Private Equity Overview
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Questions and Answers

What percentage of VC funds lose their funds?

  • 10%
  • 1/4 (correct)
  • 25%
  • 50%

    • The most common exit route in Europe is an IPO.

    False

    What percentage of funds raised in Europe comes from within Europe?

    Around 48%

    In a limited partnership, the VC or PE firm acts as the _______________________.

    <p>general partner (GPs)</p> Signup and view all the answers

    How long does a limited partnership usually last?

    <p>12-15 years</p> Signup and view all the answers

    Limited partners are responsible for the day-to-day management of the firm.

    <p>False</p> Signup and view all the answers

    What is the preferred return or hurdle rate of LPs?

    <p>Around 8%</p> Signup and view all the answers

    The catch-up provision allows the GPs to receive a significant share of the profits until the agreed-upon profit-sharing ratio of _______________________.

    <p>80/20 in favor of the LPs</p> Signup and view all the answers

    Match the phases of a funding cycle with their descriptions:

    <p>Investment phase = The phase where the fund invests in companies Payout phase = The phase where the fund returns profits to investors</p> Signup and view all the answers

    The take-down schedule specifies how the funds committed by the LPs will be paid into the fund all at once.

    <p>False</p> Signup and view all the answers

    What is the stage of a firm development where a seed/angel investment is typically made?

    <p>Start-up/idea</p> Signup and view all the answers

    IPO is generally considered a safer exit strategy compared to M&A.

    <p>False</p> Signup and view all the answers

    In what year was the first VC fund founded?

    <p>1946</p> Signup and view all the answers

    The country that represents the most value in global VC fundraising today is the ___________.

    <p>US</p> Signup and view all the answers

    Match the VC type with its description:

    <p>Independent VCs = Have a close date, e.g., Sequoia, Accel Partners Corporate VCs = Dedicated money to finding small firms with or without relations to their activity Banks = Way to diversify their investments</p> Signup and view all the answers

    What is the typical duration between VC investment and exit?

    <p>5-10 years</p> Signup and view all the answers

    What is the primary goal of VCs in the VC cycle?

    <p>Return the money to LPs and GPs</p> Signup and view all the answers

    Venture Capitalists prefer to invest in early-stage companies.

    <p>False</p> Signup and view all the answers

    In 2022, the sector that received the most VC value was ___________.

    <p>Software</p> Signup and view all the answers

    What are the common characteristics of projects that VCs invest in?

    <p>High level of risk, asymmetric information, negative cash-flows, intangible assets, and high growth potential</p> Signup and view all the answers

    What is the purpose of vesting schedules for employee stock options?

    <p>To incentivize long-term employment</p> Signup and view all the answers

    In private equity funds, the division of profit between GPs is always based on their day-to-day management roles.

    <p>False</p> Signup and view all the answers

    What is the main reason for setting a minimum size of LP's investment in a fund?

    <p>To avoid triggering regulatory and disclosure requirements and to cap the administering costs of the fund.</p> Signup and view all the answers

    The carried interest in a private equity fund might not be fully vested until the fund has returned all of the _______________________ initial capital contributions, plus any preferred return.

    <p>limited partners'</p> Signup and view all the answers

    Match the following restrictions placed on LPs with their purposes:

    <p>Minimum Size of LP's Investment = Avoids triggering regulatory and disclosure requirements Explicit Minimum and Maximum Size for the Fund = Ensures the fund is large enough to be viable late LPs = Must pay the same upfront and organizational fees as early LPs</p> Signup and view all the answers

    Why do LPs restrict the sale of GPs' interests in the partnership?

    <p>To prevent GPs from selling their interests too quickly</p> Signup and view all the answers

    Private equity funds are allowed to invest unlimited amounts in any given investment class.

    <p>False</p> Signup and view all the answers

    What is one concern related to how GPs invest in companies?

    <p>Compensation concerns, as GPs tend to receive higher compensation than warranted.</p> Signup and view all the answers

    Private equity funds are typically allowed to invest only up to a certain percentage of their _______________________ or asset value in any given investment class.

    <p>capital</p> Signup and view all the answers

    What is the purpose of co-investment with other funds, as a restriction placed on GPs?

    <p>To prevent opportunistic behavior from GPs</p> Signup and view all the answers

    What is the main characteristic of Private Equity?

