How to prepare for, and execute, a successful exit

By Mark Malinas, Noah Obradovic, David Couper, James Kanabar, Jeremy Low, Andrew Wong, Ellen Thomas, Felicity McMahon, Julian Donnan
Foreign Investment Review Board (FIRB) Mergers & Acquisitions Private Capital Private Equity Tax

The year of the exit 9 min read

After a relatively subdued 2023, we are predicting that the rest of 2024 will prove to be the year of the exit, with improving macroeconomic conditions providing the ideal environment for the exit of a number of high-quality assets.

However, it still pays to be prepared and to expect some challenges. In this Insight, we outline the six crucial elements in preparing for, and executing, a successful exit.

Key takeaways

  • The Australian initial public offering (IPO) market was relatively subdued in 2022–23, due to factors including domestic and global macroeconomic conditions and market/investor uncertainty. It remains to be seen whether the IPO window opens in the second half of 2024.
  • While more clarity on where domestic and global economies are heading could increase investor confidence in the equity market, we think it is more likely that valuation and pricing will be key to whether an IPO will ultimately proceed.
  • We recommend that vendors who are looking at an IPO as a potential exit option be ready for an IPO window, in case it closes quickly. Too, it is often easier from an execution and pricing perspective for those who launch an IPO when the window first opens than for those who launch when it's about to close.

Six crucial elements in preparing for, and executing, a successful exit:

Open the IPO window

The Australian IPO market was again relatively subdued in 2022–23. In terms of new primary raisings, the largest in that period was the IPO of Redox (c. $400 million), which spurred some optimism about an IPO window opening in late 2023. However, this did not eventuate.

As for why IPOs did not launch (and noting that a small number did get close to the finish line before being withdrawn), there are a number of potential reasons for this, including:

  • macroeconomic conditions (both domestically and globally);
  • market / investor uncertainty;
  • geopolitical tensions (eg in Ukraine and Israel);
  • poor after-market performance of a number of recent IPOs; and
  • valuation and pricing gaps between vendors and investors.

Looking ahead, it remains to be seen whether the IPO window may open again in the second half of 2024. Greater clarity later in the year on where domestic and global economies are heading and, hopefully, an easing in geopolitical tensions abroad and increased stability following government elections globally in 2024, ought to give investors greater confidence in the equity market. That said, the ASX200 has recently hit its all-time high, so investor confidence is arguably not lacking at the moment. Ultimately, we think it is more likely that valuation and pricing will be key determinants in whether or not an IPO will ultimately proceed.

For vendors looking to exit in the short to medium term, and whose business might be suited to listed life, commencing preparations for an IPO as part of a potential dual-track sale process may assist in delivering the requisite pricing tension between exit options and, potentially, a better outcome for vendors. While there is no guarantee of an IPO window opening later this year, we recommend that vendors who are looking at an IPO as a potential exit option be prepared in the event that it does, since history tells us that this window may not remain open for an extended duration. It is often easier from an execution and pricing perspective for those who launch their IPOs at the start of the window than for those who launch at the end.

Provide a clear picture with specific due diligence

Get your house in order

Sponsors have, no doubt, invested large sums of money undertaking due diligence processes on the initial acquisition and on bolt-ons during the hold period. Rather than produce vendor due diligence reports that flag many of the same issues, it is worth going through those sponsor reports, identifying matters that remain unresolved and actioning those items. Cleaner due diligence reports will mean less conditionality and negate the likelihood of buyers asking for price reductions during the pre-signing phase.

Are all vendors aligned?

For consortium-owned assets and/or those where a there is a minority investor, don't assume all vendors are aligned on timing and the reserve price for the exit – even though they should be aligned on those key thresholds. Majority shareholders should work with their advisers to ensure drags/tags operate as they expect them to and that any management shareholders are also able to be brought across.

Employment issues

Perhaps the most widely flagged legal issue in recent times is that of underpayments and/or misclassification of employees. All these issues are payroll related, so a pre-sale 'payroll audit' can work well. As sponsor-backed exits are invariably backed by warranty and indemnity insurance policies, doing this work upfront provides a clear picture of the ability to cover employment and payroll-related warranties, and flags what remediation may be necessary.

Consider financing for potential buyers

The sponsor's toolkit to manage execution risk associated with debt financing

Even though general credit conditions have improved and the market's appetite for raising leveraged loans is returning, sell-side sponsors will be acutely aware of the risk for potential purchasers in raising debt financing to fund an acquisition.

One method often employed is the use of 'stapled debt', with a lender – commonly, the sell-side financial adviser – offering to provide a debt financing solution, which is 'stapled' to the asset that can be utilised by a successful bidder, and promote certainty and efficiency in a sales process. The 'stapled debt' can be used to front negotiations with other third-party financing sources as well, to enhance a potential purchaser's ability to raise an optimal debt-financing solution.

Portability has also become a focus for sponsors. It operates as an exception to a change of control provision in a loan agreement, and removes the need for a potential purchaser to arrange its own debt financing to fund an acquisition, with the existing debt remaining in place on, and following, the sale. We have seen sponsors with assets in their portfolios that are approaching maturity assessing their ability to revise current loan agreement arrangements to introduce portability, as part of the process of readying it for an exit. While it is a bespoke arrangement, lenders are, in some instances, welcoming these discussions, as a means to maintain a level of allocated capital in a market where there has been a relatively low supply of new issuances of leveraged loans.

Continuation funds, preparedness, a sale through a third party, valuations

While there are examples of single asset continuation vehicles established by Australian private equity (PE) sponsors, their use remains nascent. However, their rapid offshore proliferation, coupled with the closing of the IPO window, may result in Australian sponsors considering continuation funds as a genuine additional exit option in their armoury.

