The three traditional exit ramps for private equity investments—corporate strategic buyers, initial public offerings and so-called secondary buyouts in which one private equity group sells to another—are all operating at optimal levels, aided by record highs of the U.S. stock market and consistently friendly credit markets.
And yet the number of U.S. companies owned by private equity firms is expected to continue growing, up from a 2014 midyear count of 7,675, according to PitchBook. With continued vitality in the economy and markets, exit activity in 2015 is expected to increase. Still, globally the inventory of PE-backed companies exceeds 13,000, roughly triple the level of a decade earlier. Private equity firms entered the financial crisis laden with cash and commitments from limited partners, so they kept buying companies; then unfriendly markets constricted exits for years. That led to longer hold times and, consequently, lower returns.
This inventory glut of PE-backed companies is reason enough to consider a fourth exit strategy, namely the Employee Stock Ownership Plan, or ESOP. ESOPs can and do buy companies owned by private equity funds, bidding competitively and closing with certainty.
Below is one inspiring case study. But there’s another reason to embrace employee ownership: As co-investors with PE funds at the front end of a buyout, ESOPs bring significant tax and operating benefits unavailable to other ownership structures. A small but growing number of players in the private equity world recognize these benefits and are aligning with ESOPs to become more effective bidders, owners and sellers of companies.