The exit era: US private equity
HEADLINES

There has perhaps never been a better time to sell a portfolio company for US private equity (PE) firms. Since the beginning of 2013, the volume and value of buyout-backed exits has climbed sharply, allowing PE firms to exit businesses for high valuations and strong returns.

In Q2 2013, US PE firms sold 158 companies worth US$36.7 billion. By contrast, the second quarter of 2014 saw the industry reap 241 exits worth US$83.7 billion—an increase in value of 128 percent. Indeed, when compared with the asset class’s Q1 2009 performance, when only 76 exits worth US$5 billion closed, Q2 2014 value was 16 times higher. This demonstrates how strongly PE has rebounded since the credit crisis.
“Valuations and contract terms favor the selling sponsor in today’s market much more than over the past number of years. As a result, sponsor hold periods are shortening to take advantage of the favorable market,” says White & Case M&A partner Carolyn Vardi.
A number of factors are driving this dynamic. Stronger portfolio company performance, the return of well-funded strategic buyers to M&A markets, increasing competition between PE firms in the mid-market and readily available debt financing have combined to drive the strong run of exits.
Matthew Kautz, White & Case M&A partner, says many buyout firms that held onto portfolio companies through the downturn when deal activity and valuations slumped—are now bringing these assets to market.
“There were a number of portfolio companies that were unable to thrive during the period between 2008 and 2011, even though they didn’t really have any fundamental issues,” Kautz says. “PE firms, especially those in the mid-market, have seen performance spike up significantly since then. These companies are now primed for exit, and buyout firms are ready to sell.”
The return of cash-rich corporates to M&A markets has created an increased appetite for these PE-owned assets. According to figures from the US Federal Reserve, non-financial US businesses have been sitting on more than $1.8 trillion in liquid securities. 
And this year, corporates have started to invest these cash war chests, with PE portfolios being an important source of deals. 
PE firms sold 284 companies worth US$105.7 billion to corporates in H1 2014, up from 215 deals worth US$42.9 billion in H1 2013. 
“Corporates are back in the middle market. They have cash at their disposal, they are more confident in the economy and their shareholders want them to start growing their businesses again,” Vardi says.
Corporate buyers haven’t been the only game in town for sellers. An increasing number of PE firms are bidding for deals as well. There were 115 secondary buyouts (PE-to-PE deals) in H1 2014 worth US$41.5 billion, up from 79 exits to other PE firms worth US$8.1 billion in H1 2013. 
Cash piles up, bargains down
Buyout houses are being put off by optimistic valuations, yet increased capital is putting pressure on PE firms to spend.
Strong exit and debt markets have had an impact on new buyout deals. Last year saw the highest values for buyouts for the past five years, and this trend is set to continue with deal values for H1 2014 higher than any other half-yearly figure with the exception of 2013.
In terms of deal volumes, there were 400 PE buyouts (worth US$77.3 billion) in the first half of 2014—beating the 338 buyouts in H1 2013. The largest PE deal in the United States for 2014 so far saw the Blackstone Group purchase US-based engineering firm The Gates Corporation for US$5.4 billion from Canada’s Pension Plan Investment Board and Onex Corporation.
These continued high valuations are driving fears that competition is bidding up prices too much. “PE firms are doing very well from exits and it is good for the PE model to have debt markets that are functioning again, but it is a double-edged sword. Auctions are very competitive and there are concerns that valuations are too frothy,” says White & Case partner Oliver Brahmst.
Spending power, seller power According to Triago, a placement agent, the amount of unused capital available to PE firms globally is sitting at a record US$1 trillion. There is, therefore, a large amount of capital chasing a limited pool of deals, which is prompting increased competition between buyout houses. Larger PE firms dipping down into the mid-market, as corporates dominate megadeal activity, has also upped the ante. “There are more funds in the mid-market than there have been over the past number of years and fewer companies to go around. It is very competitive,” says Vardi.
Healthy debt markets (a record US$605 billion of leveraged loans were issued in the United States in 2013, according to Standard & Poor’s) have allowed buyout firms to bid aggressively for portfolio companies owned by rivals, which has also pushed valuations higher. Indeed, secondary buyouts made up a greater proportion of exits in H1 2014 than in H1 2013.
As a result of the increased competition, PE buyers are becoming increasingly aggressive in their attempts to prevail in auctions and secure deals. “We have seen a number of firms try to preempt auctions in order to secure deals. In auctions, firms will put in bids ahead of the timetable that are fully priced and on very good terms in order to shut down the process as much as possible because there are so many funds involved now,” Vardi says.
Terms of negotiation The strong exit market has placed sellers in a position of strength in negotiations, and deal terms have moved in to reflect this.
The increasing use of representations and warranty insurance, which protects parties from liabilities arising from inaccuracies in transaction documents, is one example of how deal negotiations are shifting. 
“We are seeing new ways of negotiating risk allocation. In the last year to 18 months, we have seen a huge uptick in the use of representations and warranty insurance by buyers and sellers,” Kautz says. “Sellers are suggesting buyers have the insurance in order to limit exposure once the deal has closed. Buyers are coming into auctions with insurance to negotiate lower caps on indemnity post-deal because they have the insurance in place.”
Even when representations and warranty insurance is not used, sellers are still in a position to negotiate attractive caps on post-closing indemnities on transactions. 
“The seller’s post-closing exposure is almost at an all-time low,” says Kautz. “Buyers are willing to live with low caps.”
Corporates and buyout firms still have large pools of capital to invest, but sellers will continue to benefit from high valuations and favorable deal terms. Given this environment, competition for good deals is likely to remain intense for some time to come.
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Private equity exit values reach highest level in last five years Exit volumes rise 55 percent from H1 2013 to H1 2014 Trade sales break US$100 billion mark in first half of 2014 Healthy debt markets balanced by concerns over high valuations Secondary buyouts in H1 up 45 percent on H1 2013 levels