Private Equity Overview
Introduction
Background – Josh Ciampa
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•BU SMG and CAS 2005
•General Electric ( 5 years)
o •Financial Management Program (2), Leveraged Finance (3)
•First Atlantic Capital – Associate
o •NY based middle market private equity firm (Packaging, Consumer, Business Services focus)
o •Total funds under management in excess of $700M
Background – Boris Bystrov
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BU SMG and CAS 2006
Merrill Lynch / Bank of America
o Risk / Underwriting (3), Corporate Banking (1), Investment Banking (1)
LS Power Equity Advisors – Associate
o NY based private equity fund focused on the energy and power industry
o Part of a larger power company
o Total funds under management in excess of $4Bn
Private Equity Overview
What is Private Equity?
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•Management of assets for investors seeking alpha via
participating in the purchase of stock or assets in private or
public companies through a leveraged buyout
o •Control investing (own > 50% of equity and control BOD)
o •Minority or Co-investing alongside a Control investor or
injecting equity into a business directly
o •Secondaries / Fund of Funds investing (buying another
investor’s equity interest at a discount)
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•Investment fund is raised with Limited Partners committing
capital to the fund
o •Money is not sent to the fund until “called” when an equity
check is ready to be written for an investment
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•10 year fund lifecycle – 5 years to invest, 5 years to harvest
o •Illiquid investments with long time horizon
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•Fund charges 2% management fee on assets under
management (AUM) and keeps a carried interest “carry” of 20%
of the returns above a certain threshold
o •Must hit a fund hurdle rate or subject to a “claw back”
provision where investors are reimbursed
Flow of Funds
LPs (Limited Partners)
* Endowments, Pension Funds, Fund of
Funds
Exits (IPO or M&A)
Portfolio Companies
PE Funds
PE Firms / GPs (General Partners)
*Manage Multiple Funds
Types of Private Equity Firms
“Mega funds”: Multi-billion dollar funds that invest across all industries
• •Invests in mature companies with strong cash flows via leveraged buyouts
• •Examples: Blackstone, KKR, Carlyle, TPG, etc.
Middle-market: $500mm to $5bn funds that invest within specific sector or across all industries
• •Typically invests in small to mid-cap companies via equity commitments ranging from $25mm to
$100mm
• •Examples: Advent International, Golden Gate, Avista Capital, HIG Capital, etc.
Growth equity: funds that invest in earlier-stage companies
• •Typically invests in smaller targets via platform or “build-and-buy” investing
• •Examples: General Atlantic, TA Associates, Summit Partners, etc.
Sector-specific: funds that invest in one or two industries
• •Typically middle-market / growth equity or distressed
• •Examples: Silver Lake (tech), Lone Star (financials / real estate), Cressey & Co. (Healthcare), Energy
Capital Partners (Power)
Financial Institutions: private equity subsidiaries that invest across all industries
• •Typically invest in mid-stage to mature companies with commitments ranging from $25mm to $1bn
with more of a net income focus than other shops
• •Examples: GE Capital, Goldman Sachs, Barclays, etc.
Private Equity Landscape
“Mega-funds”
Growth equity
“Equit
y
check
” size
Financial institution-backed
Middle-market
Early-stage / Growth
Stage of Company / Strategy
Mature / LBO
Private Equity Market Overview
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•2007 was peak of PE related activity
•1st half of 2011 activity impacted by volatile credit markets
•Lots of activity expected in 2nd half of 2011 and 2012
Stages of Investment
• Private Equity is the asset class that purchases an equity stake in a company that
is not publicly traded on a stock exchange
• The PE landscape can be broken down by the varying strategies based on the
ownership/control, mix of debt & equity, stage of company, risk/reward, etc.
Startup
AngelInvesting
Mature
Stage of Company / Control
VentureCapital
GrowthCapital
Lines are blurring as VCs are investing in
earlier and later-stage companies
Mid-MarketPrivate
Equity
Distressed
LeveragedBuyout
Venture Capital is Early and Exciting
Venture Capital Investment
$
Billio
ns
*Source: National Venture Capital Association Yearbook 2010. Includes statistics from the PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report based on data
from Thomson Reuters.
