An Analysis of the Economic Forces Driving Partial Exits in Private Equity Transactions

Abstract

Private capital markets are rich with information asymmetries, including agency problems between General Partners (GPs) and entrepreneurs and between GPs and their respective Limited Partners (LPs). As such, this study investigates partial exits, or non 100% equity stake sales, as a mechanism by which private equity firms may mitigate inherent transactional (asset seller and buyer) and structural (GP and LP) agency challenges. Although their frequency of use by private equity firms has risen dramatically over recent decades, partial exits have drawn little academic attention in a buyout context. This thesis, thus, aims to provide explanatory detail behind private equity usage of partial exits. We propose three central hypotheses: frequency of partial exit usage will increase in (1) transaction contexts with significant information asymmetry between buyer and seller (2) situations that demand liquidity from GPs and (3) contexts in which GPs attempt to signal investment firm quality to LPs. We utilize a public dataset of over 13,000 private capital transactions, with asset, fund, and investment firm level detail per completed exit. Our results indicate that partial exit usage is indeed tied to information asymmetries faced by private equity firms; partial exit usage increases in transactions characterized by high information asymmetry and in macroeconomic and fund environments that pose liquidity constraints. Further, partial exits are demonstrated to strengthen GP fund quality signals by mitigating signaling costs associated with grandstanding and amplifying time-weighted return metrics.