    <p>Concerns small companies that are private</p> Signup and view all the answers

    The largest sector in Private Equity is Venture Capital.

    <p>False</p> Signup and view all the answers

    What is the percentage of firms that go public or are considered as having failed in Europe?

    <p>55.8% (M&amp;A)</p> Signup and view all the answers

    The amount of total investments in Europe in 2022 was __________ euros.

    <p>130B</p> Signup and view all the answers

    Match the following types of companies financed by Venture Capital:

    <p>Innovative companies in terms of technology = Innovative companies in terms of business model 1 = 2</p> Signup and view all the answers

    The leader in Private Equity is Vanguard.

    <p>False</p> Signup and view all the answers

    What is the expected IRR in Venture Capital?

    <p>(Not explicitly stated in the content, but typically 15-25%)</p> Signup and view all the answers

    What is the approximate amount of total commitments to VC firms just before the dotcom bubble crashed?

    <p>10B</p> Signup and view all the answers

    What is the main benefit of convertible preferred equity?

    <p>All of the above</p> Signup and view all the answers

    The conversion ratio is set by management prior to issue.

    <p>True</p> Signup and view all the answers

    What is the purpose of the conversion price?

    <p>The conversion price is the price at which the common stock needs to be trading for the holder of the preferred shares to make a profit on the conversion.</p> Signup and view all the answers

    The _______________________ date is the date at which the transaction is expected to be completed.

    <p>closing</p> Signup and view all the answers

    What is Enterprise Value (EV)?

    <p>The total value of a business's assets, excluding cash</p> Signup and view all the answers

    What is the main difference between non-participating and full participating preferred stocks?

    <p>Participation in additional profits</p> Signup and view all the answers

    The comparables method is more suitable for companies that are often unprofitable and experiencing rapid growth.

    <p>False</p> Signup and view all the answers

    Mandatory conversions are always optional for holders of preferred stocks.

    <p>False</p> Signup and view all the answers

    Why do founders force mandatory conversions during IPOs?

    <p>To simplify capital structure, align interests, remove preferential items, and make common shares more marketable.</p> Signup and view all the answers

    What are the three steps of the comparables method?

    <ol> <li>Identify firms with similar characteristics, 2) Search for potential measures of value, and 3) Apply those measures to the company you want to evaluate.</li> </ol> Signup and view all the answers

    The market-to-book ratio is calculated as the market value of the firm's equity divided by the _______________ on the balance sheet.

    <p>shareholder's equity</p> Signup and view all the answers

    A _______________________ is a type of liquidation preference that limits the amount holders of preferred shares can receive.

    <p>cap</p> Signup and view all the answers

    Match the following valuation methods with their characteristics:

    <p>Comparables Method = Involves identifying similar companies and determining measures of value Discounted Cash Flow (DCF) Method = Involves calculating the present value of future cash flows</p> Signup and view all the answers

    Match the types of liquidation preference with their descriptions:

    <p>Non-participating = Fixed dividend, no participation in additional profits Full participating = Fixed dividend and participation in additional profits Cap on preferred stocks = Limits the amount holders of preferred shares can receive</p> Signup and view all the answers

    Limited partners are responsible for the day-to-day management of the firm.

    <p>False</p> Signup and view all the answers

    The DCF method takes into consideration the flexibility of a company's management to make strategic decisions.

    <p>False</p> Signup and view all the answers

    What are the three problems of the DCF method?

    <p>Lack of comparable companies, Terminal Value is very sensitive to assumptions, and The Beta as the proper measure of firm risk is criticized.</p> Signup and view all the answers

    What is the common problem of the comparables and DCF methods?

    <p>They don't take into consideration flexibility</p> Signup and view all the answers

    The WACC is used to calculate the expected rate of return on equity, known as _______________.

    <p>ke</p> Signup and view all the answers

    What is the purpose of a sensitivity analysis in the DCF method?

    <p>To test the robustness of the valuation to changes in assumptions</p> Signup and view all the answers

    What is the main difference between the option pricing model and the DCF method?

    <p>The option pricing model bases investment decisions on how well the project did in the first period</p> Signup and view all the answers

    The VC method is more empirical than other valuation methods.

    <p>False</p> Signup and view all the answers

    What do VCs try to determine when they want to invest in a company?

