Exit routes, continuation vehicles and dividend recaps

Key takeaways

• A trade sale or secondary buyout delivers all the proceeds at once; an IPO usually delivers them in tranches over a year or more because of lock ups and the size the market can absorb.
• In the Northgate example, an IPO sell down returns 3.07x but at a 27.2 percent IRR, while a full sale at the IPO value in year 4 returns 3.00x at 31.6 percent.
• In a continuation vehicle, existing LPs choose to sell at the agreed price or roll into the new vehicle; a fairness opinion and an independent lead buyer are the main protections against a conflicted price.
• A dividend recap moves the Northgate deal DPI from 0.00x to 0.39x and raises IRR from 20.1 to 21.2 percent, while MOIC falls from 2.50x to 2.44x because of fees and extra interest.
• IRR rewards early cash and MOIC rewards total cash, so the same exit can look better on one and worse on the other; LPs should read both alongside DPI.

The main exit routes

A trade sale is a sale to a strategic buyer, a company in the same or an adjacent industry. Strategics can often pay the highest price because they can extract synergies the sponsor cannot, and they pay in cash at closing, so the sponsor gets a clean, complete exit. The downsides are a smaller pool of buyers, antitrust review and the risk that a strategic walks away late in the process.

A secondary buyout is a sale to another private equity sponsor. It is the most common exit in mid market private equity. The new sponsor will finance the deal with fresh debt and needs its own value creation plan, so the price is set by what that sponsor can earn from the next stage: the selling sponsor has to leave something on the table for the buyer's plan to work.

An initial public offering lists the company's shares on a stock exchange. It can achieve a high valuation for a large, growing business and lets the sponsor keep upside, but it rarely delivers a full exit. The sponsor typically sells only a part of its stake in the offering and is then locked up, usually for 180 days, before it can sell more. The remaining stake is sold in follow on offerings or block trades, each at a discount to the market price and each exposed to the share price in the meantime.

IPOs, lock ups and sell downs

Because an IPO spreads the sponsor's sale over time, the return depends on what the share price does between the listing and the final block. A rising price can produce a higher MOIC than a trade sale at the same headline value, but the later cash flows lower the IRR, and a falling price can wipe out the advantage entirely. Each block trade is sold at a discount, typically a few percent, to persuade institutional buyers to take a large amount of stock at once.

The worked example compares two ways out of Northgate Lab Supplies after four years. The sponsor invested $300.0m of equity at year 0. At year 4, the IPO values the sponsor's stake at $900.0m; a trade sale at the same value would return 3.00x immediately.

Continuation vehicles and GP led secondaries

A continuation vehicle is a new fund, managed by the same general partner, that buys one or a few assets from an older fund nearing the end of its life. The GP believes the asset has more value to create but the old fund has to return capital. Existing limited partners each choose: sell their share of the asset for cash at the agreed price, or roll their interest into the new vehicle and keep owning it. New secondary investors, led by one or more lead buyers, fund the cash for those who sell. Because the GP initiates it, this is called a GP led secondary.

The conflict is obvious: the GP is on both sides of the trade, setting a price at which its old fund sells and its new vehicle buys. The protections are a competitive process to find the lead buyer, a fairness opinion from an independent adviser stating that the price is fair to the selling fund, approval by the old fund's limited partner advisory committee, and a GP that rolls its own carried interest and commits new money to the vehicle. The new vehicle usually resets terms, with a fresh management fee and carry, often at lower rates and with carry tiered on achieving higher returns.

For a limited partner, the choice is a comparison between cash now and an expected, uncertain amount later. The worked example takes an LP with $50.0m of NAV in the asset.

Dividend recapitalisations

A dividend recap is not an exit. The company borrows new debt and pays the proceeds to its owners as a dividend, while the sponsor keeps control. It returns cash early, lifts DPI, and locks in part of the gain without selling. The cost is higher leverage, higher interest and fees, and less room for error if the business stumbles. Lenders allow it when EBITDA has grown since the original deal, so the business can carry more debt at the same multiple of earnings, and when credit markets are open.

Northgate Lab Supplies was bought for $600.0m, 10.0x EBITDA of $60.0m, with $300.0m of debt and $300.0m of sponsor equity. By the end of year 3, EBITDA has grown to $80.0m and net debt has fallen to $280.0m, 3.5x. The sponsor raises $120.0m of new debt, taking leverage to 5.0x, pays $4.0m of fees and distributes $116.0m. Without the recap, the plan is to sell at the end of year 5 at 10.0x EBITDA of $95.0m, with net debt of $200.0m.

How timing moves IRR against MOIC

Every exit choice above is partly a choice about time. IRR compounds, so a given multiple earned faster is worth more; MOIC ignores time entirely. A sponsor that sells at 2.0x after three years earns a 26.0 percent IRR. Holding three more years to reach 2.8x earns more money but only an 18.7 percent IRR. Which is better depends on who is asking: an LP that can redeploy cash at high returns prefers the IRR, while an LP that struggles to stay invested prefers the larger multiple.

Fund managers know their carried interest and their next fundraise depend on both, which creates incentives worth watching. Early partial exits and recaps raise IRR and DPI and help a GP raise its next fund. Holding assets longer, sometimes through continuation vehicles, can raise MOIC and fee income. Neither is wrong, but an LP should check which measure each decision improves and at what cost to the other.