Private Equity Investing

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Private Equity Investing

• Mehmet I. Budak

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What is Private Equity?

• Investment strategy that involves the purchase of
  equity or equity linked securities in a company
• Investment is made through a negotiated process
• By sophisticated investors with financial and
  operating expertise
• The goal is to acquire undervalued or promising
  assets and realize profits in 3-5 years after the
  acquisition
• Information asymmetry and inefficiencies are
  important factors

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Alternative Investments
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Private Equity Investment Strategies

• Leveraged Buyouts
• Venture Capital (early vs. late stage)
• Special Situations (i.e. distressed)
• Mezzanine
• Secondary Purchases
• Fund of Funds

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Leveraged Buyouts

• Established firms with track records, stable cash
  flows and stable growth rates
• Annual revenues of 25 - 500 million
• Typically in basic retail, transportation and
  manufacturing industries
• Typically have assets to borrow against and
  access to bank loans
• Seek private equity to effect a change in
  ownership, finance an expansion or restructure

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Venture Capital - Early Stage

• Firms with substantial risk of failure - business
  models and marketing approach are yet to be
  proved
• Small and illiquid investments with size of 500k
  - 2 million
• The smallest type is the entrepreneur who needs
  the financing to conduct initial research and
  development
• The most mature type are those firms that are
  starting to turn profits but need capital for
  expansion
• Angel capital is an important source of funding

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Venture Capital - Late Stage

• Firms with more certain business models
• Proven technology and market
• Profitable and need expansion capital
• General size of 2 - 15 million
• IPO or Sale expected/feasible in near term
• Original investors may achieve some liquidity
• Because the risk is generally lower and the
  liquidity higher, later-stage investments require
  lower returns than early-stage investments

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Leveraged Buyouts vs. Venture Capital

• Buyouts focus on mature companies with stable or
  sustainable growth profile
• Buyouts rely heavily on debt financing to finance
  most of the purchase price
• Venture Capital focus on high growth industries
  with riskier investment profile than buyouts
• Venture Capital relies heavily on equity
  financing and has higher return targets than
  buyouts

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Special Situations

• Investment is supplied by specialized Turnaround
  Funds (TF) for target firms that have defaulted
  on their outstanding loans
• TFs receive controlling interests, with former
  owners making up the minority interest
• TFs renegotiates terms with existing lenders,
  offering to restructure or pay off loans at a
  discount
• TFs also deliver expertise to find new markets or
  partners for the firms products, cut costs,
  change or improve the current management

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Fund of Funds

• Investing directly in PE funds can be difficult
  for individual investors and small institutions
• Relatively high investment minimums may
  disqualify some of the small investors
• Information on PE managers is difficult to locate
• Gaining access to top PE funds can be difficult
  due to high investor demand
• Fund of Funds co-mingles the investments of small
  investors into a single pool and then assembles a
  portfolio of PE funds

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How are PE Funds Structured?

• Private limited partnerships
• Individual managers are the General Partner (GP)
• Providers of capital (pensions, insurance
  companies, wealthy people) are Limited Partners
  (LPs)
• Partnerships have 10-year life with 11
  extension
• 4-6 year investment period
• 1-2 annual management fee
• Profits split 80-20, after reaching hurdle
  return level for LPs
• LPs need to fund within 2-3 weeks of capital
  call
• Penalties for failure to fund by LPs
• IRRs depend on when money is transferred by LPs

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General Partners Key Activities

• Selecting investments
• Obtaining access to high quality deal flow
• Sorting and evaluating large amount of
  information
• Structuring investments
• Designing transactions
• Monitoring investments
• Providing strategic, operational and financial
  assistance to portfolio companies
• Exiting investments
• IPO, Sale or Recapitalization

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Private Equity Partnerships and Fundraising
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Private Equity Market - Investors

• Public and corporate pension funds, endowments,
  foundations, wealthy families, insurance
  companies, foreign investors and others
• Investors expect to receive higher risk-adjusted
  returns on private equity than other investments
• Potential benefits of diversification
• Advantage of economies of scope between private
  equity investing and investors other activities

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Private Equity Market - Intermediaries