    <p>The amount of ownership of the firm they need to receive their target rate of return</p> Signup and view all the answers

    The retention ratio quantifies the expected _______________________ effect of future rounds of financing on the venture capitalist's ownership.

    <p>dilutive</p> Signup and view all the answers

    Match the following steps with the correct description in the VC method:

    <p>Compute the final value of the firm = Step 1 Discount back the final value with the target rate of return = Step 2 Compute the required percentage of ownership = Step 3</p> Signup and view all the answers

    The Black&Scholes model is appropriate for pricing a series of nested calls.

    <p>False</p> Signup and view all the answers

    What is a major limitation of the option pricing model?

    <p>All of the above</p> Signup and view all the answers

    What is the purpose of the retention ratio in the VC method?

    <p>To quantify the expected dilutive effect of future rounds of financing on the venture capitalist's ownership</p> Signup and view all the answers

    VCs typically expect a target rate of return of between _______________________ and 50%.

    <p>40</p> Signup and view all the answers

    What is a limitation of the VC method?

    <p>It uses a very large discount rate</p> Signup and view all the answers

    What is the behavior of banks when they see the first signs of distress in small companies?

    <p>They reduce their loan exposure</p> Signup and view all the answers

    Debt to equity swaps are more common in small firms

    <p>False</p> Signup and view all the answers

    What is the consequence for original shareholders in a debt to equity swap?

    <p>They lose 95% of their initial wealth</p> Signup and view all the answers

    When multiple parties need to make decisions that depend on the actions of others, but there is uncertainty or misalignment in their strategies, leading to suboptimal outcomes, it is known as a _______________________.

    <p>coordination problem</p> Signup and view all the answers

    Match the following concepts with their definitions:

    <p>Run on the firm = When creditors lose confidence in the firm's ability to meet its obligations Holdout problem = When one or a few parties refuse to agree to a deal that requires the consent of multiple stakeholders</p> Signup and view all the answers

    In common law countries, the laws are more creditor-friendly

    <p>False</p> Signup and view all the answers

    What did management do immediately after the first restructuring in the Eurotunnel case?

    <p>They repurchased their debt</p> Signup and view all the answers

    In a leveraged buyout (LBO), the acquisition of a control position in a company is financed by a mix of _______________________ and debt.

    <p>equity</p> Signup and view all the answers

    What is the reason why banks didn't trigger bankruptcy despite the firm's chronic distress in the Eurotunnel case?

    <p>Both A and B</p> Signup and view all the answers

    What is the first step a corporation must take to start the integration process?

    <p>Apply for a corporate charter</p> Signup and view all the answers

    Bylaws can be amended or repealed by the CEO of the corporation

    <p>False</p> Signup and view all the answers

    What do the bylaws of a corporation set forth?

    <p>the rights or powers of its stockholders, directors, officers and employees, and the responsibilities of the directors and officers</p> Signup and view all the answers

    The three steps of terminating a firm are liquidation, winding up, and _______________________.

    <p>dissolution</p> Signup and view all the answers

    How do Venture Capitalists finance the firm?

    <p>Using stage financing with milestones</p> Signup and view all the answers

    Preferred shares usually have voting rights

    <p>False</p> Signup and view all the answers

    What is the difference between pre-money and post-money valuation?

    <p>Pre-money is the company's value before the investment, and post-money is the company's value after the investment</p> Signup and view all the answers

    Match the terms with their definitions:

    <p>Preferred shares = Represent ownership in a company and usually confer voting rights Common shares = Have a higher claim on assets and earnings than common shares</p> Signup and view all the answers

    The dissolution of a corporation means it continues to exist legally

    <p>False</p> Signup and view all the answers

    Pre-money valuation can be computed as _______________________

    <p>post-money - Amount of the investment</p> Signup and view all the answers

    What is the purpose of lock-up clauses?

    <p>To restrict the sale of shares after an IPO</p> Signup and view all the answers

    In the Silicon Valley, non-competition agreements are strictly enforced.

    <p>False</p> Signup and view all the answers

    What is the main benefit of shopping around in venture capital funding?

    <p>Forcing competition between investors and thus getting a better price</p> Signup and view all the answers

    The right of first refusal gives investors the ability to purchase shares from founders before they can be sold to _____________________.

