Contents EXIT OPTIONS FOR PRIVATE EQUITY FUNDS IN NIGERIA 1 ABSTRACT 1 Definition of Terms 1 FORMS OF EXIT Available to Investors 2 LEGAL REGULATORY FRAMEWORK 4 EXIT OPTIONS FOR PRIVATE EQUITY FUNDS IN NIGERIA ABSTRACT Whilst some challenges persist in the region such as an infrastructure and energy deficit, and a relatively under-developed legal framework in the context of PE, recently implemented reforms and initiatives have gone a long way to diversify economies and increase regional harmonisation. Performing an exit is the process by which private equity firms achieve such goal, which is therefore a natural part of the life-cycle of every private equity transaction. Also, the number of successful exits achieved by a certain private equity house has a strong influence on its ability to attract investors and raise funds. Accordingly, the potential exit opportunities from an investment play a highly important role in an investor’s decision about whether or not to invest in a company. This is the reason why exits receive such special attention from the earliest stages of the deal. This article thus concisely outlines the different forms that exit from an investment could take to protect the investor’s interests and the advantages and disadvantages that can be gotten from each method. Definition of Terms Private Equity Funds: A private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies associated with private equity Bryan A. Garner (1999) A handbook of Business Law Terms. A private equity fund is raised and managed by investment professionals of a specific private equity firm (the general partner and investment advisor). Typically, a single private equity firm will manage a series of distinct private equity funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested. “Private Equity Funds” means a type of collective investment scheme that invests primarily in private equity/unlisted companies, whether or not in an attempt to gain control of the company S. 557 of the SEC Consolidated Rules 2013. Equity Securities: Exit Options: An embedded option within a project that allows the firm abort their operations at little or no cost. An exit option can typically only be exercised after key developments have occurred within the project. Like any other option, this instrument must be purchased at a cost which factors into the capital budgeting decision, but its value is not determined by the price of an underlying asset Exit Option Definition | Investopedia http://www.investopedia.com/terms/e/exit-option.asp#ixzz4JlFfgE1o  . FORMS OF EXIT Available to Investors Private equity investors are willing to take on more risk than banks and other traditional sources of capital and are often the only source of funds for start-ups and companies that require restructuring. These investors include wealthy individuals, institutional funds and sovereign wealth funds. They generally invest in businesses that offer higher-than-average returns on investment. They usually plan to exit their investments after realizing a reasonable return. There are thus various methods by which the investor can exit the private equity fund, they each however have advantages and risks attached to these methods. Merger Mergers are a common exit strategy. For example, a portfolio company that has had some success in developing a product or turning around its operations could be an attractive merger or takeover candidate. Mergers is an attractive strategy as it offers private equity investors a way to exchange their shares for shares in the acquiring company, cash or a combination of cash and shares. Mergers also benefit the portfolio companies by providing them access to new capital, more customers and better distribution channels. The disadvantages include loss of control, turnover of key people and the risk that the integration of the merged entities will not go smoothly Zacks, Exit Options for Private Equity Investors. Initial Public Offering One of the common ways is to come out with a public offer of the company, and sell their own shares as a part of the IPO to the public. As the case may be, you may sell your share immediately, or sell the shares allotted to you after the company gets listed and the shares start trading on the exchange. Stock market flotation can be used only for very large companies and it should be viable for the business because of the costs involved Finance Train, Exit Strategies for Private Equity Investors. IPOs require careful planning, including building relationships with market participants, filing the necessary documents and preparing detailed financial reports and forecasts. If an IPO is successful, private equity investors could cash their shares at a substantial profit. Public companies have access to a large investor base for raising capital and can use publicly traded shares as currency for acquisitions. IPOs also have serious disadvantages compared to other exit methods that need to be taken into consideration. First of all, the public offering of shares in itself does not mean an exit. The private equity provider will only be able to exit its investment when its shares are actually sold on the stock market, which is very unlikely to happen simultaneously with the IPO. Therefore, the investor seeking to perform an exit will be exposed to fluctuations and other market risks for a certain amount of time after the IPO is carried out. Also, the listing of the shares of a company is typically subject to strict regulatory requirements and restrictions, which make the IPO a lengthy and expensive process. The risk of an IPO is also that insufficient investor demand could mean a lower offering price and a lower return on investment for the private equity investors. Trade Sales Another commonly used exit route is the trade sale in which the private equity investor sells all of its shares held in a company to a trade buyer, i.e. a third party often operating in the same industry as the company itself. Trade sales to strategic buyers and secondary buyouts are most common in practice, but transaction agreements also permit exit by an initial public offering (IPO) and recapitalisation. In 2015, trade sales accounted for 50% of exits in Nigeria Practical Law, Private Equity In Nigeria: Market And Regulatory Overview The advantages of this exit option include speed, liquidity and control. This method is preferred by private equity providers mainly because it provides