UK private equity firms sell assets to themselves as exit routes dwindle
Disposal of portfolio companies to ‘continuation’ funds becomes preferred strategy to return cash to investors
UK private equity managers now see selling companies to themselves as their best option to offload investments, according to new research, as a moribund IPO market and the higher cost of financing deals make traditional exit routes more difficult.
Disposals to so-called continuation funds are the most popular option for private equity executives seeking an exit from their investments, according to a poll of 200 senior UK-based industry professionals carried out by Numis.
The results, due to be published this week, underline the rising trend of private equity funds turning to newer funds raised by the same firm as they seek to sell their assets to return cash to investors.
Private auctions, the preferred route in last year’s poll, are now the least popular of four exit options as a more difficult debt financing environment combines with political uncertainty ahead of UK and US elections.
The gloomy economic outlook and the gap between buyers’ and sellers’ valuations were also cited among the most common barriers to dealmaking. In Europe, the number of sales from one private equity firm to another dropped earlier this year to the lowest level since the Covid-19 pandemic.
The vast majority of those polled, drawn from professionals focused on mid-market deals worth £500mn-£1bn, did not expect a fully functioning initial public offering market before the final quarter of 2024.
Despite this, IPOs were ranked as the third most popular option for prospective disposals while a “dual track” process, where companies prepare a stock market listing and a private sale in parallel to keep options open, was second.
The growing use of continuation funds has attracted scrutiny with the chief investment officer of asset manager Amundi last year likening parts of the private equity industry to a “Ponzi scheme” that would face a reckoning in the coming years.
The technique involves a private equity fund selling an asset it has owned for several years from one of its funds where investors have been promised a return in cash to a newer fund where backers are not due to get their money back for a few years.
The popularity of the strategy has grown as pulling off deals has become more difficult. Global dealmaking fell to a 10-year low in the first nine months of 2023.
Supporters of the method say flipping assets from one fund to another can allow private equity firms to continue benefiting from assets with strong cash flow.
While the new fund may have different backers, or may invest alongside third parties, the method raises questions around how a private equity firm should objectively value an asset while doing the best for the investors in both funds.
The UK’s Financial Conduct Authority said this month it was planning a review of the valuations of private assets, warning that higher interest rates were likely to result in lower valuations and could present risks to the financial system.
The survey found that, for UK assets, private equity sponsors have shifted their focus from public companies to private companies.
The poll found 71 per cent of executives were focused mainly on targeting UK private companies, up from 11 per cent a year ago. The proportion focusing on UK public assets plunged from 73 per cent to 14 per cent.
The change in focus came despite respondents’ view that private assets were more likely to be overvalued than public companies.
Numis said the findings reflected “a perception that public investors may be less willing to sell currently, making it harder to execute these deals, and that there is a wider opportunity set in UK private markets”.
For the survey respondents, who were based in London but invest globally, the UK has greater appeal than other markets, Numis found, with 85 per cent saying the country was more attractive than the other markets where they invest.