• 80 of PE investments flow through specialized
  intermediaries, which are limited partnerships
• Intermediaries provide expertise in selecting,
  structuring, and managing private equity
  investments
• Intermediaries not organized as LPs play a less
  significant role today in the private equity
  market
• SBICs owned by banks and VC subsidiaries of
  non-financial corporations mostly invest their
  corporate parents capital

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Private Equity Market - Issuers

• Vary in size and their reasons for raising
  capital
• Young firms that are developing innovative
  technologies
• Middle market companies that are stable,
  profitable and need private equity to expand or
  restructure
• Going private transactions for public companies
• PIPE (Private Investment in Public Equity)
  provides financing without registration costs/
  disclosures associated with public offerings

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How are PE Funds Structured?

• Limited Partners Investors with money
• Insurance companies, pension funds, banks, and
  high net worth individuals
• Investors commit a certain amount to the fund
• They have no other active role in the fund and no
  liability beyond their commitments
• One General Partner Managers of money
• Manages the investments via a management company
• Receives management fee (typically 2) on
  commitments
• Receives carried interest in the profits

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How are PE Funds Structured?

• Contractually fixed lifetime (10-12 years)
• Capital is invested during the first 4-6 years
• Thereafter, investments are managed and
  liquidated
• Distributions are made to the limited partners in
  the forms of cash or securities
• General Partner typically raises a new fund when
  the investment phase for the existing fund has
  been completed (gt 80)
• Each fund partnership is legally separate and is
  managed independently of other fund partnerships
  (i.e KKR I vs. KKR II)

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Partnership Terms - Example

• Target Fund Size 1 billion
• Minimum Commitment 10 million
• Gross Target Return 25
• Management Fee 2
• Carried Interest 80 - 20
• Commitment Period 5 years
• Fund Term 10 years 11

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Relationship Between LPs and GPs

• LPs delegate significant responsibilities to GPs
• Resolution of potential conflict of interests
  lies in the structure of the partnership
  agreement
• Partnerships have finite lives
• To remain in business, GPs regularly raise new
  funds - easier for reputable firms with good
  record
• GP compensation is closely linked to the fund
  returns

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Partnership Covenants

• The objective is to limit excessive risk taking
  by GPs
• Covenants usually set limits on the of the
  partnerships capital that may be invested in a
  single firm
• Covenants may preclude investments in publicly
  traded and foreign securities, derivatives and
  other private equity funds, etc
• Covenants usually require that cash from sale of
  portfolio assets be immediately distributed to
  LPs
• LPs usually limit such deal fees or require that
  deal fees be offset against management fees
• Return hurdle rates for LPs

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Evaluating General Partners

• Track record, relevancy of past experience
• Generation of adequate deal flow
• Sound investment decision-making processes
• Ability to achieve successful exits / liquidity
• Advantages vs. similarly focused funds
• Sufficiency of resources
• Meaningful commitment of time
• Cohesiveness and sustainability of team
• Succession planning

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Co-investment By LPs

• Co-investments are direct investments in
  portfolio companies by LPs alongside private
  equity partnerships
• Usually, LPs acquire the securities on the same
  terms as the partnership but pay no management
  fee or carried interest
• Co-investment opportunities arise when GPs need
  additional equity financing to close a deal
• Some institutional investors see co-investing as
  an opportunity to acquire expertise in private
  equity investing
• For GPs, LPs that stand ready to co-invest
  represent a flexible source of funds for closing
  deals

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Transaction Origination
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Deal Flow

• Deal flow, access to high quality investment
  opportunities, is absolutely crucial
• GPs rely on relationships with third parties and
  industry contacts for deal flow generation
• The greater the deal flow, the higher the
  likelihood of identifying an attractive
  opportunity
• Proprietary deals are more attractive than
  deals brought by agents or intermediaries
• Less competition means lower purchase price
• Lower purchase price means higher IRRs

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Origination

• Investment banks, consultants, lawyers and
  industry contacts introduce potential
  opportunities
• Preliminary opportunity analysis will be
  performed relatively quickly
• Initial decision is quickly made whether a PE
  firm would be interested in the opportunity
• PE firms have different investment strategies and
  views of the world
• If interested, PE firms would sign
  Confidentiality Agreement to begin evaluating the
  opportunity

