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Divesting for value: Divestiture in a private equity setting - EY - Global

Divesting for value

Divestiture in a private equity setting

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Recent trends in PE markets have resulted in fewer PE exits; consequently, more PE investments are aging within the portfolios.

Private equity firms focus on maximizing selling prices.

Key points:

  • Private equity portfolio companies face increasing competition for buyer attention
  • Pre-sale exit readiness processes can help unlock hidden value and mitigate potential exposures
  • Buyer expectations are evolving toward a thorough pre-sale preparation to facilitate a smooth transaction
  • A sell-side report helps demonstrate the value proposition and drive transaction efficiencies

Value to a PE buyer

Sell-side reports provided by the seller of the target business can enhance a transaction in various ways. The report typically provides the PE buyer with an in-depth overview of the business for sale, expanding on topics covered in the offering memorandum and management’s presentation.

The in-depth perspective on the business — when it comes at a relatively early stage in the transaction life cycle — can help both parties focus on the most important business issues. This approach can accelerate and streamline transaction- related activities.

Sell-side reports also:

  • Provide an independent view of normalized earnings to the PE buyer. This can reduce greatly the time and effort expended to arrive at quality of earnings adjustments that all sides readily agree upon.
  • Provide relevant assumptions, detailed calculations and related narratives. These give the prospective buyer the background and support for quality of earnings adjustments.
  • Offer the PE buyer a level of comfort around the company’s performance earlier in the transaction life cycle. This allows the PE buyer to make informed decisions and move more quickly through the transaction.
  • Serve as a resource for the PE buyer to learn important details about the target company’s operating environment. This includes general terms and conditions with customers and suppliers, significant accounting policies, the nature of operating systems and human resource- related data and issues.

Value to a PE seller

Recent trends in PE markets have resulted in fewer PE exits; consequently, more PE investments are aging within the portfolios. Given exit considerations to generate investor returns, we expect this backlog of portfolio companies will likely come to market soon.

The backlog, coupled with the volatility of M&A in general, will drive competition for buyer attention among PE portfolio companies. Portfolio companies will need to be well vetted and prepared for the transaction to facilitate a smooth exit from the PE portfolio while obtaining maximum value.

Preparation for sale

Each PE portfolio company’s specific circumstances will determine how much effort is needed to sell the business. However, before the sales process even begins, the owner should scrutinize each investment to enable maximum value prior to and upon exit.

Divested companies are typically sold with excess cash tied up in working capital that selling entities should be able to release. Before the exit, the seller should assess and document working capital requirements of the entity and identify opportunities for cash release.

Exit readiness: initial evaluation

It’s important to give the exit process just as much attention as an initial investment. To prepare, PE sellers should ask themselves and their portfolio company management teams targeted questions, such as:

  • What is for sale?
  • Who are the likely purchasers, and why?
  • Is the core value story credible?
  • How will the business operate post-close?
  • What are the value improvement opportunities and value erosion risks?
  • Is the financial information suitable and sufficiently robust for the sale process?
  • What are the tax issues relevant to the exit?
  • What are the HR issues relevant to the exit? Have significant benefit obligations (e.g., pensions, OPEBs, 280G costs) been identified and fully vetted?
  • What will be the key factors in an efficient disposal process?

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