    <p>other parties</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Debt restructuring = Renegotiation of existing debt contracts Pure financial distress = Default on payment obligations or violating debt covenants Economic distress = Having negative NPV projects or declining operating performance</p> Signup and view all the answers

    A viable firm is one that is facing economic and financial distress.

    <p>False</p> Signup and view all the answers

    What is the purpose of a no-shop/confidentiality clause in venture capital funding?

    <p>To prevent discussions with other VCs and maintain confidentiality</p> Signup and view all the answers

    What is the primary goal of protection clauses implemented by VCs?

    <p>To prevent changes to the company's bylaws or board structure</p> Signup and view all the answers

    The droit préférentiel de souscription is also known as the _______________________.

    <p>investor's right to maintain proportionate ownership</p> Signup and view all the answers

    Debt restructuring is only possible for viable firms.

    <p>True</p> Signup and view all the answers

    What makes things even more complicated in terms of costs when a company is in financial distress?

    <p>Both direct and indirect costs</p> Signup and view all the answers

    When a company is in financial distress, its indirect costs include lawyers, consultant, and transaction costs.

    <p>False</p> Signup and view all the answers

    What are the two kinds of procedures in a default process?

    <p>Private workout and public workout.</p> Signup and view all the answers

    In a public workout, the court can impose a restructuring plan to all creditors, including those who don't agree with the plan, and provides _______________ to protect third parties.

    <p>legal oversight</p> Signup and view all the answers

    What is a characteristic of a private workout?

    <p>Lower direct costs and faster average length</p> Signup and view all the answers

    In a public workout, the court cannot impose a restructuring plan to all creditors.

    <p>False</p> Signup and view all the answers

    Match the following with their descriptions:

    <p>Private workout = Negotiation between the management of the firm and the syndicate (creditor) only. Public workout = Filing for bankruptcy and going to court.</p> Signup and view all the answers

    What is considered a soft behavior from a lender?

    <p>Accepting to reduce interest payments or principal amount, extending the maturity of the loan, or substituting equity for debt.</p> Signup and view all the answers

    A tough lender behavior always leads to liquidation.

    <p>False</p> Signup and view all the answers

    For lenders, it can be a good idea to have a _______________ behavior ex-ante to force discipline.

    <p>tough</p> Signup and view all the answers

    What is the name of the PE firm that acquired RJR Nabisco in 1989?

    <p>KKR</p> Signup and view all the answers

    The goal of sponsors in LBOs is to achieve a low annualized return on equity investment.

    <p>False</p> Signup and view all the answers

    What are the characteristics of a good LBO target?

    <p>Resilient cash flow, strong earnings, leading market position, growth potential, etc.</p> Signup and view all the answers

    LBOs typically take place when a firm is in its ______________ phase and has a slow down.

    <p>mature</p> Signup and view all the answers

    Match the steps of organizing an LBO with their descriptions:

    <p>Creation of a holding = Newco owning 100% of the target Holding lives around 5 to 7 years = At the end of the period, shareholders will own 100% of the target Exit = IPO, sale to another LBO fund, or trade sale</p> Signup and view all the answers

    LBOs are typically done over a short period of time.

    <p>False</p> Signup and view all the answers

    What is the role of the LBO after the target has been bought?

    <p>Act as an active partner and coach to the management team</p> Signup and view all the answers

    What is the purpose of the due diligence process in LBOs?

    <p>To assess the target's viability and potential for growth</p> Signup and view all the answers

    What are the 2 most common valuation methods?

    <p>Comparables and DCF</p> Signup and view all the answers

    The sponsors of an LBO earn a ______________% carried interest on profits, but only if the hurdle rate of 8% is reached.

    <p>20</p> Signup and view all the answers

    What is the most successful PE deal ever?

    <p>Blackstone's acquisition of Hilton</p> Signup and view all the answers

    The market evaluates a company based on its free cash flow.

    <p>False</p> Signup and view all the answers

    What is the formula to calculate the principal of a debt?

    <p>Principal = Annuité x {1-(1+6,5%)^-6) / 6,5%</p> Signup and view all the answers

    The Equity Value of a company is the value left for shareholders after all _______________ have been paid.