Stages of Companies
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Early-Stage
o Seed: Deployment of a relatively small amount of capital for the entrepreneur / company to prove out a concept
before qualifying for Start-up financing
 Product Development, Market Research, Build Management Team, Develop a Business Plan
o Start-up: Complete development of product & initial marketing efforts.
o Technology / product / market risk
Growth-Stage
o Capital for initial expansion – sales & marketing, continued technology development, hiring, and working capital
o Risk migrates from technology / product risk to execution / market risk
Later-Stage
o After companies have proven their ability to execute at a limited scale they will look to raise a larger round of
capital to scale the business while continuing to fund sales & marketing
o Ultimately this stage of financing should enable the company to position themselves for an exit
Value Creation
The Big 4 Drivers
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•Organic EBITDA growth
•Acquisitions
•Multiple Expansion
•Cost Cutting / Deleveraging
Strategies
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•Platform Investment
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•Industry Roll-up or consolidation strategy
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•Acquiring a solid distributor of fire protection equipment and adding
SKUs / moving into adjacent markets / products
•Acquiring a security guard company for 6.0x EBITDA and acquiring
mom and pop security firms for 3.0-4.0x EBITDA, consolidating a
fragmented industry
•Regional to national expansion
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•CompUSA: private company with 2 locations, PE investors took it
national with 100 locations and > $1BN revenue
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•Capex harvesting
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•Capacity utilization expansion
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•Satellite companies purchased post 5 yr capex investment cycle
•Helicopter transportation company purchased for a low multiple when
capacity utilization is at 40%
Managing the Inflection Points (step functional growth)
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•Upgrade management, sales
•Manufacturing – single plant to multiple locations
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•Moving US manufacturing to China
•Rethink distribution, warehousing strategy
•Brand expansion, marketing
•Single product to diverse offering
Comments on Lifecycles
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•Venture capital investing at Introduction phase
•Growth phase receives private equity investment
(growth equity)
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•Revenue ramp, addition of customers, need
for professional management, logistics,
distribution
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•Mezzanine facility
•Maturity phase supports leveraged buyout well –
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•Low capex
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•High free cash flow / Stable
Private Equity Concepts
EBITDA
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•Earnings before interest, taxes, depreciation &
amortization
•Allows for comparability across industries (asset heavy
vs. light)
•Disregards financing decisions and tax benefits
•Excludes non-cash charges against income (D&A)
Enterprise Value or Firm Value (EV)
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•Value of Debt + Equity less Cash on balance sheet
•Represents Takeover Value of Company
•EV of a public company – see chart at right
•EV of a private company = EBITDA x Exit Multiple
Valuation in Practice
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•Enterprise Value / EBITDA multiple or EV/EBITDA
•Quote value of a company as a multiple of LTM or TTM
EBITDA
Capital Structure Comments
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•Equity is the residual claim on Assets
•Liabilities have security interest on assets
•Seniority of Capital Structure
•Cost of Capital relates to relative risk of tranche
•Investors demand more return for more risk
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•Cost of Capital for tranches
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•Secured vs. Unsecured
Valuation
Private Equity LBO Example
Visual Summary
Considerations
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Equity Value increased 2.4x
while TEV increased 1.5x
(beauty of leverage)
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EBITDA increased 50% but our
return was > 100%
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Free Cash flow paid down debt
to accelerate increase in equity
value: TEV increased $120M
while Equity Value increased
$145M
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Returns would have been
higher if exit multiple was
higher than entry
Private Equity Time Allocation
30%
25%
10%
15%
15%
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Researching industry trends & opportunities; building domain expertise
Prospecting: Identifying companies of interest to proactively contact
Sourcing
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Reaching out to companies proactively or tapping the network to make first contact with
CEOs/Companies
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Networking with other investors, bankers, CEOs
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Process to determine if the firm should bid (and at what price) on a company/deal:
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Relationship building, diligence, deal structuring & returns analysis, firm buy-in, term
sheet construction, negotiations
Summary Diligence: Management, Market, Company / Product, Technology, Barriers to Entry,
Financials
Research / Prospecting /
Sourcing
Pre Term Sheet Diligence
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The company has selected our firm and we enter into a period of exclusivity where the firm
