Private Equity An Overview

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Private EquityAn Overview

• Clark L. Maxam, Ph.D.
• Director of Research Braddock Financial
  Corporation
• and
• El Pomar Professor of Entrepreneurial Finance
  University of Colorado, Colorado Springs

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Private Equity Broadly Defined

• Technically refers to any type of equity
  investment in an asset in which the equity is not
  freely tradable on a public market.
• Less liquid
• Long Term in nature

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Private Equity Categories and Players

• Angel
• Early Stage Seed, Start-up
• Professional Venture Capital
• Early Stage, Expansion, Later Stage
• Private Equity
• Later Stage, Buyout, Special Situations
• Hedge Funds
• All Stages

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The Private Equity Market
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Key Player Overlap
Angel
Venture Capital
Private Equity
Hedge Funds
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Traditional Private Equity Primary Activity

• Professional pools of capital that buy all the
  publicly traded equity of target companies Go
  Private
• Usually done with borrowed money
• High degree of leverage
• Aka Leveraged Buyout

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The Basic Value Creation FormulaFundamental
Ideas

• Re-focuses acquired businesses resulting in lower
  costs and improved efficiency.
• Value is created through basic finance that says
  debt can increase firm value if you can afford
  it!
• Exploits corporate aversion to debt (Henry McVey,
  Morgan Stanley).
• Regulatory Arbitrage Sarbanes-Oxley

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The Basic Value Creation FormulaDebt can
increase Value

• Dupont Equation

Leverage Debt as of Assets ? Equity ?
Multiplier ? ROE
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The Basic Value Creation FormulaDebt can
increase Value
Consider a company that takes on debt at a cost
of 3 in Net Income, but changes NOTHING ELSE.
Could drop NI to 4.8 and still match the previous
ROE!!
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The Basic Value Creation FormulaAn Example
Carlyle Group

• Leveraged Buyout

Case 1 (5 years) No Profit Increase
Case 2 (5 years) Profit Increase
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Source International Financial Services
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Private Equity Investments by Country
Source International Financial Services
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Source National Venture Capital
Association,Thomson Venture Economics
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Source National Venture Capital
Association,Thomson
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Source Cambridge Associates, LLC
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Private Equity Issues Going Forward

• PE as a new Model of General Management (Jensen)
• Overcomes entrenched thinking, management and
  disjoint between manager incentives and capital
  markets.
• Problematic Trends
• Publicly held Private Equity oxymoron
• Fee Structures not tied to exit
• Hedge funds in the PE business not a
  transaction business.

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Private Equity Issues Going Forward

• 2007 estimate of160B in dry powder ? 750B ?
  590B in debt appetite.
• Banking capacity is finite and already extended.
• Potential regulatory limits

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Private Equity Issues Going Forward

• PE Boom has been fueled by
• Historically low rates
• Regulatory arbitrage
• Both could reverse quickly and change the metrics
  dramatically