Secondary Buyout

A secondary buyout is the sale of a portfolio company from one financial investor to another. One fund exits, while another takes over and continues the development. For the seller it is an exit, for the buyer a new investment. Such transactions account for a substantial share of exits in the mid-market, because not every company has a suitable strategic buyer and a listing only becomes viable above a certain size.

The process usually runs efficiently, because both sides speak the same language, materials are already professionally prepared and management has experience of such a procedure. The obvious question is where value creation for the second investor is meant to come from if the first has already implemented the obvious improvements. Credible answers are a different strategy, such as internationalisation instead of cost reduction, a different size class with access to larger acquisitions, additional capital for growth, or simply the fact that the seller must sell because of fund life rather than because the potential is exhausted. Conversely it must be examined critically whether the figures presented already benefit from measures by the previous owner that cannot be repeated, and whether investment was deferred in favour of short-term earnings.

For the buyer the appeal lies in a professionally prepared company with reliable reporting, an experienced management team and documented processes, which shortens diligence and eases execution. The price is that the easy improvements have often already been made and value creation has to come from growth, add-on acquisitions or entering new markets. Empirically, returns on such transactions average somewhat below those on first-time buyouts but are less dispersed, because the risk of undiscovered legacy issues is lower.