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Screening of Deals

• Deal screening is art and science
• PE firms receive many investment proposals in a
  year
• Proposals are first screened to eliminate those
  that are clearly fail to meet investment criteria
• Specialization on a specific industry or
  geography reduces the number of investment
  opportunities considered
• Initial review takes a 1 2 days and results in
  the rejection of 90 of proposals received by a
  PE firm
• Surviving proposals then become subject to a
  secondary review after the signing of a
  Confidentiality Agreement
• Proposals that survive the preliminary and
  secondary reviews become the subject of a
  comprehensive due diligence process

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Non-Binding Indications of Interest

• Commonly referred to as 1st round bid
• Give sellers a perspective on the level of buyer
  interest and the valuation parameters buyers are
  likely to assume
• Indication of interest subject to
• Completion of business, legal, accounting and
  environmental due diligence
• Negotiation and execution of documents
• Receipt of necessary approvals
• Negotiation of employment agreements with key
  management

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Leveraged Buyouts
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What is an LBO?

• Acquisition of a company where a PE firm uses
  cash equity and debt to fund the purchase price
• PE firm injects equity into a new shell company
  (NewCo), which borrows debt and simultaneously
  acquires the target
• PE firm contributes capital, operating and
  financial expertise, strategic insight, contacts
  and management talent
• Management ownership increases, creating higher
  incentives to improve operations and deliver
  results
• Debt is repaid by the operating cash flows or by
  the sale of non-core assets of the acquired
  business
• LBO is similar to buying and renting out a house
  - the rent cash flows to pay down the mortgage
  debt

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Typical LBO Structure
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Typical LBO Structure

• Varies over time with market conditions
• Sources of financing
• 40 50 senior bank debt (5-7 years)
• 20 30 subordinated debt (8-12 years)
• 20 40 common equity
• Bank debt is secured from receivables, inventory
  and PPE

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Good LBO Candidates

• History of consistent profitability
• Predictable cash flows to service debt
• Availability of excess cash
• Easily separable assets or businesses
• Strong management team
• Strong brands and market position
• Industry with barriers to entry
• Little danger from disruptive changes
  (technology, regulatory, etc.)
• Visible/feasible exit strategy (IPO or MA)

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Value Creation

• Strategic
• Vision, growth initiatives, add-on acquisitions,
  exit
• Operational
• Sales, costs, assets
• Organizational
• Processes, structure, systems, skills
• Financial
• Balance sheet, tax structure, capitalization
• Expansion in valuation multiples
• Advantages of being private

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How Do PE Firms Create Value?

• Minimize purchase price
• Maximize leverage
• Minimize liabilities purchased
• Manage transaction costs
• Improve business operations
• Maximize tax efficiency
• Optimize exit

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Minimize Purchase Price

• Avoid competition
• Auction process vs. proprietary deal
• Maintain price discipline
• Avoid deal fever
• Maximize deductions from headline price
• Earn outs
• Liabilities pension, legal, other

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Maximize Leverage

• Maintain competitive process among banks willing
  to fund the transaction
• Choose right financing structure
• Balance of risk, flexibility and interest cost
• Seller notes and staple financing
• Deeply subordinate and at attractive terms
• Partner with co-investors

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Minimize Liabilities Purchased

• Detailed due diligence
• Legal
• Financial
• Accounting
• Environmental
• Tough negotiations
• Reps and Warranties

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Transaction Costs and Taxation

• Minimize transaction costs
• Internal costs
• Aborted deal costs
• Maximize tax efficiency
• Increase interest tax shield
• Increase depreciation
• Increase tax deductible amortization

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Improve Business Operations

• Top line growth
• New markets, partners
• Products
• Margin improvement
• COGS
• SGA

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Exit

• Difficult to predict future business cycles and
  market conditions
• Prepare an exit strategy and groom the business
  for that exit
• Trade sale or MA clean cash exit
• IPO long process, company needs to be above a
  certain size, lock-up restrictions
• Leveraged recapitalization allows sponsor to
  remove invested capital prior to ultimate exit,
  increases IRR and hedges against poor exit
• Secondary buyout selling to another sponsor

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Sources and Uses of Funds
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Sources of Funds

