just twelve months away from a life changing liquidity event.

00:03:14: It stops holding water!

00:03:15: You literally cannot motivate management team With an exit horizon That constantly recedes.

00:03:22: It's essentially like holding your breath underwater.

00:03:24: That is

00:03:25: a good way to put

00:03:25: it!

00:03:25: You can fake for three years, right?

00:03:27: Maybe impress the LP advisory committee.

00:03:30: but as six or seven-year hold you need actual scuba gear.

00:03:34: Yeah...you

00:03:34: really do.

00:03:35: You just can't rely on financial engineering to bail out a stagnant top line anymore.

00:03:43: Which is reflected perfectly in the data Vaishnavikaram Reddy shared from Apollo.

00:03:48: Oh, The Value Creation Breakdown?

00:03:49: Exactly!

00:03:50: If you look at where value creation is actually coming from and current exits, seventy-five percent is driven by pure revenue growth Wow.

00:03:58: And only eight percent is coming for multiple expansion.

00:04:00: That is

00:04:00: just a staggering inversion from the Zerp era.

00:04:04: The market is no longer going to subsidize a lack of organic growth?

00:04:07: No, not at all.

00:04:09: And if you're sitting on a board demanding that pivot From financial engineering To operational heavy lifting You are seeing massive human toll.

00:04:17: On the executive suite.

00:04:19: Jafford de Becheme pulled some data from Alex's partners That really highlights this.

00:04:23: The CEO turnover stat, right?

00:04:25: Yeah.

00:04:25: Sixty-five percent of funds end up replacing the CEO during the hold period.

00:04:30: It's brutal!

00:04:31: But he argues that high failure rate stems from impossible contradictory mandates handed down by the board.

00:04:37: How so?

00:04:38: Well think about it...the investment committee is demanding accelerated top line growth to justify this prolonged hold.

00:04:44: but at the same time the banking syndicate is enforcing strict covenants requiring cash preservation.

00:04:51: Right.

00:04:51: And meanwhile, the original founder is fighting to maintain the culture.

00:04:55: so the CEO's just trapped in a structural crossfire

00:04:58: and that burnout extends straight to the finance function too.

00:05:01: John Louis noted that portfolio CFOs currently have an average tenure of two-and-a-half years.

00:05:06: Two

00:05:07: and half years?

00:05:08: So on seven year hold

00:05:10: you're cycling through three different financial leaders for single investment.

00:05:13: every transition just bleeds momentum.

00:05:16: Robert Friedman actually addresses this specific friction particularly for distressed or underperforming portcodes.

00:05:23: What's his take?

00:05:24: He says the classic GP mistake is hunting for this unicorn CFO, like someone who can act as a ruthless firefighter to stabilize a distressed asset and then seamlessly pivot into a visionary growth-CFO to prep for an exit

00:05:41: Right which I mean that profile rarely exists.

00:05:44: exactly.

00:05:45: so he solution is A really race approach.

00:05:48: okay I like that.

00:05:49: You hire a specialized turnaround CFO whose entire mandate is putting out the fire, stabilizing liquidity and enforcing rigorous financial controls

00:05:58: Stopping the pleading Right

00:05:59: And then once foundation secure you deliberately hand baton to growth oriented CFO.

00:06:06: someone who specific muscles are geared toward scaling operations running complex exit process

00:06:12: Because expecting one person to sustain both modes over a grueling seven-year hold is driving that massive turnover we are seeing.

00:06:20: Exactly!

00:06:21: So if the underlying operations are grinding through this extended hold and traditional M&A exit door is bottlenecked, LPs still knocking on doors demanding distributions right?

00:06:31: Oh they definitely do so.

00:06:32: GPs have to artificially manufacture liquidity.

00:06:34: They have to defend their IRR and prep for their next fundraise.

00:06:38: This brings us the surge in DPI trades.

00:06:40: Right, distributing pating capital without relinquishing control?

00:06:44: Exactly!

00:06:45: Jetson pointed out a major uptick in GPs selling minority stakes to hybrid capital providers like we saw Apollo inject two billion dollars into Apex and Blackstone put four hundred million euros into Group Premium.

00:06:56: Yeah you sell off twenty percent.

00:06:58: return that cash to your LPs to quiet the noise And keep control of an asset You want to compound further.

00:07:03: But Johnson also brings up a critical structural debate about the cost of that capital.

00:07:08: Selling minority equity stake is permanent dilution,

00:07:11: right?

