Private Equity Investing
Mehmet I. Budak
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What is Private Equity?
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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
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
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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
Venture Capital - Early Stage
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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
Venture Capital - Late Stage
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Firms with more certain business models
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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 firm’s products, cut costs,
change or improve the current management
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Fund of Funds
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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
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 +1+1 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 Partner’s Key Activities
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Selecting investments
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Structuring investments
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Providing strategic, operational and financial
assistance to portfolio companies
Exiting investments
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Designing transactions
Monitoring investments
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Obtaining access to high quality deal flow
Sorting and evaluating large amount of
information
IPO, Sale or Recapitalization
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 riskadjusted 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 parent’s capital
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Private Equity Market - Issuers
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Vary in size and their reasons for raising
capital
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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?
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Limited Partners – Investors with money
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One General Partner – Managers of money
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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
Manages the investments via a management
company
Receives management fee (typically 2%) on
commitments
Receives “carried interest” in the profits
How are PE Funds Structured?
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Contractually fixed lifetime (10-12 years)
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Capital is invested during the first 4-6 years
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Thereafter, investments are managed and liquidated
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Distributions are made to the limited partners in the
forms of cash or securities
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General Partner typically raises a new fund when the
investment phase for the existing fund has been
completed (=> 80%)
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Each fund partnership is legally separate and is
managed independently of other fund partnerships
(i.e KKR I vs. KKR II)
Partnership Terms - Example
 Target
Fund Size
 Minimum Commitment
 Gross Target Return
 Management Fee
 Carried Interest
 Commitment Period
 Fund Term
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$1 billion
$10 million
25%
2%
80% - 20%
5 years
10 years +1+1
Relationship Between LPs and GPs
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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
Partnership Covenants
The objective is to limit excessive risk taking by GPs
 Covenants usually set limits on the % of the
partnership’s 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
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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
Co-investment By LPs
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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
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
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Less competition means lower purchase price
Lower purchase price means higher IRRs
Origination
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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
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PE firms have different investment strategies and views of
the world
If interested, PE firms would sign Confidentiality
Agreement to begin evaluating the opportunity
Screening of Deals
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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
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:
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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
Leveraged Buyouts
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What is an LBO?
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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
Typical LBO Structure
Ownership
Current Owners
Purchase price
Acquiror (LBO firm)
Equity investment
NewCo
Bonds
Bank loan
Bond Holders
Banks
NewCo acquires Target
Target
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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
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 Bank
debt is secured from receivables,
inventory and PP&E
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Good LBO Candidates
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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 M&A)
Value Creation
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Strategic
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Operational
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Sales, costs, assets
Organizational
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Vision, growth initiatives, add-on acquisitions, exit
Processes, structure, systems, skills
Financial
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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
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competition
Auction process vs. proprietary deal
 Maintain
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price discipline
Avoid “deal fever”
 Maximize
price
deductions from headline
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
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Balance of risk, flexibility and interest cost
 Seller
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notes and staple financing
Deeply subordinate and at attractive terms
 Partner
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with co-investors
Minimize Liabilities Purchased
 Detailed
due diligence
Legal
 Financial
 Accounting
 Environmental
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 Tough
negotiations
 Reps and Warranties
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Transaction Costs and Taxation
 Minimize
transaction costs
Internal costs
 Aborted deal costs
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 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
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 Margin
COGS
 SG&A
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improvement
Exit
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Difficult to predict future business cycles and market
conditions
Prepare an exit strategy and groom the business for
that exit
Trade sale or M&A – “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
Sources and Uses of Funds
SOURCES
New Revolver (L + 275 bps)
$ 25.0
Purchase Price of Equity
New Term Loan A (L + 275 bps)
150.0
Refinance Existing Debt
630.0
New Term Loan B (L + 325 bps)
200.0
Assume Capital Leases
25.0
Transaction Costs
20.0
Assume Capital Leases
25.0
Total Senior Debt
400.0
New Senior Subordinated Notes (12%)
Total Debt
New PIK Preferred / Seller Paper (14%)
Acquiror’s Equity / Strategic Cash
Total Sources
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USES
$
250.0
250.0
650.0
75.0
200.0
$925.0
Total Uses
$925.0
Sources of Funds
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Equity
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Debt
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Bank debt (“senior” debt)
High yield debt (“subordinated” debt)
Mezzanine securities
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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
Can be structured to be more “debt-like” or more “equitylike” depending on the situation
Bank Debt
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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
Bank Debt
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Revolving Credit Facilities vs. Term loans
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Pro Rata facilities
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Revolver and Term Loan A – held by commercial banks
Buy and hold mentality, shrinking segment
Institutional tranches
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Revolvers allow multiple drawings for working capital and
general corporate needs
Term loans funded at closing
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
High Yield Bond Debt
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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
Mezzanine Debt
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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
Due Diligence
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Due Diligence
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Objective
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Valuation
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Diligence establishes basis for valuation, price and
negotiation
Diligence is expensive and time consuming
Diligence strategy
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Validate business concept
Verify market
Appraise management
Validate forecasts
Preliminary evaluation to identify “deal-breakers” before
spending time and money on detailed due diligence
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
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Market characteristics, segments, size,
growth, cyclicality, key metrics,
demographics?
Projected market share and sales volume?
Low barriers to entry into the market?
Is target’s business model sustainable?
How will the business be perceived by
customers?
Regulatory issues?
Competition
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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 target’s business strategy different
than competitors’?
What are target’s competitive advantages?
What are the target’s competitive
disadvantages?
Threat from potential new entrants?
Customers
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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?
Products
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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?
Management
 Competent?
 Experienced?
 Cohesive?
 Strategic?
 Flexible?
 Incentivized?
 Proactive?
 Realistic?
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Financials
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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?
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
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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
SG&A – components, trends, discretionary costs,
fixed vs. variable, cost savings
Other – restructurings, acquisitions, contingencies
CAPEX
 Determine
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Maintenance or mandatory CAPEX
 Determine
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normalized annual CAPEX
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 target’s
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?
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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
Transaction Structuring and
Documentation
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Term Sheets
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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 target’s 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
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Mainly refers to areas covered in due diligence
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Provides basis for refusal to close the transaction if untrue
(pre-close)
Provides basis for post-closing indemnification for damages
if untrue (post-close)
Financial statements, liabilities, contracts, real estate,
litigation, taxes
Both buyer and seller gives Reps & Warranties
Buyer’s objective – understand what I am buying
Seller’s objective – increase certainty of closing
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
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Post-closing covenants
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Largely to the benefit of buyer
Objective is to preserve the asset to be purchased and
ensure closing occurs
To the benefit of seller
Objective is to protect certain interests once seller no longer
owns the business
Covenants
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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
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Post-closing
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No changes to compensation
No hiring or firing of key management employees
Closing Conditions
Transaction will not close until all conditions are satisfied
 Representations and warranties are true
 Absence of material adverse change in the business
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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
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72
“Drop dead” date – financing and regulatory
Breaches - break up fee ~5%
Fiduciary out
Buyer’s objective – to be able to walk away if anything major is wrong
Seller’s objective – to have some certainty that transaction will close if
things are in reasonable order
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
73
Heads Up Memo
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74
Why is the company being sold?
What is the investment thesis?
How does the opportunity fit with the PE
firm’s investment strategy and skill base?
What are the size, structure and timing of the
investment?
What is the PE firm’s “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?
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:
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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?
Portfolio Company Monitoring
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Portfolio Company Life
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Year 1 – Figure out what you just bought
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Years 2-3 – Strategic Plan and Execution
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Develop strategic business plan
Make investments, pursue acquisitions
Execute plan
Pay down debt
Year 4-5 – Prepare for Exit
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Fix problems, focus on 2-3 key areas to improve
Assess and change out management
Windows dressing, clean up
Sell on good performance
Portfolio Monitoring
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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
Portfolio Monitoring
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79
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 MD&A write-ups from portfolio
companies
Annual audit reports
Portfolio Company Assistance
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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
Mechanisms of Control

