What Is a Secondary Buyout (SBO)?

The term secondary buyout (SBO) refers to a transaction involving the sale of a portfolio company by one financial sponsor or private equity firm to another. This kind of buyout indicates the end of the seller's control or involvement with the company. Secondary buyouts have historically been perceived as panic sales. As such, they can be hard to consummate. Secondary buyouts are not the same as secondary market purchases or secondaries, which typically involve the acquisition of entire portfolios of assets.

Key Takeaways

  • A secondary buyout is a transaction involving the sale of a portfolio company by one financial sponsor or private equity firm to another. 
  • SBO opportunities provide seller firms with instant liquidity.
  • These buyouts make sense when the selling firm realizes gains from the investment or when the buying firm can offer more benefits to the entity being sold.  

How Secondary Buyouts (SBOs) Work

A secondary buyout is a financial transaction that involves the sale of a portfolio company—an entity in which a corporation has an investment. The buyer and seller are normally a financial sponsor or a private equity firm. A secondary buyout offers a clean break between the seller and other partner investors. Private equity firms looking to exit an investment had two other options available to them—they either took their portfolio companies public or sold them to another company active in the same industry.

Part of the reason that seller private equity firms seek out secondary buyout opportunities is that they offer instant liquidity similar to an initial public offering (IPO). Although they may be smaller in scope, an SBO allows the selling company to forgo having to fulfill the regulatory requirements that come with an IPO. Secondary buyouts often make sense when the selling firm already realizes significant gains from the investment, or when the buying private equity firm can offer greater benefits to the firm being bought and sold. Buyouts are also considered distressed sales because they're done at times when firms need to sell assets to avoid financial problems. In these cases, most limited partner investors considered them to be unattractive investments.

The selling company can forgo the regulatory requirements of taking the entity public by undergoing a secondary buyout.

The 2000s saw an increase in the popularity of secondary buyouts. This development was largely driven by increases in available capital for such buyouts. The number of SBOs continues to increase—in fact, more than 40% of all private equity exits come by way of secondary buyouts. Private equity firms continue to pursue secondary buyouts for a variety of reasons including:

  • A sale to strategic buyers or an IPO may not be an option for a niche or small business
  • Secondary buyouts might be able to generate quicker liquidity
  • Slow growth businesses with high cash flows may be more appealing to private equity firms than they are to public stock investors or other corporations

Special Considerations

There are a few things the buying company can do to make sure the buyout makes sense including determining the potential for future success for the entity by reviewing its previous successes and conducting stress tests and other research.

Secondary buyouts are successful if the investment matures to the point where it is necessary or desirable to sell rather than continue holding the investment. Or, if the investment has generated significant value for the selling firm. A secondary buyout may also be successful if the buyer and seller have complementary skill sets. In such a scenario, a secondary buyout can generate significantly higher returns and outperform other types of buyouts over the long term.