00:07:11: And he argues that nav loans net asset value loans might offer a far more efficient lever for generating distributions.

00:07:18: Yeah because with an av loan you can secure low double digit pricing avoid giving up any equity upside and maintain complete optionality over the exit timing.

00:07:28: But I mean, i would push back a little on the risk profile there.

00:07:31: Yeah because with a nav loan you're frequently cross-collateralizing The performing assets in your fund to support a dividend recap across the broader portfolio.

00:07:39: That's true.

00:07:40: if valuations take a systemic hit that Cross collateralization introduces A massive contagion risk that a clean minority equity sale just avoids.

00:07:49: and that is the Exact attention investment committees are wrestling With?

00:07:53: Are You willing To introduce Fund level leverage to avoid asset Level dilution?

00:07:58: Exactly.

00:07:59: And if neither of those tools fits the mandate, GPs are aggressively pivoting to continuation vehicles.

00:08:04: Nicole Eppdorf highlighted the sheer scale of this market.

00:08:08: It's gotten huge

00:08:09: it really has.

00:08:09: there have been twenty nine CV exits over a hundred million dollars This year alone.

00:08:15: that's thirty three billion dollars in total deal value.

00:08:18: Yeah, Teddy Mogar shared a textbook example of this with Keyhaven.

00:08:22: They closed a one hundred million euro CV for Novation Tech.

00:08:25: Right.

00:08:26: What's interesting there is they executed the CV after already growing EBITDA by seven times!

00:08:31: They had clear winner.

00:08:32: but original fun life was expiring.

00:08:34: So a CV just lets them cash out the LPs who need liquidity?

00:08:38: Yep Reset the clock to new secondary capital and keep writing the compounding growth of proven asset.

00:08:44: It smart

00:08:45: Really smart.

00:08:46: Quick pause here.

00:08:46: If you are finding this breakdown of private markets valuable and want to stay ahead Of these structural shifts take a second to subscribe To the deep dive.

00:08:54: we have a lot more ground-to-cover on how these vehicles Are evolving.

00:08:57: yeah, an expanding on that evolution.

00:08:59: The continuation concept isn't even restricted equity biots anymore.

00:09:04: It's rapidly bleeding into private credit.

00:09:06: all right.

00:09:06: so nolly mahani pointed That out.

00:09:08: yes she noted that blackstone recently raised roughly one billion dollars for a credit CV Anchored by Allianz Global Investors.

00:09:16: The mechanics of a credit CV are so fascinating because you Are solving for a completely different problem.

00:09:22: in an equity CV You want to hold on to a winner, right?

00:09:25: But private credit your dealing with mismatched maturity walls like you might have originated A portfolio of five-year term loans but Because the M&A market stalled Your borrowers are delaying refinancing.

00:09:37: Yeah And if your credit fund has a strict life cycle and LPs one out at year seven you're stuck holding performing paper that just hasn't paid off yet.

00:09:45: So instead of forcing a distressed sale those loans into an illiquid secondary market, the manager transfers the entire loan portfolio in to new vehicle backed by secondary investors?

00:09:56: Exactly!

00:09:57: The existing LPs get their par-value distributions and the new investors acquire seasoned portfolio yielding cash flows.

00:10:05: But underwriting requires completely different lens doesn't it?

00:10:09: Oh totally You're not modeling future revenue multiples.

00:10:13: Your stress-testing debt service coverage ratios and default probabilities under a prolonged high rate environment,

00:10:20: makes sense.

00:10:21: While we were looking at debt mechanisms Liam Collier Moore shared this massive data point for Moody's on traditional dividend recaps.

00:10:28: right the recap room in MEAA.

00:10:30: Yeah moody's estimates there is forty one billion euros of recap room across me AA buyout companies before that additional leverage Actually threatens their credit ratings.

00:10:41: I mean it sounds like this massive liquidity reservoir.

00:10:44: It does

00:10:45: but Benjamin force here built a mathematical model that exposes the brutal reality of actually using that runway.

00:10:51: Oh, The math avoiding.

00:10:53: yeah

00:10:54: if a GP decides to load up an asset with recap debt just to postpone and exit And wait for better multiple.

00:11:00: they're racing against the ticking clock of interest expense and compounding LP hurdle rates

00:11:05: and his math is incredibly unforgiving.

00:11:07: he really is Using a baseline LBO with say, twenty million in EBITDA and the Nine X multiple.

00:11:13: He calculated that minimum operational growth required to justify delaying an exit by just one year.

00:11:19: Right.

