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Exits? You haven't even entered yet.

Exits have become something of a rarity in the private equity arena of late as the financial markets continue to struggle. Toby Mansel-Pleydell of Concorde Aquila Corporate Finance looks at the exits issue from an entrepreneur's viewpoint.

It's a fact of life with venture capital and private equity that, before the investors have even paid money into a company, they are already thinking about how and when they will reap the rewards of their investment. The ‘exit' is a key issue that needs to be agreed with the new investors at the time of the capital raising - which means that anyone considering raising private equity funding should give the matter serious thought even before they approach prospective investors.

It is worth starting by setting out some basic facts about the motivations of private equity investors active in Hungary. Typically, they (a) target a minimum annualised return of 35 per cent - 40 per cent on their investment; (b) expect to obtain an exit within a three to five year period; (c) need a clear idea in advance of how that exit can be achieved; and (d) need to be in a position to influence the timing of the exit - usually even to force an exit in certain circumstances.

If you are looking for capital and the above conditions seem totally unacceptable to you, then perhaps you need read no further and can use this booklet instead to prop up a wobbly piece of furniture. But if they strike you as no worse than unreasonable, then consider the fact that private equity investors are, somewhat understandably, not interested in investing where there is no realistic prospect of liquidating their holding within their target exit period - no matter how attractive the investment opportunity may otherwise seem. Thus, it is important to recognise before, during and after the capital raising process that the investor is perhaps as much concerned to maximise the prospect of achieving an exit as he/she is to maximise the return on the investment.

An exit for an institutional private equity investor - and/or any other investor, including the original shareholder(s) - will usually take one of the following forms: an outright sale to a strategic buyer, a listing and offering on a stock exchange, or an acquisition of the shares by other shareholders - probably involving the senior managers. Of these, a trade sale is generally considered as the most likely exit route, especially given the current weakness of the Budapest Stock Exchange, which has provided an exit for institutional private equity only a few times, the most recent example being Synergon in 1999. Indeed, unless there is a realistic prospect of the company achieving a listing on a recognised supranational stock exchange (such as NASDAQ, EASDAQ or Neuer Markt), the investors will need to be persuaded that it can be sold to a strategic buyer in due course. The third option (buy-back by management and/or other shareholders) is rare and, at best, offers a possible alternative to one of the other two main exit scenarios.

Which brings us back to you, the person looking for development capital for your company. If you do bring in private equity, you must be prepared for the likelihood - or at least the distinct possibility - that, within a few years, you will have to sell your company to a strategic buyer - possibly even one of your competitors. Most owner-managers find this idea alarming, preferring to think that a more benign exit can somehow be achieved. But they should not try to kid themselves, for the reality is that a trade sale can never be ruled out as a potential exit route.

And you should anyway not be afraid of this eventuality. Strategic investors normally buy a company because of - not in spite of - the perceived quality of its management, and a new owner is therefore more likely to be interested in retaining and motivating senior managers than in getting rid of them. Added to which is the distinct attraction that a sale to a trade buyer will normally yield the highest valuation, incorporating a significant element of control premium (as much as 30 per cent or 40 per cent) not available in the case of a stock exchange listing. So at least you will be able to retire and live happily ever after if being part of a larger organisation turns out not to be your cup of tea.

Finally, a few words about the jargon. Relatively early on in negotiations with private equity investors, you are likely to come across expressions such as drag- and tag-along rights, third party limitations, ‘all-out-together', flipover, ratchet mechanisms, etc. If these issues do not concern you, then they should. There is a common perception among entrepreneurs that ‘as I am a successful and experienced businessman, I should be able to negotiate these matters on my own with some support from my lawyer'. But consider the fact that you generally get only one chance to attract private equity investors into your company. It is a crucially important step for you, and you had better get it right first time. As in virtually every aspect of life, you will be better off seeking the help of an expert with the right experience who can ensure that your interests are properly looked after, otherwise that exit may never even happen.

Copyright © 2003 Hungarian Venture Capital Association

Toby Mansel-Pleydell is a managing partner at Concorde Aquila Corporate Finance.

Concorde Aquila Corporate Finance, a 75 per cent owned subsidiary of Concorde, is an independent provider of corporate financial advisory services to corporations, financial institutions and investment funds in Hungary. CACF was formed in 2001 through the acquisition of a controlling stake in Aquila Corporate Finance, which was merged with Concorde's existing investment banking activities. For more information please visit www.con.hu

Hungarian Venture Capital and Private Equity Association (HVCA) represents virtually all major sources of venture capital and private equity in Hungary and is dedicated to promoting the industry for the benefit of entrepreneurs, investors, its practitioners and the economy as a whole. For more information please visit www.hvca.hu