Cours complet 3.pdf

Private Equity PE funds include funds devoted to: Venture Capital segment: investment in young and promising companies, start-up companies. they have specific features that make them distinct from over large corporations (lack of information, or sales…) - it inf...

Private Equity PE funds include funds devoted to: Venture Capital segment: investment in young and promising companies, start-up companies. they have specific features that make them distinct from over large corporations (lack of information, or sales…) - it influences the relation of the company and the investors for example. Leverage Buy Outs: Financial operations by which a major firm is bought by either the managers or a special fund. It requires the firm to have bad results, problems in the management team, lack of incentive ! the firm is bought out. It means that the firm was traded on a stock exchange and delisted of a stock exchange (“out” part of the name) and if the acquirer is successful in reorganizing the company, after a couple of years the firm is again listed on a stock market. These firms are very large companies, valued several billions dollars but at some part in time, experience some problems so they need re organization done through the sale. Project Financing: Quite specific. Problem: to finance some kind of big infrastructure; a firm is created with the purpose of creating this infrastructure (tunnel under a channel…). Dedicated to a single operation, product. Require very large operations and generally the government is involved in the project. Distressed debt investments: The debt restructuring business. Large companies that experience some losses which are unable to pay their interests or to repay the principle of a loan. Banks that have financed them need to find a solution not to loose their investment. The restructure of the debt: a fracture of this debt is transferred to equity; instead of holding a pure debt claim, banks eventually hold both debt and equity. Very insightful negotiation process by which everybody has to make concession, the process is sometimes successful but in many circumstances ! problems. Mezzanine investment, consolidations: fund that provides (generally subordinated) debt to facilitate the financing of buyouts, with a right to a part of equity upside. Private firms (not publicly traded on a stock exchange) ≠ public firms (traded on a stock exchange) Economic Impact Economic impact: Investments as % of GDP 2012 Less than 1% of the total GDP; France is in the average of Europe ! very modest size ; the average is quite similar. The economic can’t be measured only in % of GDP. Largest markets are Sweden and the UK. However, if you look at the business press, you will find a lot dedicated to it: !These firms are creating a lot of jobs = huge potential, great impact on job creation ! Initial public offering: the first time that a firm sells its shares to the stock market. Since then, more people are working at Intel. !Starbucks started as 2,521 people working as of IPO and currently, it is now 191,000. All these firms receive money from venture capital. !Venture capital is not purely dedicated to technology. With a good business model, you will receive money from venture capital. !1 The national venture capital association: Venture capital funds finance technology companies but also companies with an original business model. Example: INTEL. At the time, Intel was lunched at the public market for the IPO, the company was about 500 people. Now on the pay roll the company registers more than a 1000 people. This corporation received money from VC xx during its first year You have to consider also the progression in terms of employment. Companies with an original business model: Starbucks (not only restricted to technology) For the time of an IPO, they employed 2050 people; now 160 000 working for Starbucks. Gains in term of economic impact are huge. Magnitude of the PE sector changes over the years: 2000: more than 100 billion dollars of capital committed to VC funds. Committed= VC firms received from investors more than 100 000 million dollars to invest in portfolios companies. 2003: from 100 billion $, it decreases to a little more then 10 000$ (1/10). It’s remarkable about this industry: there are some ups and downs even though the tendency is quite steady over time. There were no changes in the opportunity set of investors because of technology shocks. The VC market is muck smaller than the LBO market it makes sense as the buy outs segment is dedicated to larger and older companies. We have an order of magnitude of investment: We observe that the VC segment is much smaller than the LBO segment. Funds raised in 2012 for the PE segment: 23 billion dollars; VC: 3.6 billion dollars; LBO: 16.5 Billion $ Comparisons The pension funds are much bigger than any other actor in the business including the mutual funds or insurance companies. But there are also small actors: sovereign wealth funds; hedge funds; PE. Hedge Fund: Their objective is to have very steady returns over time, to hedge for the fluctuations of the market. The aim is to protect investors from market fluctuations. In bad years, when the financial market experiences some disappointing