Private Equity Is Finding New Ways to Cash Out After IPOs

(Bloomberg) — Private equity firms are facing a double dilemma. IPO markets, the usual path for exiting investments, have been gradually reopening, but not enough for them to cash out completely. Option B for getting paid, borrowing the money by putting it on the company’s balance sheet, will only make the first problem worse by spooking equity investors.

Enter Hellman & Friedman, which engineered a strategy last month that allowed it to cut its stake in security company Verisure Plc via an initial public offering and raise €1 billion ($1.2 billion) for a payout by issuing debt from a special-purpose vehicle that sits outside of Verisure’s balance sheet.

Now, analysts say the approach could become a model for other buyout firms that have struggled to return cash on investments made during the era of cheap financing and near-zero interest rates.

“Private equity firms are having to be more creative about generating returns upfront,” said Jonathan Parry, capital markets partner at White & Case. “We’re not at a stage where owners can sell large chunks of their holding at IPO.”

Other buyout firms have previously used margin loans to pay dividends, which tend to be cheaper for borrowers, but shorter dated and allow banks to demand repayment under certain conditions.

In H&F’s case, the deal is unusual because of the type of debt raised, called payment-in-kind, and that it was done at a holding company level on a minority stake. As well, there are no repayment triggers on the PIK debt.

“We are certainly seeing PE sponsors seeking to get creative to take advantage of what are extremely frothy equity markets,” said Alex Robb, a finance partner at Ropes & Gray. He said there are likely to be fewer cases of margin loans being used by buyout firms and more bespoke options to add leverage at holding company levels.

The upshot of this process is that H&F pockets quick cash as it waits for a bigger payday when the shares can be sold. One of the problems in the industry is that stock investors have been wary about buying private equity-backed companies burdened by debt, forcing sponsors to sit on their stakes for longer.

As a result, one increasingly popular strategy in private equity-backed IPOs has been to sell primarily new shares and use the proceeds to pay down the company’s debt. The hope then is that lighter debt load helps propel the stock higher after the IPO, allowing the PE firm to drip-feed its stake to the public market.

Verisure’s IPO

For its part, Verisure’s stock is off to a strong start. Its shares have risen about 20% since its debut, which marked the largest European IPO in three years.

In H&F’s case, the buyout firm and Verisure’s other shareholders sold around €492 million worth of shares largely through the overallotment option in the IPO. And then to fund a bigger payout, H&F used an entity, called Aegis Lux 1A, which holds its Verisure position, to sell the PIK note.

While PIK bonds give borrowers the option to delay interest payments and roll it into the principal, H&F is expected to pay cash, according to people familiar with the matter. Banks led by Morgan Stanley arranged the deal, which was underwritten, said the people, asking not to be identified.

Representatives for H&F and Morgan Stanley declined to comment.

If Verisure shares climb higher, H&F could start to bring blocks of its about 44% stake to market once lock-ups expire, the people said. However, the PIK notes have to be repaid if H&F’s stake falls to less than 20%, they added. Since the financing is separate from Verisure’s capital structure, it doesn’t add to its leverage ratios.

The deal was part of a broader plan to delever Verisure and make it more attractive to public investors, they said. Verisure’s leverage ratio has dropped to around three, down from roughly 4.7 before the IPO. The aim is to bring that level as low as 2.5 by the end of 2026, with the hope of achieving an investment-grade rating.

“So long as there is appetite for deals like this, raising PIK on a company stake for the purpose of taking it out as a dividend, then there is scope to see more going forward,” said Sabrina Fox, a leveraged finance expert and founder of Fox Legal Training. “Credit markets are hotting up and there is scope for innovation.”

(Updates with stock performance in 10th paragraph.)

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