00:11:20: Factoring into cost of debt cash conversion standard LP risk version you need guaranteed expected EBITTA growth at least seven point-one percent.

00:11:30: just break even on decision to wait

00:11:32: Just Break Even.

00:11:34: So if you miss that seven point one percent hurdle The frictional costs of holding the asset, debt service and management fees.

00:11:43: It all actively destroys value for your LPs compared to simply taking a lower multiple today.

00:11:48: Exactly!

00:11:49: Waiting is not a neutral position.

00:11:52: it's an aggressively expensive active decision.

00:11:55: So if math dictates that you can no longer afford to wait And finally bring this asset market You are stepping into incredibly adversarial diligence environment.

00:12:05: Oh, buyers are tearing apart the quality of earnings right now.

00:12:08: Yeah and Chandan Mahajan highlighted a new dynamic that is quietly cratering exit multiples

00:12:15: The AI Penalty.

00:12:16: This

00:12:16: is huge.

00:12:17: He points out that diligence teams are drawing a hard line between owning AI capabilities And renting them.

00:12:22: Right

00:12:23: If a portfolio company has integrated AI by simply renting tokens via an API from OpenAI or Anthropic That acts as permanent scaling operational cost.

00:12:33: And the valuation impact there is brutal.

00:12:35: because if you're targeting, say a fifteen X exit multiple and your diligence reveals of one million dollar annual run rate for API token rentals.

00:12:45: The buyer Is going to capitalize that expense?

00:12:47: Yeah they just stripped fifty million dollars straight off Your enterprise value.

00:12:51: exactly.

00:12:52: Diligence teams are walking into management presentations asking Are we acquiring a proprietary technological moat or are We Just assuming liability For your expensive software rental agreement?

00:13:02: Exactly.

00:13:04: But conversely, Kristoff Torter illustrated how you can engineer massive valuation premiums through the structure of your revenue

00:13:11: The underground contractors example?

00:13:13: Yeah

00:13:13: it's such a great model.

00:13:14: So if we have highly fragmented market You could look at two different companies operating in same geography with identical equipment Both generating exactly to million dollars and EBITDA.

00:13:23: Okay

00:13:24: but one clears the marketed eight million while other commands twelve million

00:13:28: A fifty percent premium on identical profitability.

00:13:31: Right

00:13:32: And Totter notes, this is entirely driven by master service agreements.

00:13:37: The buyer paying twelve million dollars isn't buying today's profit.

00:13:40: they're buying the contractual certainty that the revenue will recur tomorrow without the company having to continuously bid for project work.

00:13:48: Right.

00:13:49: So once recurring revenue crosses a specific threshold maybe twenty five percent of total mix then multiple functionally decouples from base earnings

00:13:58: It all comes down to de-risking forward projections.

00:14:02: And Nick Bradley pointed out that founders and GPs routinely leave millions on the table by failing to de-risk the basic operational plumbing before the exit.

00:14:11: Yeah, he calls it The Hundred Day List phenomenon.

00:14:14: That's

00:14:14: such a painful psychological trap.

00:14:16: It really is.

00:14:17: A founder or management team gets exhausted at end of hold period.

00:14:22: They know there are cash leaks, messy data silos, stalled sales initiatives.

00:14:26: But they just figure the new buyer will deal with.

00:14:29: But Bradley points out that the cheapest asset a private equity buyer acquires is the list of problems the seller was too tired to fix.

00:14:36: Yep, The buyers diligence team scopes out those exact inefficiencies, deducts the cost of fixing them from purchase price executes the turnaround in first one hundred days post close and pockets one-hundred percent resulting margin expansion.

00:14:50: So if you're not aggressively auditing an optimizing your own operations in twelve months prior you were voluntarily donating your exit multiple to the next sponsor.

00:15:00: Wow,

00:15:01: and navigating who that next sponsor even is has become incredibly complex.

00:15:06: Aaron Nasbit highlighted a structural shift in the buyer universe

00:15:09: right?

00:15:10: The valuation gap between private equity and strategic corporate buyers is aggressively narrowing.

00:15:15: historically if a GP wanted top dollar they ran a process tailored for other financial sponsors because PE could utilize cheap leverage to outbid cautious strategics.

00:15:25: But Nasbit notes the current media multiples for PE are sitting around eleven point five x evita, while strategics have crept up to eight point nine X.

00:15:33: but The headline multiple is essentially a mirage in this environment right?

00:15:37: nasbit argues you have to look at the actual deal structure.