a complete and immediate exit from the investment. Another advantage of the trade sale is that in this case, the negotiations take place with a single buyer which allows for a quicker and more efficient process which is not subject to the regulatory restrictions applicable to IPO transactions. In a trade sale transaction, the investor can also exercise more control over the whole process, and in certain cases might even end up obtaining a higher value for the company compared to other exit methods. On the other hand, trade sale is not free from potential problems and risks either. The disadvantage is that the management of the portfolio companies could resist transferring control to another investor, especially to an existing or potential competitor. However, this resistance may not exist if the private equity investors negotiate a management buyout with the founders and management of the portfolio company. A trade sale might also entail serious business risks as the buyer is oftentimes a competitor of the company, which will inevitably obtain confidential business information during the negotiation process. Secondary Buyout In the case of a secondary buyout, the company is sold by a private equity investor to another private equity firm. In other words, the particular nature of a secondary buyout lies in that private equity houses appear on both sides of the deal, while in the average transaction private equity investors would only be involved either as seller or purchaser. There are a number of possible reasons why an investor may choose this method as the exit route. It can be a means of shortening the life-time of a transaction which has become a priority for private equity houses in the recent economic climate, and therefore secondary buyouts have become increasingly popular. Sometimes, the investor which carried out the original acquisition is not willing to (or cannot) finance a business anymore, even though the company might not yet be ready for a trade sale or IPO. In that case, selling the company to another private equity firm which sees potential in further developing the company might be a reasonable solution. This method can also be used by the management when they wish to replace the private equity investor backing the company. A secondary buyout offers the advantages of an immediate and complete exit and it can be carried out even faster than a trade sale or an IPO. This plays a significant role in its increasing popularity. Leveraged Recapitalization Leveraged recapitalization is a partial exit method, whereby the private equity investor is able to extract cash from a business without actually selling the company. This is achieved by re-leveraging the company i.e. substituting some of the company’s equity with additional debt. It is usually done by the company raising money by borrowing from a bank or issuing bonds, which amount is then used to repurchase the company’s own shares from the investor. The most important advantages generally associated with leveraged recapitalizations are that investors can remain in control whilst still receiving payment and the possible tax benefits compared to other types of exits. On the other hand, there are significant disadvantages to this method too. A leveraged recapitalization may result in over-leverage that can eventually lead to financial difficulties and even bankruptcy. Also, increased leverage limits the flexibility of the company’s operations. Liquidation This is the least favorable option but sometimes will have to be used if the promoters of the company and the investors have not been able to successfully run the business. Other Options Other exit options include restructuring, special dividends and redemption rights. Restructuring could involve shutting down unprofitable units, downsizing staff and making managerial changes to reduce operating expenses and increase cash flow. Restructuring could precede a sale, IPO or merger. Private equity investors may also be able to negotiate partial or complete exits by demanding portfolio companies to redeem their shares for cash or issue special dividends. LEGAL REGULATORY FRAMEWORK In the area of securities regulation, the question for Nigeria is no longer whether private equity should be regulated as the extent to which private equity should be regulated would seem to have been answered as Nigeria’s private equity regulations which are basic and largely non-interfering. The regulatory strategy adopted by Nigeria’s Securities and Exchange Commission is to require that fund managers apply for authorization and registration of a private equity fund by submitting an application and a copy of the proposed fund’s information memorandum. The Regulations stipulate a minimum paid-up capital for private equity fund managers and a threshold for exemption of PE funds from regulatory oversight. There are also marketing/ investment restrictions as well as reporting, valuation and governance obligations on a private equity fund manager. Overall, what the Regulations do is to set the tone and minimum standards for LP engagement. Specific Provisions in the SEC Rules provide for Private Equity Funds from sections 557 to 563. These rules shall apply to all private equity funds with a minimum commitment of N1billion investors’ funds. S. 559 provides for Eligibility provisions as follows: The fund manager of a private equity fund shall have a minimum paid-up capital as prescribed by the Commission. 560. Restrictions: A private equity fund shall not a. solicits funds from the general public, but shall privately source funds from qualified investors alone; b. invests more than 30% of the Funds’ assets in a single investment. 561. General Requirements An application for authorization and registration of a private equity fund shall be filed along with the information memorandum to be issued to the target investors. Finally, the provisions for Valuation at Section 563 1. A private equity fund investments’ shall be valued at fair value, where fair value is the amount for which an asset could be exchanged between knowledgeable willing parties in an arm’s length transaction. 2. In the absence of an active market for the financial instrument, the valuer shall estimate fair value utilizing a disclosed valuation methodology. These provisions expressly govern private equity funds and this is a welcome development in Nigerian investments and foreign investments policies.