    <p>debts</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>EV = Total value of a business's assets, excluding cash, and is indifferent to the firm's capital structure. Equity Value = The value left for shareholders after all debts have been paid. FCF = Free Cash Flow, which is the cash available to the firm after all expenses and investments. DCF = Discounted Cash Flow, a method used to estimate the value of a company.</p> Signup and view all the answers

    What is the main goal of creating value in a company?

    <p>To grow the business and expand margins</p> Signup and view all the answers

    The dividend of a company is the same as its free cash flow.

    <p>True</p> Signup and view all the answers

    How is the Enterprise Value (EV) calculated?

    <p>Either by determining the Net Present Value of all Free Cash Flow to the Firm (FCFF) in a DCF model, or by subtracting cash from the total value of a business's assets.</p> Signup and view all the answers

    What is the role of a board member in a company?

    <p>Gets involved in specific projects</p> Signup and view all the answers

    A good leaver clause provides favorable treatment to individuals who leave the company due to misconduct.

    <p>False</p> Signup and view all the answers

    What is the formula for Money on Money Multiple (MOM)?

    <p>Value at which you sell the shares / Value at which you bought them</p> Signup and view all the answers

    Leverage amplifies the ROE when the cost of debt is __________ ROA.

    <p>less than</p> Signup and view all the answers

    What is the impact of debt on ROE?

    <p>The larger the proportion of debt to equity, the more sensitive the ROE is to changes in ROA/ROCE.</p> Signup and view all the answers

    Match the following types of leaver clauses with their descriptions:

    <p>Good leaver = Favorable treatment to individuals who leave the company under certain positive or neutral circumstances. Bad leaver = Less favorable treatment to individuals who leave the company under negative circumstances. Retirement = Leaving the company due to retirement. Misconduct = Leaving the company due to gross misconduct or breach of contract.</p> Signup and view all the answers

    Lock-up clauses require managers to hold their shares for a certain period after the IPO.

    <p>True</p> Signup and view all the answers

    What is the formula for IRR?

    <p>IRR = (1 + (Gain / Initial Investment))^(1 / Number of Years) - 1</p> Signup and view all the answers

    Study Notes

    Overview of Private Equity

    • Private equity (PE) includes venture capital (VC), leveraged buyouts (LBO), and distressed debt
    • LBO is the largest sector in PE, focusing on mature companies
    • PE is concerned with small, private companies
    • It is the smallest industry compared to hedge funds, mutual funds, etc.
    • Blackstone is the leader in PE, while Vanguard is the leader in mutual funds
    • General Partners (GPs) manage PE funds

    Fundraising and Investments in Europe

    • Total investments in Europe in 2022: 130B euros
    • Total investments in venture capital (VC) in Europe in 2022: 18B euros
    • PE investment as a percentage of France's GDP: 0.91%

    Venture Capital (VC)

    • VC finances innovative companies in terms of technology and business model
    • Examples of VC-backed companies: GAFAM (Google, Amazon, Facebook, Apple, Microsoft)
    • Expected IRR in VC: 30%, but reality is around 15%
    • Only 1/4 of VC firms achieve IRR above 15%
    • The most common exit route in Europe: trade sale (55.8%)

    Partnerships

    • A limited partnership is a business arrangement where investors (Limited Partners, LPs) join together to create a fund
    • LPs contribute capital, have no say in investment decisions, and are protected by liabilities
    • GPs are responsible for day-to-day management, not protected by liabilities, and receive carried interest
    • Repartition of ownership: 99% from LPs, 1% from GPs
    • Phases of a funding cycle: investment phase and payout phase
    • Profits are split between LPs and GPs: 80% to LPs, 20% to GPs

    Restrictions and Concerns

    • LPs impose restrictions on GPs, including minimum investment size, fundraising limits, and investment guidelines
    • GPs may have opportunistic behavior, and LPs may fear this
    • LPs may restrict GPs' investment activities, such as limiting investment size and reinvestment of profits

    The VC Industry

    • 4 stages of firm development: start-up, development, growth, and maturity
    • 4 stages of investment: seed, early-stage, late-stage, and exit
    • IPO is a riskier exit strategy, while M&A is generally safer
    • First VC fund was founded in 1946 by a Harvard professor
    • US dominates global VC fundraising, with a significant impact from the Clarification of the Prudent Man Rule in 1979
    • VC cycle: fundraising, investment, company growth, exit, and returns