Board Representation
GPs are extremely influential and effective outside directors
 GPs have the resources and staff to monitor portfolio companies
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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 GP’s 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
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Control of Access to Additional Financing
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81
Venture Capital is provided in several rounds
Influence of original investor is high on new GPs’ willingness to
participate in subsequent rounds
Best Practices
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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
Exit
83
Exit
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84
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
Exit Planning
Need to forecast the evolution of the business
 Closely follow macro trends in the industry
 Who are the likely buyers?
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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
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M&A Exit
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Advantages
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Disadvantages
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86
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
May not be welcomed by the management – sale
or merger imply reduced independence
Buyer appetite can be unpredictable
M&A Sellside Process
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87
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
IPO Exit
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Advantages
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Disadvantages
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88
Prestige of becoming a publicly traded company
Currency for future M&A activity
Increased visibility for the company
Preservers a company’s independence and provides
continued access to capital
Not an immediate, “clean” liquidity event for investors
Long and time-consuming
Distraction for management
Expensive process
Information disclosure requirements
Lock ups
IPO Process
Due Diligence and Drafting
1.

Initial Filing with SEC
2.

Generally accessible to the public and does not include the expected share price
range for the offering
Structuring and Valuation
3.

Selecting co-managers, setting the initial filing range that serves as a valuation
guideline for investors during the marketing process
Prospectus Distribution
4.

SEC gives comments on each draft of registration statement, the preliminary
Prospectus is mailed broadly to potential investors
Salesforce Education
5.
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On the company’s story before marketing to potential investing clients,
management dry runs
Targeting Investors
6.
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Meetings with senior management, iterative drafting of registration statement
(Business Overview, Risk Factors, Financials, MD&A)
Identification of best potential buyers, determine “anchor” buyers based on their
current holdings of stock, one-on-one meetings
IPO Process
Syndication
7.
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Roadshow and Bookbuilding
8.
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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
9.
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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
10.
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90
The lead underwriter takes the primary responsibility for this, syndicate members
underwrite a fixed amount of stock and may be given additional allotments
Balance supply and demand in the aftermarket, over-allotment option, on-going
research coverage (after 25 days) and trading support
Recapitalization
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91
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
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
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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
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Other Topics
93
Business Plan
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94
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
Business Plan – Key Sections
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95
Concept/Opportunity
Strategy
Operations
Markets
Customers
Products
Competition
Risks
Implementation
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
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96
Raising Money
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The process of raising money may have
significant costs
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97
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
Presenting to Private Equity Firms
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98
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
Questions in PE Minds
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99
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 M&A market trends?
Can we/they win?
Developing Economies Need…
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100
Capital
Strategic vision
Growth
Credibility
Global best practices
Investor contacts
Management talent
Private Equity Provides….
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101
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
Positive Impact of Private Equity
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102
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”
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
103
Entrepreneurial Environment
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104
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
Long-Term Capital Sources
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105
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 musthave for private equity industry
Rules for Private Equity Investing
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
106
Develop your own idea of what a business is worth
Avoid auctions
Pick your spots
Approach each potential transaction with overwhelming force
Follow the cash
Get timely help from experts, advisors
Keep your emotions in check (“deal fever”)
Develop trust with your team and managers
Make sure acquired company managers concentrate on the
few vital objectives
When management team is not working, change them as
soon as possible