In many circles, when private equity managers talk about exits, the conversation often shifts to IPOs or trade sales. These remain powerful routes to liquidity and value realisation, but in practice, many exits today happen in less headline-grabbing ways: secondary sales to another fund or management buyouts (MBOs).
These routes are increasingly attractive, especially when public markets are volatile or strategic buyers are cautious. But they bring with them a unique set of legal challenges. Funds that anticipate these challenges early can position themselves for smoother transactions, faster execution, and less value leakage.
Secondary Sales: When the Buyer Is Another Fund
A secondary sale can be appealing because it provides a clean exit and a natural buyer who already understands the dynamics of the sector. However, the devil is in the detail.
One of the most common pitfalls arises from the seemingly straightforward, yet often poorly structured, drag-along, tag-along, and co-sale rights. Typically negotiated at the time of investment and left untouched for years, these provisions are only truly tested at exit. Too often, funds discover the drafting does not work as intended. Minority shareholders may resist being dragged by pointing to drafting deficiencies, while additional parties can complicate the deal by exercising co-sale or tag-along rights and insisting on parallel participation.
The fix? Critically “road-test” these provisions at the time the transaction is formed, or at the very least, well before exit discussions actually commence. It is far easier to amend shareholder arrangements in a moment of calm than during heated negotiations with a buyer waiting in the wings.
In this context, “road-testing” means evaluating whether the drafting will withstand the realities of an actual exit. Boilerplates simply will not do. This requires not only ensuring that the mechanics are internally consistent, but also confirming enforceability in light of corporate law, the company constitution, and any competing contractual arrangements. Sophisticated funds model potential exit pathways, whether a trade sale, secondary sale, or management buyout, against the existing rights to determine whether the provisions support their strategic objectives. By identifying gaps or unintended consequences early, amendments can be made on a consensual basis rather than under the pressure and leverage of a live transaction.
Management Buyouts: Balancing Conflicts and Incentives
In an MBO, existing management step into the shoes of the buyer. This can be an elegant solution, particularly when the team knows the business intimately and has a vested interest in its continued success. But it is also fraught with potential conflicts.
The dual role of management as both sellers (aligned with the fund) and buyers (pushing for favourable terms) can create tension. From a legal perspective, clarity and transparency are essential. The fund must carefully manage information flow, negotiation dynamics, and fiduciary duties.
Additionally, structuring warranties and indemnities in this context is a balancing act. Management may be reluctant to give extensive warranties once they step into the buyer’s shoes, but the fund still needs to demonstrate to its investors that it has protected downside risk. Solutions, such as warranty and indemnity insurance, or limited recourse frameworks, may help bridge this gap.
Warranties, Indemnities, and Value Preservation
Regardless of whether the exit is to another fund, competitor or via an MBO, warranties and indemnities are often an important battleground. Poorly structured risk allocation can erode value, either through post-completion claims or protracted negotiations that delay closing.
Funds can reduce this risk by:
- Preparing disclosure materials well in advance and along the way, so there are fewer surprises in diligence.
- Considering insurance solutions to shift risk and speed up execution.
- Aligning early with management on who gives which warranties, and on what basis.
The goal should be to avoid the last-minute brinkmanship that can eat into both value and relationships.
The Common Thread: Planning Ahead
What unites these scenarios is that the legal foundation for a clean exit is often laid years before the transaction itself. Shareholder agreements, management incentive structures, and governance arrangements that can seem an afterthought at the time of investment, become pivotal at exit.
PE funds that build exit readiness into their portfolio oversight, not just financial readiness, are best placed to achieve strong returns. This means:
- Regularly reviewing constitutional and shareholder documents for enforceability.
- Ensuring management equity is structured with clear buy-back and exit provisions.
- Mapping out regulatory or third-party consents that might be required, long before they are critical.
- Ensuring the return horizon is commercially realistic. Ambitious targets have their place, but unrealistic timelines can create unnecessary pressure, distort decision-making, and ultimately erode value. Setting expectations that align with market conditions and the company’s genuine growth trajectory will reduce the risk of disappointment at exit.
Conclusion
For private equity, returns are ultimately judged not by the acquisition but by the exit. IPOs and trade sales may capture headlines, but secondary sales and management buyouts are increasingly the real workhorses of the industry.
The message is simple: in exits, as in investments, preparation pays.
For more information, speak with our experienced corporate team today on (03) 9481 2000 or info@tauruslawyers.com.au.