    Valuation

    • EV (Enterprise Value) is the total value of a business's assets, excluding cash and capital structure
    • Equity value is the value left for shareholders after debts are paid
    • Comparables method: 1) identify similar firms, 2) search for measures of value, and 3) apply those measures to the company
    • Problems with the comparables method: difficulty in finding similar firms, misguided valuations, and lack of flexibility
    • DCF (Discounted Cash Flow) method: compute FCFs, terminal value, WACC, and NPV
    • Problems with DCF method: lack of comparable companies, terminal value sensitivity, and beta estimation
    • Option pricing model: computes the value of flexibility in investments, using binomial trees
    • Problems with option pricing model: sensitivity to variables, estimating volatility, and reducing real-world problems to simple models### Retention Ratio
    • Quantifies the expected dilutive effect of future rounds of financing on venture capitalist's ownership
    • Required Current Percentage Ownership (given dilution) can be calculated using a formula

    Structuring the Deal

    • To start the integration process, a corporation must:
      • Apply for a corporate charter
      • File an application with the Secretary of State
    • Bylaws:
      • Mandates stating how the company will operate
      • Rights or powers of its stockholders, directors, officers, and employees
      • Can be amended or repealed by the board or by a vote of the stockholders
    • 3 steps of the termination of a firm:
      • Liquidation: converting remaining fixed assets and inventory into cash
      • Winding up: paying taxes, leading to the proper time and conditions for dissolution
      • Dissolution: the corporation ceases to exist legally
    • Financing the firm using stage financing, where venture capitalists set milestones to reach
    • Venture capitalists fear entrepreneur's opportunism, so they use stage financing to mitigate this risk

    Valuation

    • Pre-money valuation: post-money valuation - amount of investment
    • Post-money valuation: post-money = pre-money + investment
    • Example of pre-money and post-money valuation calculation

    Shares

    • Preferred shares:
      • Have a higher claim on assets and earnings than common shares
      • Often pay a fixed dividend before common shareholders
      • Do not usually have voting rights
    • Common shares:
      • Represent ownership in a company and usually confer voting rights to shareholders
      • Dividends are not guaranteed and can fluctuate
      • Shareholders have a residual claim on the company's assets after debts and preferred shareholders are paid in a liquidation event
    • Convertible preferred equity: gives the holder the right to convert preferred shares into a specified number of common shares
    • Conversion ratio: number of common shares shareholders may receive for every converted preferred share
    • Conversion price: price of each common share that must be reached for conversion to be beneficial

    Term Sheet

    • Closing date: the date at which the transaction is expected to be completed
    • 3 types of liquidation preference and their differences:
      • Non-participating preferred stocks: fixed dividend, no right to participate in additional profits
      • Full participating preferred stocks: fixed dividend, share the rest with common stockholders on an as-converted basis
      • Cap on preferred stocks participation rights: limits the amount that holders of preferred shares can receive from a company's distributions or liquidation events
    • Optional conversions: the possibility to convert preferred stocks into common stocks
    • Mandatory conversions: forcing conversion into common stocks, often during IPOs
    • Lock-up clauses: restrict selling shares after an IPO for a certain period
    • Investor information rights: the firm must provide information to major investors
    • Investor's right to maintain proportionate ownership: if new shares are issued, existent shareholders have the right to buy some of it to maintain their percentage of ownership
    • Non-competition agreement: agreement in which the founder and the team must stay in the company for at least 1 year

    Distressed Debt Restructuring

    • Debt restructuring: renegotiation of existing debt contracts
    • When does it happen? When the firm cannot make payments or violates covenants
    • Examples of troubled debt restructuring: Alstom, Eurodisney, Eurotunnel, Ferruzzi Group
    • Covenants: debt/Equity, max debt/EBIDTA, min interest coverage
    • Distinguishing between viable firms and non-viable firms
    • Direct and indirect costs of financial distress
    • When is debt restructuring efficient? For viable firms

    Private Workout vs. Public Workout

    • Private workout: negotiation between the management of the firm and the syndicate (creditor) only

    • Public workout: filing for bankruptcy, court-imposed restructuring plan

    • Advantages of private workout: lower direct costs, shorter length, secrecy

    • Characteristics of a public workout: court-imposed plan, transparency, legal oversight

    • How to choose between the two: depends on the viability of the firm, deterioration of liquidation values, country's inclination, difficulty of implementing a private workout### Private Equity (PE) Firms

