4.1 Exits and the end of a fund

A private equity fund makes money for its investors only when it sells what it owns. Until then, a portfolio company's value is an estimate on a report. The exit is the point where that estimate becomes cash that can be paid out to limited partners (LPs).

Exits drive almost everything in the second half of a fund's life: the distributions LPs receive, the performance figures in lesson 4.2, and when the general partner (GP) earns carried interest. If you process distributions, report to investors or monitor a fund as an LP, you need to know where the cash comes from and what can delay it.

Why exits matter to the fund

Look again at the illustrative cash flows for Ashcombe Capital Fund I from lesson 2.2 ($m, $100m of commitments):

Almost every dollar in the "Distributed" row comes from an exit or a partial exit. Distributions peak in years 6 and 7, when the companies bought in the early years are ready to sell. The smaller amounts in years 9 and 10 are the tail: the last few companies, which are often the hardest to sell.

In lesson 3.2, the fund's $100m of equity in Northfield Components grew to $200m at exit after five years. How that $200m actually turns into cash depends on the exit route.

The main exit routes

Sale to a strategic buyer. A strategic buyer (or trade buyer) is a company in the same or a related industry, such as a larger manufacturer buying Northfield Components. Strategic buyers can often pay well because they expect synergies: cost savings or extra sales from combining the two businesses. A trade sale usually sells the whole stake at once, so the fund gets a clean, complete exit.

Secondary buyout. In a secondary buyout, one private equity firm sells a company to another. The buyer believes it can create more value in the next stage. For the selling fund, it works like a trade sale: a full exit for cash. (Don't confuse this with "secondaries", the market for buying and selling existing fund interests, which appears below.)

Initial public offering (IPO). In an IPO, the company lists its shares on a stock exchange. An IPO is usually only a partial exit. The fund typically sells some shares at listing, and agrees to a lock-up: a period, often several months, during which it can't sell more. After that, it sells the rest over time, or sometimes distributes the shares themselves to LPs (a distribution in kind). The final return depends on the share price during the sell-down.

Dividend recapitalization. A dividend recap isn't really an exit. The company takes on new debt and uses it to pay a dividend to its owners. The fund receives cash but keeps all its shares. This can return capital early, which helps the fund's IRR (lesson 4.2). The risk is that the company now carries more debt. If trading weakens, it has less room to cope, and the lenders' claim ranks ahead of the equity (see PC101 3.1 on the capital structure).

GP-led secondaries and continuation funds. Sometimes a GP wants to keep owning a good company beyond the fund's life. In a GP-led secondary, the GP sets up a new vehicle, often called a continuation fund, which it also manages. The continuation fund buys the company (or several companies) from the old fund, using money from new secondary investors. Each existing LP typically chooses to:

• sell: take its share of the sale price in cash, as with any exit; or
• roll: move its exposure into the continuation fund and keep owning the company.

These deals carry a clear conflict of interest: the GP is effectively on both sides, setting a price between the fund it is leaving and the fund it is joining. Common safeguards include a competitive process to set the price, independent advice such as a fairness opinion, and review by the LP advisory committee (LPAC), a small group of LP representatives consulted on conflicts.

Choosing the route and the timing

The GP chooses the exit route based on market conditions, the type of company and the buyers available. It may run a dual-track process: preparing an IPO while also talking to buyers, then picking the better outcome.

Timing matters too. Selling too early can leave value on the table. Selling too late ties up LPs' money and lowers the IRR, even if the final profit is larger. When markets are weak, exits slow down and distributions to LPs are delayed.

The end of a fund

Most funds have a fixed term, commonly 10 years from the first close, as set out in the limited partnership agreement (LPA). By the end, the GP is expected to have sold the companies, paid out the proceeds and closed the fund.

In practice, some companies are often still unsold near the end. LPAs commonly allow term extensions, often one year at a time and up to a set limit. Extensions frequently need the consent of the LPAC or a majority of LPs; the exact rules vary by fund. Management fees during an extension are often reduced or stopped, though again terms vary.

Winding down a fund usually involves:

1. Selling or otherwise dealing with the last companies, which may include a continuation fund.
2. Settling remaining liabilities and expenses, sometimes keeping a small reserve for claims from past sales.
3. Making final distributions and calculating the final carried interest.
4. Preparing final financial statements, having them audited, and dissolving the fund.

For fund accounting and operations teams, the tail end of a fund can be as much work as the start: small, irregular distributions, reserves to track and a final set of reports to produce.

Key terms

• Exit: the sale or other event through which a fund turns an investment back into cash.
• Strategic (trade) buyer: a company in a related business that buys a portfolio company, often expecting synergies.
• Secondary buyout: the sale of a portfolio company from one private equity fund to another.
• IPO: an initial public offering, when a company first lists its shares on a stock exchange.
• Lock-up: an agreed period after an IPO during which existing owners can't sell more shares.
• Dividend recapitalization: adding debt to a company to pay a dividend to its owners without selling shares.
• Continuation fund: a new vehicle, managed by the same GP, that buys one or more companies from an older fund.
• LP advisory committee (LPAC): a group of LP representatives that the GP consults on conflicts of interest and certain fund decisions.
• Term extension: an agreed lengthening of a fund's life beyond its original term.

Key takeaways

• Distributions to LPs come almost entirely from exits, so exits shape a fund's cash flows and performance.
• Trade sales and secondary buyouts usually give a full exit; IPOs are usually partial, with a lock-up and later sell-down.
• A dividend recap returns cash without selling, but loads the company with more debt.
• Continuation funds let LPs sell or roll; because the GP is on both sides, independent advice and LPAC review are common safeguards.
• Funds commonly run for about 10 years, with extensions often needing LP or LPAC consent, followed by a wind-down.