• Equity
• New equity injection from LBO sponsor
• Potential equity contribution from existing
  management
• Potential continuing equity investment by
  existing shareholders (rollover)
• Equity from a strategic partner
• Debt
• Bank debt (senior debt)
• High yield debt (subordinated debt)
• Mezzanine securities
• Can be structured to be more debt-like or more
  equity-like depending on the situation

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Bank Debt

• Senior secured (most senior debt)
• Flexible, interest rate is floating
• Matures before other debt classes, amortizing
• Typically callable/prepayable at par
• Quarterly interest payments
• Maintenance covenants
• Structured at the operating company level
• Underwritten via syndication
• Diligence, commitment, launch, syndicate, fund

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Bank Debt

• Revolving Credit Facilities vs. Term loans
• Revolvers allow multiple drawings for working
  capital and general corporate needs
• Term loans funded at closing
• Pro Rata facilities
• Revolver and Term Loan A held by commercial
  banks
• Buy and hold mentality, shrinking segment
• Institutional tranches
• Consist of Term Loans B, C or D- held by
  insurance companies, CLOs and CDOs, growing
  segment
• Purely transactional, liquidity in the secondary
  market
• Minimal front-end amortization

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High Yield Bond Debt

• Usually subordinated and/or unsecured
• Interest rate is fixed, maturity of 8-10 years
• Bullet maturity after full bank debt
  amortization
• Usually not callable at par in early years,
  typically 1-5 years
• Structured at the operating company level
• Publicly quoted security
• Incurrence covenants
• Diligence, document, roadshow, price and fund

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Mezzanine Debt

• Subordinated to bank debt and high yield bonds
• Flexible, typically floating interest rate
• Non-amortizing, bullet maturity typically after
  10 years
• Cash PIK coupon payment further enhanced with
  equity warrants
• PIK component can eat into equity
• Structurally subordinated at the holding company
  level
• Incurrence covenants

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Due Diligence
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Due Diligence

• Objective
• Validate business concept
• Verify market
• Appraise management
• Validate forecasts
• Valuation
• Diligence establishes basis for valuation, price
  and negotiation
• Diligence is expensive and time consuming
• Diligence strategy
• Preliminary evaluation to identify
  deal-breakers before spending time and money on
  detailed due diligence

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Key Topics for Due Diligence

• Business concept, opportunity
• Market
• Competition
• Customers
• Products
• Management
• Financials
• Returns

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Business Concept, Opportunity

• What is the concept/opportunity?
• Is the opportunity sustainable?
• Potential size of the opportunity?
• How can the target company capitalize on the
  opportunity?
• Is the proposed plan/strategy realistic?
• How does the target business fit to its markets
  and region?
• Why are we so smart or lucky?

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Market

• Market characteristics, segments, size, growth,
  cyclicality, key metrics, demographics?
• Projected market share and sales volume?
• Low barriers to entry into the market?
• Is targets business model sustainable?
• How will the business be perceived by customers?
• Regulatory issues?

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Competition

• Who are the direct competitors?
• Relative size, scope, cost basis, brands and
  market share?
• What are the key factors/levers of competition in
  the industry?
• How is targets business strategy different than
  competitors?
• What are targets competitive advantages?
• What are the targets competitive disadvantages?
• Threat from potential new entrants?

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Customers

• Who are the customers?
• Current and future customer base?
• What specific market and customer needs does the
  target business serve?
• How do customers make their purchase decisions?
  Key criteria?
• Customer satisfaction and retention?
• Does the projected number of customers or sales
  make sense? Realistic?
• How will the target acquire new customers?

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Products

• Product life cycle, penetration trends?
• Product pricing?
• Product profitability?
• Productivity versus competition?
• Maintain or jettison certain products?
• Plant consolidation?
• Inventory optimization?
• CAPEX requirements?
• Development plans?

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Management

• Competent?
• Experienced?
• Cohesive?
• Strategic?
• Flexible?
• Incentivized?
• Proactive?
• Realistic?

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Financials

• What is the optimal capital structure?
• Are revenue and cost projections comprehensive,
  realistic, reasonable?
• What are the underlying business assumptions of
  the projections?
• Impact of various business case scenarios?
• How does cash flow in this business?
• How much capital investment needed? When?
• Correct accounting treatment?
• What are the key sensitivities?