    • Notable PE firms: KKR, Blackstone, Bain, Merril Lynch

    LBO of RJR Nabisco by KKR in 1989

    • Deal value: 31Batthetimeofpurchase,over31B at the time of purchase, over 31Batthetimeofpurchase,over55B inflation-adjusted today
    • Result: failed to generate value for investors, considered a failure

    Most Successful PE Deal

    • Blackstone and Hilton: generated $12B for investors after going public in 2013

    Twitter's Value

    • Down 55% compared to when Elon Musk bought it

    LBO Characteristics

    • Very long-term investment, typically 8-10 years
    • Not suitable for all investors due to the long-term commitment

    GP Compensation in LBOs

    • Charge 1.5%-2% management fees
    • Charge 20% carried interest, but only if the hurdle rate of 8% is reached

    LBO Timing

    • Typically occurs when a firm is in its mature phase and has slowed down
    • Purpose: restructuring, bringing efficiency, and rejuvenating the company

    Incentives for LBOs

    • Huge leverage (high debt): motivates management to work hard and generate significant cash flows
    • Decreased number of shareholders: concentrates profit among a few hands, incentivizing management to work hard
    • High annualized return on equity investment (IRR)
    • High absolute return (MoM)

    LBO Steps

    • Create a holding company (Newco) owning 100% of the target
    • Holding company lives for 5-7 years
    • Exit: IPO, sale to another LBO fund, or trade sale

    Good LBO Target Characteristics

    • Resilient cash flow
    • History of strong earnings
    • Leading market position or protected niche
    • No major market disruption expected
    • Growth potential
    • Good visibility on CAPEX needs
    • Operational improvements and cost savings possible
    • Asset reorganization (e.g., selling real estate)
    • Attractive at exit for pre-identified buyers
    • Strong management in place or identified

    Due Diligence Process

    • Initial due diligence (3-4 weeks): draft business plan, exchange views on financing and valuation, and letter of intent
    • Full due diligence (2 months): access to data room, finalize financing and valuation, and draft sale and purchase agreement
    • Negotiations: finalize sale and purchase agreement
    • Finalization (1-3 months): finalize operation, documentation, and regulatory filings

    LBO Role after Acquisition

    • Acts as an active partner and coach to the management team
    • Holds veto rights over important decisions
    • Provides strong support in financing, M&A, and exit-related aspects
    • Holds significant power, including the ability to change key management personnel

    Lock-up Clauses

    • Managers are required to hold their shares for a certain period after the IPO
    • Ensures they remain committed to the company's long-term success

    Good/Bad Leaver Clauses

    • Good leaver clauses: provide favorable treatment to individuals who leave the company under certain positive or neutral circumstances
    • Bad leaver clauses: provide less favorable treatment to individuals who leave the company under negative circumstances

    IRR Formula

    • IRR = (1 + (Total Value / Initial Investment))^(1/Number of Years) - 1

    Money on Money (MoM) Multiple

    • MoM = Value at which you sell the shares / Value at which you bought them

    Leverage and ROE

    • Leverage amplifies ROE when the cost of debt is less than ROA/ROCE
    • The larger the proportion of debt to equity, the more sensitive ROE is to changes in ROA/ROCE

    Creating Value

    • Grow the business
    • Expand margins (same sales)
    • Expand multiples (EV/EBITDA, P/E)
    • Reduce debt level (delever) by the end
    • Tax savings with tax consolidation

    FCF Calculation

    • FCF = EBIT(1-T) + Depreciation - Inc in NWC - CAPEX

    Debt Calculation

    • Principal = Annuité x {1-(1+6.5%)^-6) / 6.5%}

    Dividend and Debt Repayment

    • Dividend is the annuity, which is used to repay interest and debt

    Valuation Methods

    • Comparables: to have a "ballpark value" of the firm
    • DCF

    EV (Enterprise Value)

    • Total value of a business's assets, excluding cash, and indifferent to the firm's capital structure
    • Can be calculated using either the market capitalization or the Net Present Value of all FCFF in a DCF model

    Equity Value

    • The value left for shareholders after all debts have been paid
    • Calculated by subtracting debt from the EV

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    Description

    A brief introduction to private equity, covering its components, investments, and trends in Europe.

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