What Is Secondary Buyout?
A secondary buyout occurs when a private equity firm acquires a company that is already owned by another private equity firm. This type of transaction falls within the broader category of Private equity, a form of capital investment where funds are not listed on a public exchange. Essentially, it's a "firm buying a firm from a firm" within the private market sphere, distinct from a primary buyout where a private equity firm buys a company directly from its founders or a corporate parent. Secondary buyouts have become an increasingly common exit strategy for financial sponsors looking to realize their investments.
History and Origin
The concept of private equity began to take shape in the mid-20th century, with significant growth and institutionalization occurring from the 1980s onward, marked by the rise of leveraged buyout (LBO) activity. As the private equity industry matured and the volume of investments grew, firms increasingly sought various avenues to realize returns for their limited partners. Initially, secondary buyouts were not as favorably viewed as acquiring a private company or taking a public company private, often perceived as less attractive by investors. However, as the market evolved, and particularly after the dot-com bust and prior to the global financial crisis, secondary buyouts began to gain traction.7 This shift was driven by several factors, including the desire for faster realizations compared to an Initial public offering (IPO) and often simpler execution than a sale to a strategic corporate acquirer. The growing size and complexity of the private markets further cemented secondary buyouts as a legitimate and active segment of the broader private equity landscape.
Key Takeaways
- A secondary buyout involves one private equity firm selling a portfolio company to another private equity firm.
- These transactions serve as a significant exit mechanism for selling financial sponsors and provide liquidity to their investors.
- Secondary buyouts allow buying private equity firms to deploy capital into established businesses that have often already undergone some operational improvements.
- While they offer quicker exits, secondary buyouts can sometimes lead to increased leverage on the acquired company and potentially limit future return on investment due to higher entry valuations.
Interpreting the Secondary Buyout
In the context of private equity, a secondary buyout is often interpreted as a sign of a mature and liquid market. For the selling private equity firm (the general partners), it represents a successful monetization event, allowing them to return capital to their limited partners and potentially generate substantial capital gains. For the acquiring private equity firm, a secondary buyout can offer a less risky proposition than a primary buyout, as the target company has already been de-risked and potentially optimized by the previous financial sponsor. The buyer typically performs extensive due diligence to assess the remaining value creation potential.
Hypothetical Example
Consider "TechSolutions Inc.," a software company acquired by "First Capital Partners," a private equity firm, five years ago. First Capital Partners invested heavily in TechSolutions, streamlining its operations, expanding its customer base, and increasing its revenue. Now, First Capital Partners believes it has maximized its initial value creation and is ready to exit.
Instead of pursuing an IPO or a strategic acquisition by a larger tech company, First Capital Partners entertains offers from other private equity firms. "Growth Equity Group" sees further potential in TechSolutions, perhaps through international expansion or additional product development. After conducting thorough valuation and due diligence, Growth Equity Group agrees to purchase TechSolutions Inc. from First Capital Partners. This transaction, where a private equity-owned company is sold to another private equity firm, constitutes a secondary buyout.
Practical Applications
Secondary buyouts are increasingly common across various sectors, reflecting the expanding scale and sophistication of the private equity market. They provide an important avenue for liquidity within the private markets, allowing investors to exit positions in private equity funds.6 For the selling firm, a secondary buyout offers a flexible way to return capital to investors without relying on unpredictable public markets or lengthy strategic sales processes. For the acquiring firm, it presents an opportunity to invest in companies with proven business models and established management teams that have already been vetted and improved by a prior private equity owner. From 2006 to 2019, the number of secondary buyout exits in private equity increased by 5.2% per year, while exits via IPOs declined.5 This trend highlights the growing reliance on secondary buyouts as a key liquidity event.
Limitations and Criticisms
Despite their increasing prevalence, secondary buyouts face several criticisms. One major concern is the potential for "leverage on leverage." Companies involved in secondary buyouts may already be highly indebted from the initial leveraged buyout, and a subsequent buyout often involves adding even more debt financing.4 This increased debt load can make the company more vulnerable to economic downturns or operational challenges, potentially leading to financial distress or bankruptcy.3,2
Another criticism revolves around the value creation potential. While the selling firm may have extracted significant value, the acquiring firm might find limited room for further operational improvements, leading to reliance on financial engineering or market multiple expansion for returns. There are also concerns that some secondary buyouts can be driven by the need of general partners to demonstrate distributions to their limited partners, even if it means selling a company at a high Net asset value to another fund within the same investor base.1 This can create a perception of "financial musical chairs," where the underlying company's true value may not be fundamentally enhanced.
Secondary Buyout vs. Primary Buyout
The primary distinction between a secondary buyout and a Primary buyout lies in the seller of the target company.
Feature | Secondary Buyout | Primary Buyout |
---|---|---|
Seller | Another private equity firm or financial sponsor | Founders, family owners, or corporate parent |
Target Status | Already private equity-owned | Typically privately held, or a public company going private |
Due Diligence | Often more focused on incremental value and existing operations; company has prior PE stewardship | More fundamental assessment of the business, often less institutionalized operations |
Value Creation | Focus on next stage of growth, operational tweaks, or financial restructuring | Initial operational improvements, scaling, professionalizing management |
Risk Profile | Potentially lower execution risk as the company has been "institutionalized" | Can be higher execution risk, but potentially greater upside from initial transformation |
While a primary buyout involves the initial acquisition of a company by a private equity firm, a secondary buyout is a subsequent transaction involving a company that has already been under private equity ownership. The confusion often arises because both are types of leveraged buyouts within the broader private equity landscape.
FAQs
What is the main purpose of a secondary buyout?
The main purpose for the selling private equity firm is to realize its investment and provide returns to its investors. For the acquiring private equity firm, it's an opportunity to invest in a company that has already been vetted and often improved by a previous private equity owner, potentially offering a more defined path to future growth.
Are secondary buyouts common?
Yes, secondary buyouts have become increasingly common in the private equity market. They represent a significant portion of private equity exit activity, especially as the overall private equity market has grown and matured.
How does a secondary buyout differ from a secondary market transaction?
A secondary buyout refers specifically to the sale of a portfolio company from one private equity firm to another. A broader "secondary market transaction" in private equity typically refers to the sale of an existing limited partner interest in a private equity fund from one investor to another, providing liquidity to fund investors rather than exiting a portfolio company.
What are the advantages for the buying firm in a secondary buyout?
Advantages for the buying firm can include reduced due diligence risk due to the company's prior private equity ownership, a clearer understanding of the company's financials and operations, and potentially a shorter holding period to achieve a return. The company may also be more professionally managed compared to a non-private equity owned target.