In the context of private equity investment, exit governance is a crucial aspect of the value creation journey that is frequently overlooked despite its importance. The structures, procedures, and supervision mechanisms that were built by the private equity firm and the board of directors of the portfolio company in order to manage the transition from ownership to a successful sale or listing are referred to as “transitional management.” Not only is this not only an administrative task, but it is also a strategic function that has direct implications for the ultimate valuation multiple, the pace at which the transaction is completed, and the certainty that it will be closed. Exit governance that is effective guarantees that the process of divestment is carried out with rigour, transparency, and strategic alignment.
The ever-changing mandate of the Board
When a private equity investment is getting close to the limit of the holding time that was envisaged for it, the mandate of the board of directors of the portfolio business goes through a substantial movement. Once upon a time, the key purpose was to increase operational efficiency, achieve organic growth, and make smart acquisitions. However, now the primary focus is on being ready to depart the market. It is necessary for the board, which is normally made up of members from the financial sponsor, independent directors, and key management people, to make a conscious move from a steering committee for expansion to a dedicated supervision group for a complex transaction. In order to successfully navigate this shift, it is necessary to conduct an open and honest evaluation of the maturity of the firm, its position in the market, and its readiness to undergo intensive due diligence from potential purchasers or public markets.
The establishment of a separate Exit Committee or the formal definition of the exit-related obligations of the existing board is an important activity that falls under the purview of governance. This committee serves as the central nervous system for the sale process. It is responsible for overseeing the appointment of advisors, which may include investment banks, legal counsel, and accounting firms, and it also provides strategic direction on the potential exit routes, which may include a trade sale, a secondary buy-out, or an initial public offering (IPO). The governance framework is responsible for ensuring that all potential conflicts of interest are detected and addressed. This is especially important with regard to management incentives and the different timetables that different shareholders have. When it comes to maintaining momentum and integrity throughout a high-pressure sales process, it is of the utmost importance that there is open and honest communication between the board of directors, the financial sponsor, and management. Ned Capital has a wealth of information on governance of PE exit strategies, visit their website for more.
Responsibilities that are Shared by Management
The top management team of the portfolio firm is subjected to a large amount of responsibility when it comes to effective exit governance. It is expected of them to keep a relentless focus on the day-to-day operations and the achievement of key performance indicators (KPIs) in order to preserve the momentum of the business, while at the same time devoting a significant amount of time and resources to the preparation of the business for sale. The board must provide both clear direction and assistance in order to successfully fulfil this dual responsibility, which is intrinsically difficult.
The governance structure is responsible for ensuring that the management team has access to the required resources, data, and protection from process fatigue in order for them to successfully carry out their obligations. This includes the establishment of a Data Room preparation team that is accountable for the compilation and verification of each and every piece of operational, financial, and legal documents that a buyer will examine. A governance failure at this stage, such as inadequate or inconsistent data, can lead to significant delays or a reduction in the final offer price, which can erode buyer trust and cause the buyer to lose confidence in the transaction.
In addition to this, the governance framework needs to take into consideration the essential component of managerial incentive. When it comes to dealing with certainties, the loss of important workers during the exit phase can be catastrophic, thus it is essential to maintain employee retention and motivation. On the other hand, the board of directors and the financial sponsor are responsible for methodically designing structured incentive programs. These schemes typically take the form of departure bonuses or equity participation that is vested upon a successful sale. These schemes need to ensure that the interests of management are aligned with those of the shareholders who are selling their shareholders. This will ensure that the management team is rewarded for successfully arranging the transaction as well as for successfully running the business.
Cleaning up both the operations and the finances
A proactive phase of operational and financial de-risking is required by strong exit governance, and this period must begin well before the formal beginning of the sale process. It is the responsibility of the board to manage activities in order to guarantee that the company is presented in the most robust and easily transferable manner possible. To accomplish this, it is necessary to address any existing “skeletons,” which may include prospective liabilities, unresolved legal concerns, or complex, non-standard contracts that have the potential to discourage a prudent purchaser.
When it comes to finances, the production of Quality of Earnings (QoE) is the primary focus of governance. In order to meet the requirements of the buyer-specific scrutiny and complete audit preparedness, the financial reporting of the portfolio firm needs to go beyond the conventional compliance requirements. Add-backs are expenses that are not recurring or one-time and are often put back to earnings to illustrate the ‘real’ profitability. The board of directors is responsible for ensuring that add-backs are considered conservative, properly documented, and justifiable. Add-backs that are aggressive or unjustified are a common source of disagreement and have the potential to damage confidence during the process of due diligence. By executing a vendor due diligence (VDD) under the supervision of the board, which gives a clean and unbiased perspective of the company’s financials, good governance necessitates the pre-emption of the buyer’s quality of experience report. This considerably streamlines the process and reduces the knowledge gap between the parties involved.
The Management of the Exit Route and the Integrity of the Process
When it comes to exit governance, one of the most important decisions that must be made is the selection of the exit route. This might be a competitive auction, a strategic bilateral sale, or an initial public offering (IPO). The preparations and oversight that are necessary for each route are different from one another. An initial public offering (IPO) necessitates the formation of compliance at the level of a public company, which includes preparation to comply with Sarbanes-Oxley and the selection of non-executive directors who have substantial expertise in the public market. When conducting a competitive trade sale, the board is required to carefully regulate the disclosure of information to numerous bids. This is done to ensure that all bidders are on an equal playing field while also preserving proprietary information.
Regardless of the course of action that is taken, the board is responsible for maintaining the process’s integrity. The establishment of reserve prices, the approval of the short-list of bids, and, most importantly, the formulation of the ultimate proposal to the shareholders are all included in this process. During this time period, the board of directors is tasked with striking a compromise between the fiduciary obligation to maximise shareholder value and the requirement to guarantee that the company continues to be a viable, going concern.
The execution of a transaction that is both smooth and maximises value is the conclusion of good exit governance responsibilities. This demands the board of directors and management to make a purposeful transformation in their attitude, as well as to have foresight and discipline. With the use of the governance framework, the inherent complexity of a private equity disposal can be transformed into a managed, successful, and profitable final chapter of ownership. This is accomplished by creating defined duties, regulating information flow, proactively de-risking the firm, and aligning incentives.