spends a significant amount of time conducting diligence on every aspect of the business
before completing the transaction
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Full model; transaction memo; legal documents; continued negotiations
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Attend board meetings
Support companies with strategy, hiring, future financing, and exits
Ad hoc projects
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Fundraising
Reporting on company, deal, and fund performance
Ad hoc projects
Post Term Sheet Diligence
Portfolio Company Support
Internal Projects / Reporting
Private Equity Deal Process and Responsibilities
New Deal Evaluation
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•Origination
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•Investment Bank auctions
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•Proprietary relationships with PE Funds, Companies
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•1st Round Deal Evaluation
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•Receive CIM (Confidential Info Memo) from a bank
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•Evaluate investment opportunity
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•LBO Model
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•Bid
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•Management Meetings
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•Evaluate quality of management
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•Plant / facility tours
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•Data room access
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•2nd Round Bids
Portfolio Management
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•Strategy sessions
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•Organic Growth
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•Acquisitions
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•Help management build budget
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•Market sizing analysis
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•Market growth analysis
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•Customer analysis
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•Attend Board of Director meetings
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•Set short term and long term goals for company
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•Discuss long term exit strategy for company
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•2nd Round / Formal Diligence
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•Data Room access
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•Investment thesis
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•Access to management for questions
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•Refine investment case – build full operating model
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•Quality of Earnings, Environmental, Legal, Insurance
review, Third party industry study
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•Review of major contracts, financials, audits, other
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•Financing Sources
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•Negotiate purchase agreement
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•Negotiate lender credit agreements
•Weekly sales reviews with CFO or CEO
•Monthly analysis of financials
•Assist with C-level hiring
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•Interview candidates
•Acquisitions
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•Meet with CEO and management of potential targets
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•Research targets and make offers
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•Engage bankers for strategic alternatives
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•Build M&A models for tuck acquisitions
Career in private equity
PE associate program overview
• •Typically two-year commitment for pre-MBAs
• •Some firms (mostly middle market) offer ability to stay without MBA or return post-MBA
• •Ability to co-invest available at certain firms
What do private equity firms look for?
• •Most firms typically require background experience in investment banking and less
frequently consulting for pre-MBAs
• •Strong analytical / modeling skills (excel modeling test)
• •Excellent communication skills
Life after private equity
• •Top-tier business school
• •Lateral to other PE shops, hedge funds, etc.
Closing Thoughts
Career in PE
Market
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Supply of money on sidelines driving purchase
multiples
Financing markets remain conservative
Very difficult to be a value investor in this market
Shrinking number of funds, consolidation
Operational value vs financial engineering
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Suggested Reading
Recommended Classes at BU
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AC346, AC347 (Intermediate Accounting)
AC414 Financial Statement Analysis
Finance, economics
Have a tangible skill set
Differentiate yourself
Take upper level 300 and 500 liberal arts classes
Directed Study
Excel modeling
PE values transaction and business experience
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2-5 yrs experience is the sweet spot for entry
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Larger funds - MBA, smaller funds more flexible
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Highest recruits from banking; Also consulting,
corporate training programs, and industry
Life after PE
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BD, Consulting, Start-up
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Move funds (large cap, middle market, VC,
value, public equities, fixed income, high yield,
mezz)
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FT, WSJ, Barron’s, Economist, IBD, Seeking Alpha,
Wired
One up on Wall Street, Beating the Street (Peter
Lynch)
The Shareholder Letters of Marty Whitman, Warren
Buffet
Barbarians at the Gate, Against the Gods