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Confirming Value

• Financial and accounting diligence is primarily
  focused on drilling into the basic components of
  valuation
• Recurring EBITDA (adjust for extraordinary items)
• CAPEX
• Working Capital
• Cash Flow
• Multiple

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Recurring EBITDA

• General issues exclusions, accounting changes,
  pro forma adjustments
• Revenue components, method of recognition,
  customers, customer arrangements, pricing/volume
• Margins components of cost of sales, gross
  margin trends
• Reserves under/over statement of profits
• Compensation benefits, headcount needs,
  transition issues, bonus
• SGA components, trends, discretionary costs,
  fixed vs. variable, cost savings
• Other restructurings, acquisitions,
  contingencies

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CAPEX

• Determine normalized annual CAPEX
• Maintenance or mandatory CAPEX
• Determine expansion CAPEX
• Discretionary CAPEX
• CAPEX between signing and closing of transaction
  reduce net cash position
• Important to have correct CAPEX assumptions in
  calculating exit value

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Working Capital

• Analyze working capital cycle
• Components of B/S accounts
• Needs and trends
• Savings opportunities
• Potential closing balance sheet issues
• Important to have correct working capital
  assumptions in calculating exit value

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Legal Due Diligence

• Conducted in tandem with business, financial and
  accounting due diligence
• Structure the transaction in the most tax
  efficient manner
• Understand the legal aspects of targets business
  and assets being acquired
• Identify and evaluate liabilities
• Materials are typically made available for review
  in a data room

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What Is a Bad Deal?

• No real competitive advantage of PE firm
• Long list of things that have to go right to make
  the deal work
• Build it and they will come is not a good
  business strategy
• Aggressive estimates of future growth
• Employing the wrong management team
• True downside case is not adequately evaluated

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Transaction Structuring and Documentation
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Term Sheets

• Preliminary documents designed to provide a
  framework for negotiations between investors and
  the target company
• Provides collective understanding of the proposed
  transaction, basic terms and conditions
• Generally focuses on the targets valuation and
  the conditions under which investors agree to
  provide financing
• Term sheet eventually transforms into a formal
  agreement known as the Purchase Agreement, which
  is a legal document that details
• who is buying what
• from whom
• at what price
• when

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Key Sections of Term Sheets

• Acquirer
• Target
• Valuation
• Structure of acquisition
• Management compensation
• Debt financing
• Board of directors
• Rights
• Transaction fees
• Management fees

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Purchase Agreement

• Transaction terms and structure
• Description of asset sold
• Calculation of purchase price
• Closing date
• Reps and Warranties buyer and seller
• Conditions to closing seller
• Conditions to closing buyer
• Conditions for termination

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Purchase Agreement

• Clarity regarding key financial and deal terms
• Business/assets being acquired and the
  liabilities being assumed
• Arrangements for asset sharing going forward
• Protecting the acquirer from contingent or
  undisclosed liabilities
• Locking up the target, no shopping of the deal
• Representations and Warranties verification of
  factual matters covered during the due diligence
• Pre-closing operations
• Closing conditions fiduciary outs, break up fee
• Purchase price adjustments post closing
  adjustment

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Representations and Warranties

• Statement of fact at a particular point in time
• Purpose
• Provides basis for refusal to close the
  transaction if untrue (pre-close)
• Provides basis for post-closing indemnification
  for damages if untrue (post-close)
• Mainly refers to areas covered in due diligence
• Financial statements, liabilities, contracts,
  real estate, litigation, taxes
• Both buyer and seller gives Reps Warranties
• Buyers objective understand what I am buying
• Sellers objective increase certainty of closing

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Covenants

• Agreements to act or refrain from acting in the
  future
• Positive vs. Negative covenants
• Necessary because signing and closing are not
  simultaneous
• Pre-closing covenants
• Largely to the benefit of buyer
• Objective is to preserve the asset to be
  purchased and ensure closing occurs
• Post-closing covenants
• To the benefit of seller
• Objective is to protect certain interests once
  seller no longer owns the business

