8 minute read 19 May 2021
Colorful bird houses on tree trunk in forest

How private equity is refining exit strategies for stronger valuations

Authors
Andrew Wollaston

EY Global Reshaping Results, Restructuring and Strategy and Transactions Private Equity Leader

Seasoned financial advisor and restructuring professional who has been with EY for over 30 years. Proud father of three. Poor golfer. Lover of animals and the outdoors. Interested in family history.

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.

William (Bill) Stoffel

EY US Private Equity Leader

Transformation leader in private equity at Ernst & Young LLP. Loving husband and father to four teenagers. Avid history reader. College basketball fan.

Pete Witte

EY Global Private Equity Lead Analyst

Helping clients and stakeholders understand the trajectory and impact of vital trends. Developing thought leadership and insightful content. Aspiring platform tennis pro.

Charles Honnywill

EY UK&I Divestiture Advisory Services Leader

Transaction Partner. Experienced in complexity and international issues. Passionate about giving back to the community. Ex-rugby coach; now focused on charitable work.

Tim Dutterer

EY-Parthenon Head of Private Equity

Technology and private equity strategic advisor. Advocate for technology that improves life for people with disabilities.

Glenn Engler

EY-Parthenon Global Digital Leader, EY Americas Strategy and Transactions Digital Strategy Leader

Helping organizations shape their business strategy in a digital world. Relentlessly curious. Passionate board member. Husband. Father.

Gregory Schooley

EY US Value Creation Leader

Seasoned executive combining operational, M&A and strategy experience. Trusted advisor on critical business decisions. Passionate and proactive who values a healthy debate. Father and traveler.

Winna Brown

EY Americas Financial Accounting Advisory Services Private Equity Leader

Trusted advisor to fast-growing, transitional companies. Believes in what matters is who is with you for the ride. Family. Friends. Trusted Relationships.

8 minute read 19 May 2021

PE exit activity is returning with vigor after the dramatic, pandemic-induced capital markets slowdown in the first half of 2020.

In brief
  • Private equity leaders are considering tax, ESG, digitalization and working capital factors in their divestment of assets.
  • As the attractiveness and valuation of businesses shifts in a volatile period, PE exit volume is on the rise.

Half of private equity (PE) executives surveyed are planning exits to public markets through initial public offerings (IPOs) or special purpose acquisition companies (SPACs) in the next 18 to 24 months, according to the EY 2021 Global Private Equity Divestment Study.

PE exits jumped roughly 40% to nearly US$600b during the 12 months ending March 2021, with strength in IPO markets and sales to SPACs contributing to a spike in deal value and volume not seen in a decade, Dealogic data shows. That compares with US$426.7b in PE exits during the 12 months ending March 2020. As the pandemic’s immediate impact recedes, and its long-term effects on consumers, markets and geopolitical trends become clearer, PE firms’ transactions are likely to remain robust given their access to capital. PE, excluding venture capital funds, had approximately US$1.7t in dry powder as of 31 March 2021, according to Preqin.

2021 Global Private Equity Divestment Study PE exit destinations

The study reveals that digitalization of businesses’ operating models or routes to market has become a leading driver of higher deal valuation — more important than proven organic growth. But the study also shows working capital improvements, a traditional value driver, is still key.

Respondents to the survey reveal that PE priorities over the next 12 months are expected to be dominated by the need for accelerated exits. These will all be affected by the impact of the pandemic on the portfolio businesses themselves, their markets, M&A processes and investor appetite. Other changes are afoot, including greater relevance of environmental, social and governance (ESG) factors and tax concerns.

Factoring ESG into exits

As external concerns weigh on decisions in the near term, nearly three-quarters of PE firms (72%) say they expect to capture an ESG premium in businesses that they are considering exiting based on specific ESG qualities.

While social impact policy, including diversity and equality commitments, appears to be the area of greatest focus globally (57%) for PE firms seeking to capture an ESG premium in exits, the value attributed to ESG qualities at point of exit is evolving. Furthermore, PE firms say they are actively courting potential buyers with a strong ESG record to capture a premium. By region, 57% of Asia-Pacific PE firms indicate they are seeking a buyer with a strong ESG record; 50% in the Americas; and 41% in EMEA.

2021 Global PE Divestment Study where focusing efforts to capture ESG premium in exits

Driving value through digitalization

Digitalization of a business ranked as a critical component of the value story and divestment thesis in the last major exit for 52% of respondents. Arguably accelerated by the pandemic, digitalization is a key value driver that:

  • Impacts the operating model, cost base and break-even point for a business
  • Enables revenue growth through better customer service, pricing and margin
  • Allows new routes to market that expand the addressable customer base

The ability to harness and analyze data to improve automation, strengthen predictability and drive targeted improvement in supply chains, marketing, operations and other areas makes artificial intelligence (AI) an attractive area for M&A. More than half (51%) of PE firms regard AI as an important value lever for portfolio companies over the next 18 to 24 months. In addition to increased automation of processes and controls, AI can also support forecasting and decision-making that directly impact margin enhancement and cash conversion.

2021 Global PE Divestment Study portfolio companies focus areas to drive value

Many portfolio companies have learned to operate with an increasingly remote workforce. Among companies that rank security as a top priority, more than half (53%) say cybersecurity concerns are now acute, given the demands of cloud computing, connected devices and the remote workforce. 

Portfolio companies are already required to show how their cost profile and revenue growth prospects are likely to trend. Apart from digitalizing their operating models, our experience shows the highest performers are using data analytics to communicate the equity story to buyers. For 45% of PE firms with a primary focus on digital growth, digital analytics are the top priority for their portfolio companies’ digital development. Concurrently, they are investing in centralized data repositories, including data lakes, that enable them to bring insightful opportunities to portfolio companies to improve KPIs or change operating models.

