An IPO sells the first tranche of the stake at a discount and leaves the rest to a sell-down priced by the market, which a valuation headline does not show.
At the same valuation, an IPO exit returns less than a trade sale because the sponsor sells only part of its stake at the IPO, at a discount, and the rest in blocks after the lock-up. On an illustrative buyout with 200 million invested and a stake worth 460 million in year 5, a trade sale returns 2.30x and 18.13 per cent; the IPO route returns 420.7 million, 2.10x and 13.94 per cent if the share price simply holds. The shares would have to rise 12.7 per cent a year after listing to match the multiple, and 33.2 per cent to match the IRR.
Worked in full in The Buyout Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Sponsors often present an IPO as the premium exit, and for very large companies it may be the only route that clears the size. But the IPO is not a sale of the stake. It is a sale of the first tranche, a listing, and the start of a sell-down that runs for a year or more at whatever price the market sets. The comparison has to be made on the sponsor's dated cash flows, not on the valuation the IPO headline prints.
| Input | Value |
|---|---|
| Sponsor equity invested, year 0 | 200.0 |
| Fair value of the sponsor's stake, year 5 | 460.0 |
| Trade sale: whole stake sold in year 5 at fair value | 460.0 |
| IPO price discount to fair value | 12% |
| Share of stake sold at the IPO, year 5 | 30% |
| Underwriting fee on the IPO tranche | 3.0% |
| First block after the 180-day lock-up, year 5.5 | 35% at a 5% discount |
| Second block, year 6.5 | 35% at a 4% discount |
| Fee on each block | 1.5% |
| Share price after the IPO | trades at fair value, flat |
The base case is deliberately kind to the IPO: the trade sale gets no control premium, and after listing the shares trade straight back up to fair value, so the 12 per cent discount costs the sponsor only on the first tranche.
Proceeds 460.0 in year 5. MOIC = 460.0 / 200.0 = 2.30x. IRR = 2.301/5 − 1 = 18.13%.
Stake at the IPO price = 460.0 × (1 − 12%) = 404.8.
Proceeds = 30% × 404.8 × (1 − 3.0%) = 121.44 − 3.64 = 117.80.
Year 5.5: 35% × 460.0 = 161.00, less the 5% block discount = 152.95, less the 1.5% fee = 150.66.
Year 6.5: 161.00, less 4% = 154.56, less 1.5% = 152.24.
Flows: −200.0 at year 0, 117.80 at 5.0, 150.66 at 5.5, 152.24 at 6.5. Total 420.7, MOIC 2.10x.
Excel, with dates in A1:A4 and flows in B1:B4: =XIRR(B1:B4,A1:A4), which gives 13.94%.
| Route | Proceeds | MOIC | IRR | Weighted exit year |
|---|---|---|---|---|
| Trade sale | 460.0 | 2.30x | 18.13% | 5.00 |
| IPO and sell-down | 420.7 | 2.10x | 13.94% | 5.72 |
The IPO route gives up 39.3 million, 8.5 per cent of the proceeds, and 4.18 points of IRR. The cash shortfall comes from three places: the IPO discount on the first tranche, the fees, and the block discounts. The IRR shortfall is larger than the cash shortfall suggests because 70 per cent of the stake arrives half a year to a year and a half later, while the fund's money is still counted as invested.
The break-even is a market call. To match the trade sale's 2.30x the shares must rise 12.7 per cent a year after listing. To match its 18.13 per cent IRR they must rise 33.2 per cent a year, because the deferred proceeds have to earn the deal's own rate of return before they add anything.
| Share price change a year | Proceeds | MOIC | IRR |
|---|---|---|---|
| −20% | 361.5 | 1.81x | 11.11% |
| Flat | 420.7 | 2.10x | 13.94% |
| +10% | 451.4 | 2.26x | 15.26% |
| +20% | 483.0 | 2.41x | 16.53% |
| IPO discount | Proceeds | MOIC | IRR |
|---|---|---|---|
| 0% | 436.8 | 2.18x | 14.77% |
| 12% | 420.7 | 2.10x | 13.94% |
| 20% | 410.0 | 2.05x | 13.38% |
Even a 20 per cent annual rise after listing leaves the IPO at 16.53 per cent, below the trade sale's IRR, though it beats its multiple at 2.41x. A 20 per cent fall turns a 2.30x deal into 1.81x. The pricing discount matters less than the price path: moving it from 0 to 20 per cent changes proceeds by 26.8 million, while a 20 per cent rise or fall in the market changes them by 62.3 or 59.2 million. The sponsor that lists keeps 70 per cent of its stake exposed to the market for six months and 35 per cent for eighteen.
Comparing the IPO valuation with the trade sale price and calling the higher one the better exit. The IPO valuation is a price per share, and 70 per cent of the sponsor's shares are not sold at it, or on that day. A second mistake is to compute the IPO return as if the whole stake were sold at the first day's close, which ignores the lock-up and block discounts and places all proceeds in year 5. Exit timing alone moves IRR, as when a buyout fund should sell shows; the IPO adds a market bet to it.
The exit waterfall and the sponsor's IRR by annual and by dated flows are built in the free workbooks for this book.
Because most of the stake is sold later and below the market price. In the illustration only 30 per cent is sold at the IPO, at a 12 per cent discount, and 35 per cent each at years 5.5 and 6.5 at block discounts of 5 and 4 per cent. The weighted exit date moves from 5.00 to 5.72 years and IRR falls from 18.13 to 13.94 per cent.
On the illustrative figures, 12.7 per cent a year to match the trade sale's 2.30x multiple and 33.2 per cent a year to match its 18.13 per cent IRR. The IRR hurdle is higher because the deferred proceeds must first earn the deal's own rate of return over the sell-down period.
As dated cash flows: the IPO tranche at the IPO price less the underwriting fee, then each block at the market price less a block discount and fee, on its own date, with XIRR over the whole series. In the illustration the flows are 117.80, 150.66 and 152.24 million against 200.0 invested, for 13.94 per cent.
This article is one calculation from The Buyout Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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