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Covenants

• Pre-closing
• Operations in the ordinary course of business
• No solicitation of proposals from competing
  buyers
• No dividends and distributions
• No issuance of equity or incurrence of debt
• No acquisitions and divestitures
• No execution of significant contracts
• No change in accounting practices
• Post-closing
• No changes to compensation
• No hiring or firing of key management employees

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Closing Conditions

• Transaction will not close until all conditions
  are satisfied
• Representations and warranties are true
• Absence of material adverse change in the
  business
• Excludes general economic or industry conditions,
  stock price movements, failure to meet forecasts,
  matters known to buyer
• Receipt of required government approvals and
  major third party consents
• Debt financing available on terms and conditions
  set forth in commitment letters
• Termination is cessation of both parties
  obligations
• Drop dead date financing and regulatory
• Breaches - break up fee 5
• Fiduciary out
• Buyers objective to be able to walk away if
  anything major is wrong
• Sellers objective to have some certainty that
  transaction will close if things are in
  reasonable order

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Deal Process Inside the PE Firm

• Initial screening of deals
• Heads up memorandum
• Non-binding indications / term sheets
• Detailed due diligence and evaluation
• Formal and detailed presentation to the
  investment committee
• Final approval and funding

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Heads Up Memo

• Why is the company being sold?
• What is the investment thesis?
• How does the opportunity fit with the PE firms
  investment strategy and skill base?
• What are the size, structure and timing of the
  investment?
• What is the PE firms edge in the process?
• What is the due diligence road map?
• How will the PE firm exit the investment?
• What are the expected returns and key assumptions
  driving the projections?

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Formal Investment Committee Memo

• Analysis of the deal opportunity, the business,
  the transaction, the process, industry trends,
  due diligence results
• Detailed discussion of risks and opportunities
• Detailed analysis of operating and financial
  projections
• Detailed scenario analysis and projected returns
• Key questions to answer
• Why do we want to do this deal?
• What is our edge?
• What value do we bring to this deal?
• Who is the competition?
• How and when will we exit?
• Impact of this deal on the rest of the portfolio?

76
Portfolio Company Monitoring
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Portfolio Company Life

• Year 1 Figure out what you just bought
• Fix problems, focus on 2-3 key areas to improve
• Assess and change out management
• Years 2-3 Strategic Plan and Execution
• Develop strategic business plan
• Make investments, pursue acquisitions
• Execute plan
• Pay down debt
• Year 4-5 Prepare for Exit
• Windows dressing, clean up
• Sell on good performance

78
Portfolio Monitoring

• Takes place at least quarterly
• Candid and open discussion on the status of each
  investment
• Progress of investment thesis
• Value already created
• Problems experienced
• Changes needed to the game plan
• Basis for valuation
• Exit planning and timing

79
Portfolio Monitoring

• Information gathering is crucial
• Board seats provide meaningful access
• Monthly financial and operational statistics are
  provided to PE investors
• Regular interaction (weekly/monthly conference
  calls) with management
• Weekly PE firmwide meetings
• Quarterly MDA write-ups from portfolio companies
• Annual audit reports

80
Portfolio Company Assistance

• Strategic and operational advice
• Financial engineering expertise
• Recruitment of top management and board members
• Leveraging industry contacts for identifying
  future partners, markets
• Revenue growth
• Gross margin improvement
• Operating expense reduction
• Cash flow improvement
• Crisis management
• Corporate governance
• Exit preparation
• Degree of involvement varies with type of
  investment

81
Mechanisms of Control

• Board Representation
• GPs are extremely influential and effective
  outside directors
• GPs have the resources and staff to monitor
  portfolio companies
• Allocation of Voting Rights
• GP investment is large enough to achieve majority
  ownership
• In some situations, GPs may obtain voting control
  even if they are not majority shareholders
• In general, a GPs voting rights do not depend on
  the type of stock issued. For example, holders of
  convertible preferred stock may be allowed to
  vote their shares on an as converted basis
• Control of Access to Additional Financing
• Venture Capital is provided in several rounds
• Influence of original investor is high on new
  GPs willingness to participate in subsequent
  rounds

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Best Practices

• Interact regularly with the management and gather
  timely information
• Focus on top 2-3 priorities and deliver strategic
  and operational assistance
• Evaluate progress made vs. plan
• Identify problems early
• Adjust game plan as needed
• Value portfolio companies conservatively
• Prepare for exit at least one year in advance

