July 17, 2020

Private Equity: Sponsors Preparing for Exit Window to Open

With valuations taking a big hit and the turmoil that the pandemic has created for many portfolio companies, many sponsors that might otherwise have sought an exit this year are biding their time until more favorable conditions return. This recent McKinsey report says that sponsors are using this additional time to prepare for an exit. Here’s an excerpt on some of the “hard pivots” that portfolio companies are taking to enhance their value:

As we mentioned, the recession has revealed material weaknesses in some business models, such as those of specialty retailers that mistakenly saw themselves as essential to consumers and of retailers that lack bargaining power with suppliers. After solving their immediate liquidity issues, forward-thinking sponsors are making the hard choices now to pivot to a stronger and more resilient business model.

One technology company preparing for exit sold predominantly into the real-estate and hospitality sectors. It had generally priced on a pay-per-use model, which was attractive to many customers. It had previously resisted attempts to move to a fixed-fee software-as-a-service (SaaS) model, as many similar companies have done. Although it has sufficient cash on hand to withstand a protracted downturn, it is now taking the plunge, moving many of its customers to fixed-price or take-or-pay contracts that will provide an even greater cushion in the next downturn (and will probably support better financing).

Some portfolio companies are also diversifying revenues to reduce cyclicality and improve resilience. For an infrastructure-services company focused on logistics and installation of capital equipment, this means a shift toward recurring revenues tied to services in operations and maintenance. Similarly, an industrial-equipment company shifted its mix to include more digitally enabled services.

John Jenkins