Canaries used to serve as an early warning system for coal miners. Before the existence of computerized monitoring systems, coal miners used canaries to monitor the buildup of toxic gases. These tiny birds are far more sensitive to methane and carbon monoxide than humans. Male canaries also love to sing. When the canaries in the mine stopped singing that meant they were probably dead and coal miners knew that it was time to get out before they too succumbed to the gasses. Having an early warning system has its privileges.
As business owners, it would be great to have a similar system that would alert us to when it might be a good idea to consider cashing out or selling at least a portion of our business before economic conditions make it difficult or impossible to do so. Even though we don’t have a canary we do have some proxies that can help us decide what to do.
Private equity (PE) firm activity can provide a kind of early warning system for business owners. Following what PE firms do can help us determine whether or not it’s a good time to consider selling our businesses (assuming they are in selling condition of course). The signals that PE activity is providing right now could mean that business owners should actively consider exiting.
PE firms are cashing out at a record pace
According to Preqin, a leading provider of comprehensive data and research on private equity, real estate, hedge funds and infrastructure funds, private equity firms are selling their investments at a record-breaking pace. 309 “exits” with a value in excess of $120 billion were announced during the second quarter of 2011. This represents a 50 percent increase from the $80 billion in exits announced during the first quarter of the year. The fourth quarter of 2010 set the previous record of exits with $81.5 billion in announced sales.
Private equity firms aren’t selling because they are strapped for cash. As an industry they have over $400 billion in funds ready to invest. The reason they are selling, in part, is because fund managers believe they can secure good valuations (i.e. high prices) for their investments.
Could this be our canary?
PE funds continually buy and sell. But three straight quarters of record activity is more than just coincidence. Perhaps managers believe that prices will soon go down or buyer appetite will wane due to economic conditions. If the current quarter shows a similar level of exits then accelerating your plans to exit may be warranted.
So who is going to buy your company?
There are many different types of buyers, but if your company has sufficient scale, our canaries may also be in the market to buy. Even though exit activity is at a record, PE funds still need to buy companies. These purchases could be direct purchases for the fund or as part of a portfolio company expansion strategy.
During the second quarter of the year, 674 private equity buyout deals were announced with a total value of nearly $76 billion. Only 21 of these deals were valued at over $1 billion—97 percent of private equity buy outs were for relatively small transaction values.