Continuation funds can offer a range of benefits. In particular, they can provide liquidity and crystallise gains for investors in the selling fund electing to roll their interest, while also allowing sponsors (and investors in the continuation fund, including rolling investors) to retain exposure to high-performing assets and benefit from continued upside. Alternatively, for distressed assets or where market conditions are not optimal, continuation funds can provide for additional turnaround time (or allow assets to be sold when market conditions have improved).

However, continuation fund transactions involve inherent conflicts and there are a number of things sponsors need to consider:

  • The terms of the selling fund will likely require limited partner advisory committee (the LPAC) approval. We have seen sponsors seek to include pre-clearance clauses but in most cases these are successfully resisted.
  • The LPAC's key focus will be on the sale price and underlying valuation, and it is standard practice for the sale price to be supported by an independent valuation and/or a price set by a competitive sales process.
  • The Institutional Limited Partners Association (ILPA) has released guidance on continuation funds, reflecting feedback from both sponsors and investors, and supporting the need for LPAC approval and a competitive process (including third-party price validation). It also seeks to: (a) establish minimum timeframes for investors to make sell or roll decisions; (b) require that the terms of rolling investors' side letters should, where relevant, apply to their continuation fund investment; and (c) ensure parity of economic terms for rolling investors (including no increase to the management fee or carry). Controversially, ILPA advocates that there should be full rollover of carried interest into the new vehicle (rather than crystallisation at the point of sale). However, and, in our experience, it is not common practice.
  • The US Securities and Exchange Commission (the SEC) has adopted new rules to regulate the private fund industry, which are due to come into force later this year. The SEC considers that a market-driven price discovery process may not always represent an accurate value of the relevant asset, and the rules require sponsors selling to a continuation fund to obtain from an independent adviser either: (a) a fairness opinion, confirming the sale price is fair; or (b) a valuation opinion, confirming the value (either as a single amount or a range) of the assets being sold. The rules do not apply to Australian sponsors and are subject to ongoing legal challenges but – given the international investor base of many of the largest Australian sponsors – if/when they come into force, we would expect to see them impact Australian continuation fund transactions.

Factor in FIRB

Buy-side considerations

Ascertain if Foreign Investment Review (FIRB) approval is required

There are different FIRB approval triggers, depending on whether the purchaser is a 'foreign government investor' (FGI) under the FIRB rules, and whether the proposed transaction involves a direct acquisition (an 'onshore transaction') or indirect acquisition (an 'offshore transaction') of interests in an Australian entity, business or land. FGIs are subject to more extensive FIRB approval triggers than non-FGI foreign persons, so the first step is to ascertain if the purchaser is considered an FGI. This, in turn, will depend on the composition of investors in the purchaser's fund.

Allow sufficient time to obtain FIRB approval

Notwithstanding statutory timeframes, in practice there is no fixed period within which a decision on a FIRB application must be made, as there can be extensions. Expect a longer timeframe where the acquisition of the target raises national interest and/or national security considerations.

Consider the target's ability to comply with FIRB conditions

It is not uncommon for FIRB approvals to be issued subject to conditions. Applicants are given the opportunity to comment on proposed conditions; however, purchasers should check whether proposed conditions of a target group, operational or behavioural in nature, can be complied with by the target. In our experience, there is particular focus on tax conditions regarding acquisitions by PE.

Sell-side considerations

Assess the execution risk

Sellers should assess the execution risk arising from a purchaser's need to obtain FIRB approval. There are two key risks – of the purchaser not obtaining approval, and of a lengthy FIRB assessment period. The risk level will turn on various factors, including the nature and size of the target's Australian business, the identity of the purchaser and its owners, and the geopolitical environment.

Be prepared to assist with the FIRB process

While it is the purchaser's obligation to determine if it requires FIRB approval and to apply for it, the seller and target will be asked to provide information to assist with the FIRB analysis and for inclusion in the purchaser's application, and also to respond to FIRB's post-lodgement questions. In a competitive sale process, consider preparing a 'FIRB insert' of target information that bidders can include in their FIRB applications.

Look into payable tax

Foreign investors exiting an Australian investment will need to closely consider whether any tax is payable.

For investments in companies that have material investments in Australian real property, an analysis will need to be undertaken to determine if the shares are 'indirect Australian real property interests'. If so, the buyer will need to withhold tax on the proceeds payable to the investor. As a practical matter, the circumstances in which the Australian Taxation Office (the ATO) requires engagement on this issue are increasing, and there are a number of active ATO reviews in this area.

For investments in a company that is not land rich, a foreign investor should review whether any exit gains may be protected by the application of a double tax agreement between Australia and the country in which the foreign investor is resident. There have been recent changes to some of Australia's double tax treaties that deny treaty benefits where obtaining such benefits was 'one of the principal purposes' of the structure or transaction.

Consider the regulators

If the exit involves a sale to a strategic buyer, review by the Australian Competition and Consumer Commission (the ACCC) may need to be factored in. The ACCC is a tough regulator – with new leadership, it is not afraid to take different positions from those taken historically. Going in with your eyes wide open about the complexity and time involved to secure ACCC approval is important, as is ensuring the buyer is well advised and the vendor has a seat at the table in any discussions with the ACCC.

Any deal this year takes place against the backdrop of the merger reforms, with the Federal Government having recently announced the introduction of a mandatory and suspensory merger review regime from 1 January 2026. Vendors may be keen to avoid the risk of an untested new regime by exiting ahead of the regime's introduction. But buyers – particularly those looking to execute roll-up strategies – should know that the new thresholds will empower the ACCC to look back on acquisitions over the past three years, meaning buyers will need to think strategically about the assets they truly want to keep if there is merger control risk.