Growing focus on tax

Tax is a big value driver on exit, and depending on an investor’s rate, tax can either contribute significantly to or sap returns.

Transfer pricing exposures on intercompany transactions ranked highest (41%) among tax items that affected exit value the most. Non-income tax exposures (28%) and income tax exposures (25%) also ranked among tax issues that can reduce value.

Conversely, certain tax planning may enhance the value of a portfolio company on exit. Adjusting tax planning and transfer pricing associated with changes to portfolio company supply chains has the most significant impact on how dispositions are structured, according to more than half (52%) of respondents. Delivering a step-up in the tax basis of assets (43%), efficient placement of bank and shareholder financing into a structure (38%), post-close restructuring (34%), and simply remediating or indemnifying tax exposures before a sale (33%) also rank as levers for tax-efficient dispositions.

2021 Global PE Divestment Study potential tax items most affecting exit value

Given the current political climate in the US, with anticipated tax increases that may influence other countries, two-thirds (65%) of PE leaders now expect changes in tax policy to impact the timing of their exits.

Working capital improvements on the agenda

The pandemic exposed some portfolio companies’ structural weaknesses and, according to 58% of respondents, required fast action to access capital. This included bridge loans and temporary credit facilities as markets and supply chains seized up. Also, 44% of PE firms reported a visibility gap in linking profits to cash flow.

Nearly a third (31%) of PE firms say improvements in working capital management and EBITDA cash conversion formed the basis for significant value on exit, ranking ahead of organic and inorganic growth and manufacturing cost improvements.

Successful exit preparation

63%

of PE firms rank working capital optimization among the top three factors of importance to their exit strategy.

Working capital optimization continues to take center stage in successful exit preparation. Nearly two-thirds of PE firms (63%) rank it among the top three factors of importance to their exit strategy. The focus on working capital is expected to continue in PE exits across sectors facing significant disruption, including entertainment, tourism and energy.

Improving value by refining exit strategies

When the right deal comes, moving fast may be as crucial as a well-developed and data-backed exit equity story for the business.

Nearly two-thirds (63%) of PE firms say they are opportunistic in terms of choosing their exit timing. However, most of the causes of value erosion point to the need for speed to execute the exit over the readiness of the business and its management.

2021 Global PE Divestment Study determining right time to sell


Forty percent of PE firms cite a lack of fully developed diligence materials, including product/service road maps, as a source of value erosion that leads buyers to reduce price. Other areas of negative impact on exit value include a high level of debt (36%), deteriorating performance (35%) and lack of time to manage the process with buyers (35%).

Conclusion

Significant short-term uncertainty and market volatility have changed the divestment landscape for PE owners. They are actively in a phase dominated by opportunistic exits while buyers seek out quality assets and capital markets are buoyant.

The pandemic effect is still playing out — both short and long term. It has accelerated changes in attitudes to factors that are now affecting the attractiveness and valuation of businesses — notably digitalization and ESG metrics. But traditional factors remain important, including tax and cash — they remain kings.

By continually refining and changing, PE firms have reacted fast to the pandemic and are now well positioned to build strong valuations and achieve exits that take advantage of the market conditions.

Summary

This annual survey of more than 100 private equity executives from around the world is conducted by Thought Leadership Consulting, a Euromoney Institutional Investor company. The survey gathers their perspectives on exit strategy, preparation and execution.

PE participant profile:

  • Results are based on an online survey of 106 global PE executives conducted between February and March 2021.
  • Nearly all (90%) of respondents are PE deal professionals, from firms across the Americas (38%), EMEA (32%) and Asia-Pacific (30%).
  • More than two-thirds (67%) of respondents’ firms have US$30b or more in assets under management (AUM).

About this article

Authors
Andrew Wollaston

EY Global Reshaping Results, Restructuring and Strategy and Transactions Private Equity Leader

Seasoned financial advisor and restructuring professional who has been with EY for over 30 years. Proud father of three. Poor golfer. Lover of animals and the outdoors. Interested in family history.

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.

William (Bill) Stoffel

EY US Private Equity Leader

Transformation leader in private equity at Ernst & Young LLP. Loving husband and father to four teenagers. Avid history reader. College basketball fan.

Pete Witte

EY Global Private Equity Lead Analyst

Helping clients and stakeholders understand the trajectory and impact of vital trends. Developing thought leadership and insightful content. Aspiring platform tennis pro.

Charles Honnywill

EY UK&I Divestiture Advisory Services Leader

Transaction Partner. Experienced in complexity and international issues. Passionate about giving back to the community. Ex-rugby coach; now focused on charitable work.

Tim Dutterer

EY-Parthenon Head of Private Equity

Technology and private equity strategic advisor. Advocate for technology that improves life for people with disabilities.

Glenn Engler

EY-Parthenon Global Digital Leader, EY Americas Strategy and Transactions Digital Strategy Leader

Helping organizations shape their business strategy in a digital world. Relentlessly curious. Passionate board member. Husband. Father.

Gregory Schooley

EY US Value Creation Leader

Seasoned executive combining operational, M&A and strategy experience. Trusted advisor on critical business decisions. Passionate and proactive who values a healthy debate. Father and traveler.

Winna Brown

EY Americas Financial Accounting Advisory Services Private Equity Leader

Trusted advisor to fast-growing, transitional companies. Believes in what matters is who is with you for the ride. Family. Friends. Trusted Relationships.