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Exit
84
Exit

• Limited partnerships must be dissolved within a
  certain time as they need to return capital to
  LPs
• Exit Monetization and realization of paper
  profits
• Exit requires advanced planning and preparation
• Sale
• IPO
• Recapitalization

85
Exit Planning

• Need to forecast the evolution of the business
• Closely follow macro trends in the industry
• Who are the likely buyers?
• Strategics vs. financial buyers
• Foreigners vs. local buyers
• Exit preparation takes time
• Execute strategy and hit the budget forecasts
• Develop and prepare the management team
• Establish a clean track record (audits)
• Establish a reputable and competent board

86
MA Exit

• Advantages
• Buyers usually pay a premium
• Clean exit with greater certainty
• Cheaper than IPO
• Faster and simpler than IPO
• Convince one buyer vs. the whole market
• Disadvantages
• May not be welcomed by the management sale or
  merger imply reduced independence
• Buyer appetite can be unpredictable

87
MA Sellside Process

• Investment bank (target advisor) due diligence
• Investment bank (target advisor) writes selling
  memo
• Narrow the universe of potential buyers and place
  initial calls into buyers
• Send and negotiate confidentiality agreements
• Send preliminary bid letters
• Analyze preliminary bids
• Create management presentations
• Assemble data room
• Buyer due diligence
• Send final bid letter
• Analyze final bids
• Negotiate key terms
• Contract negotiations and documentation
• Transaction announcement

88
IPO Exit

• Advantages
• Prestige of becoming a publicly traded company
• Currency for future MA activity
• Increased visibility for the company
• Preservers a companys independence and provides
  continued access to capital
• Disadvantages
• Not an immediate, clean liquidity event for
  investors
• Long and time-consuming
• Distraction for management
• Expensive process
• Information disclosure requirements
• Lock ups

89
IPO Process

• Due Diligence and Drafting
• Meetings with senior management, iterative
  drafting of registration statement (Business
  Overview, Risk Factors, Financials, MDA)
• Initial Filing with SEC
• Generally accessible to the public and does not
  include the expected share price range for the
  offering
• Structuring and Valuation
• Selecting co-managers, setting the initial filing
  range that serves as a valuation guideline for
  investors during the marketing process
• Prospectus Distribution
• SEC gives comments on each draft of registration
  statement, the preliminary Prospectus is mailed
  broadly to potential investors
• Salesforce Education
• On the companys story before marketing to
  potential investing clients, management dry runs
• Targeting Investors
• Identification of best potential buyers,
  determine anchor buyers based on their current
  holdings of stock, one-on-one meetings

90
IPO Process

• Syndication
• The lead underwriter takes the primary
  responsibility for this, syndicate members
  underwrite a fixed amount of stock and may be
  given additional allotments
• Roadshow and Bookbuilding
• Schedule of meetings with investors in key cities
  around the world, lasts 2-3 weeks, roadshow team
  makes formal presentations to investors at these
  meetings, key investors are met in a one-on-one
  format, smaller investors are accommodated in a
  group
• In tandem with the marketing effort, the
  bookbuilding process begins, investors submit
  indications of interest for shares in the IPO,
  the lead managers collect these orders and build
  a book of demand over the course of the marketing
  period, a critical component is the collection of
  qualitative feedback on the orders in the book
• Pricing and Allocation
• The quality of the book and aftermarket
  intentions of investors are critical, share
  performance in the aftermarket is important,
  allocations to institutional and retail investors
• Aftermarket
• Balance supply and demand in the aftermarket,
  over-allotment option, on-going research coverage
  (after 25 days) and trading support

91
Recapitalization

• Usually, the acquired company is highly levered
  at the beginning
• Over time, the company pays off debt with cash
  flows from its operations
• This creates additional capacity to add more debt
  1-3 years after the acquisition
• When additional debt is issued, excess cash is
  dividended out to the equity investors
• Investors achieve partial monetization
• Refinancing a mortgage is effectively a
  recapitalization