00:15:40: yeah

00:15:40: exactly A private equity firm might offer you a ten-X multiple... ...but the term sheet requires you to roll over twenty percent of your equity.

00:15:48: carry a massive seller note and accept PIK interest

00:15:52: Right.

00:15:53: Whereas a strategic buyer might bid eight point five X, but they're funding it from their own corporate balance sheet with all cash at close.

00:16:01: Strategics are pricing the asset based on internal synergies not leveraged IRR model.

00:16:07: They don't have to survive a panicked credit committee.

00:16:10: So in a constrained financing market that lower strategic bid often delivers a significantly higher immediate cash-on-cash return To the LPs than heavily structured PE paper.

00:16:21: It really shows how wild the extremes of The Exit Universe have gotten.

00:16:24: On one end of the spectrum, Gary Lu detailed Apollo's move to invest two point six billion dollars into New York Yankees at its well-billion dollar valuation.

00:16:33: Yeah treating premium sports franchises as the ultimate infrastructure play

00:16:38: Exactly!

00:16:38: You have absolute scarcity deeply entrenched recurring revenue from media rights, bulletproof stadium economics.

00:16:45: But then you flip to the other extreme and public markets are ruthlessly punishing assets that rely on narrative over fundamentals.

00:16:53: John L brought up The Spectacular Failure of Firmus...

00:16:57: Yeah,

00:16:58: they attempted a five billion dollar IPO.

00:17:01: They're targeting this massive valuation premium but they only had two actually operating data centers

00:17:06: Only Two?

00:17:08: The vast majority of their projected capacity and like ninety-seven percent of their contracted revenue was sitting on unbuilt, unenergized floors.

00:17:15: Oh wow.

00:17:16: So the public markets essentially looked at the prospectus And said we are pricing as heavy industrial concrete risk not as a hyper scale software platform.

00:17:25: The liquidity window for narrative-driven infrastructure is just slam shut.

00:17:29: Institutional buyers demand energized power and hard assets.

00:17:33: So we have a market completely bifurcated between premium hard assets commanding massive multiples, And A three point eight trillion dollar backlog of average companies struggling to find a buyer without heavily structured concessions.

00:17:46: Which leads you rather unsettling systemic question For you to mull

00:17:49: over.

00:17:50: If the traditional mechanisms Of price discovery are jammed How do we actually know what that backlog is worth?

00:17:57: I mean the industry relies on the GPs internal marks, but the transparency there is getting heavily scrutinized.

00:18:03: Yeah and LPs frequently try to audit those internal marks by looking at pricing in the secondary market.

00:18:08: however Mustafa Siddiqui warns that relying on Secondary Pricing Is Fundamentally Flawed.

00:18:13: Why's That?

00:18:14: Because secondary buyers often lack The Time or Access To Do Bottom-Up Asset Level Diligence On A Portfolio Of Fifty Companies.

00:18:22: Instead, they price the portfolio top-down based on the GP's historical brand reputation and broad sector trends.

00:18:29: Siddiqui knows this methodology routinely results in secondary markets' min pricing assets by twenty to thirty percent.

00:18:35: neither

00:18:36: direction.".

00:18:36: Wow!

00:18:37: So The Secondary Market is essentially acting as a blunt instrument not precision lie detector for primary marks?

00:18:44: Exactly

00:18:45: And Evan Clark shared research from edHEC that should give any LP pause.

00:18:51: Historically, exits cleared at a median of nineteen percent above their reported carrying values but since twenty-twenty two the share value actually realized through exits has halved and those historical valuation uplifts have

00:19:05: plummeted.".

00:19:06: And the most concerning data point from EdHEC is that assets held beyond seven years which remember as now the industry average they show very limited to zero uplift.

00:19:17: The longer the asset sits on the balance sheet, the less likely that the GP is to actually realize a premium over-the-mark value.

00:19:23: Man... If the exit event is only in contravertible measure of performance and that window is barely cracked open it casts a long shadow over the validity of those trillion dollar valuations!

00:19:33: The market is just operating on faith that operational scuba gear will hold out for enough time before the M&A engine to restart.

00:19:41: Yeah… It's a tense waiting game.

00:19:44: If you enjoyed this episode, new episodes drop every two weeks.

00:19:47: Also check out our other editions on PE Value Creation Private Equity Fundraising Venture Capital M&A and Strategy & Consulting.

00:19:55: Thanks

00:19:56: for joining the deep dive today.

00:19:57: Keep questioning the models And we'll see ya next time.