92
Capital Distribution to LPs

• Once an investment is monetized, the profits
  will be divided between LPs and GPs according to
  the partnership agreement
• 80 / 20 is usually the norm
• 80 to the LPs
• 20 to the GPs
• A minimum return hurdle for LPs may have to be
  cleared before GPs can claim their share of
  profits (I.e. 8)
• Clawback provision
• High returns make a strong track record which in
  turn makes future fundraising easier

93
Other Topics
94
Business Plan

• Identify a business need or niche and demonstrate
  its feasibility
• Analyze a product within the context of market
  and customer
• Evaluate the viability of a technology
• Describe major goals, objectives, and vision for
  1 year, 3 years and 5 years
• Assess ability of management to execute
• Provide detailed financial projections

95
Business Plan Key Sections

• Concept/Opportunity
• Strategy
• Operations
• Markets
• Customers
• Products
• Competition
• Risks
• Implementation

96
Concept/Opportunity

• Always stated within the context of an existing
  or projected market
• Translate concept into terms that investors can
  understand
• Clearly highlight which market needs will be
  filled or issues will be addressed
• Have comprehensive knowledge of the competitive
  environment and the potential reactions from
  competitors
• Analyze the current and future customer base in
  detail

97
Raising Money

• The process of raising money may have significant
  costs
• Time
• Opportunity cost of distraction
• Significant amount of questions and information
  requests
• Impact on the organization (I.e. uncertainty)
• Direct expenses travel, legal and accounting
• May be beneficial to hire reputable advisors with
  relevant past fundraising experience and track
  record

98
Presenting to Private Equity Firms

• Identify relevant PE firms
• May make sense to use advisors
• Most effective if someone credible refers you to
  the PE firm
• Do your research in advance
• At the initial meeting, impress them and capture
  their interest
• PE firms time is the biggest asset

99
Questions in PE Minds

• Who are these people?
• Do they fit the way we do business?
• What is the value and appeal of this business?
• Will there be enough customer demand for its
  products?
• What can go wrong with this company?
• What needs to be accomplished to justify this
  valuation?
• What are the key trends in the industry and
  sector?
• How dependent is the value of this company on the
  overall performance of the sector or industry?
• What is the likely response from competition?
• Do they have the right experience and skills to
  deliver?
• Do they have a realistic, relevant and flexible
  strategy?
• What are the exit implications?
• IPO and MA market trends?
• Can we/they win?

100
Developing Economies Need

• Capital
• Strategic vision
• Growth
• Credibility
• Global best practices
• Investor contacts
• Management talent

101
Private Equity Provides.

• Access to long-term financing
• GPs and LPs with significant investing experience
  around the globe
• Valuable strategic insights and operational
  expertise
• Significant financial discipline
• Substantial credibility and visibility to target
  company and the country
• Best practices to pursue profitable growth

102
Positive Impact of Private Equity

• A long-term support to those companies with the
  potential of success and sustainability
• Builds and grows business faster than they
  otherwise would
• Encourages entrepreneurial spirit, technological
  advancement and job creation
• Crucial to the existence, feasibility and success
  of businesses in the seed/start-up and expansion
  stages
• Teaches discipline of the buyside

103
Priorities for Private Equity

• Promote entrepreneurial environment and increase
  incentives for entrepreneurial investments
• Facilitate private equity fund formation
• Develop long-term capital sources
• Incorporate private equity needs and perspectives
  into policy-making

104
Entrepreneurial Environment

• Minimum regulation and bureaucracy
• Simplified requirements of company formation
• Support for private equity and entrepreneurial
  education
• Favorable tax regime capital gains
• Equity and options ownership
• Awareness of private equity as engine of growth
  and value creation

105
Long-Term Capital Sources

• Access to long-term funding is essential for PE
  firms
• Development of pension funds and relevant
  regulatory regime is a critical step
• U.S. example
• Pension funds should be allowed to invest in
  private equity
• Unrestricted movement of capital is a must-have
  for private equity industry

106
Rules for Private Equity Investing

1. Develop your own idea of what a business is worth
2. Avoid auctions
3. Pick your spots
4. Approach each potential transaction with
   overwhelming force
5. Follow the cash
6. Get timely help from experts, advisors
7. Keep your emotions in check (deal fever)
8. Develop trust with your team and managers
9. Make sure acquired company managers concentrate
   on the few vital objectives
10. When management team is not working, change them
    as soon as possible