returns, then hedge fund investors are promised better returns. HF are restricted to big investors because it is riskier (based on anticipations). Hedging —> protecting from the evolution of the market How to hedge from the market’s fluctuations? ! Insurance company: hedge funds buy stocks with a good potential hoping that in the end you will make money ! Identify stocks that you think in the future will have bad performances, you will sell these stocks; they sell these bad potential stocks short without holding them. Imagine that they think that the stock price will go from $100 to $80, if they can sell for $100 a stock that they don’t hold in their portfolio and then give it to the client 2 months later when it’s worth 80 !2 then it will make money. Because the HF will buy it when it costs $80 ! Gain of $20. It’s a very risky business. If the stock price rise, you’ll lose money. The good point with selling stocks short is that it hedges you from market’s fluctuations because in some sense you do a 2 sided business 1 : hoping that for some stocks the price will go down; 2: hoping that the stock price will go up. It protects you What makes the business even riskier for investors: HF use leverage to magnify the financial returns. They also borrow money from banks just to increase their leverage and amplify the financial return that they promised to their investors. If it’s positive, the leverage is a good point, it increases the financial performance but if you make loses it’s a problem, you don’t have enough money to repay the banks. In many instances, the HF have failed and investors have lost money. Sovereign wealth fund: it’s owned and managed by some government body. The biggest one is owned by China. In Europe: the Norwegian government has a good of sovereign wealth fund; use the profits of oil sales to invest and guarantee to the next generation the same life level. We have little information about them; they’re not as transparent are other funds. Governments often do not disclose information about returns; we know that they’ve big funds but we don’t know much about the returns. PE: very small compared to others. The incentives you receive are linked to the success firm you invest in. Performance In the mid 90s, you can observe that VC represented more than 50% of the PE section. In 2014, it was less than 20% of the total. On the contrary, the money required to finance LBOs has dramatically increased because LBO targets are bigger: we need more money now. LBO segment is larger. In Europe, PE segment is divided into 2 sections = LBO and VCs. The side of LBOs is much larger than VCs = like in the US. Source of the funds that are invested in European firms in the private equity segment: the majority comes from Europe, but the quarter of the money comes from the United States. This is a global business. The contracts that are signed between private equity investors and the firms they finance and the business forms are the same all over the world, whether it comes from Europe or United States (although it came from the US). Overall, returns are impressive. Is that sufficient for investors? We are all Risk averse. We are talking about risky investment; there is a high % of failure. When you invest in distressed debt, you face a high % of failure. The value at which a firm which was backed by a DC is sold to another corporation: the VC invested in company A 1million$; they sold few years later because the company was acquired by a company operating in the same sector. Some companies were sold 10 TIMES their initial investment; but in some cases the initial investment was not recooked (Half in 2002 were sold in less than their initial investments). !3 You have to take into account that when you invest in one firm, the objective is to make money. PE = special assets for investors ➔ Illiquid assets (≠ stock exchanges) CSQ : - Higher risk for the investors - Higher required compensation - Important performance (IRR ≈ 13% annual) ! !4  VC IRR increases throught years (new cies) Buyouts : bigger Cies with a larger size ! money involved higher ! Example 2008 : On average, after a VC operation, if the firm is sold/merge/acquired: - 30% are non-valuable - 30% from 1 to 4 times more than the initial investment - 24% from 4 to 10 times more than the II ! !5  IN THE US PE industry is rising, both in terms of number of funds and in terms of amount of invested money. Picks: the end of the 90’s, 2006-2008! The overall trend is an increase in this type of industry, with some picks and impressive recessions. ! ! !6  VENTURE CAPITAL I. AN OVERVIEW OF THE VC INDUSTRY 1. First modern VC fund: American Research and Development (ARD) ! Founded in 1946 by the MIT President, a HBS Professor and local business leaders ! Commercialized the technologies developed for WWII ! Almost ½ of ARD’s profits came from its $70,000 investment, in Digital Equipment Company in 1957, which returned $355 million. After the WWII in the east part of the US, when it came to commercialize some military innovations that could be turn in standard products for the general public. They thought it would be a waste not to benefit from the military inventions. From the start, these fund had exactly the same features as the funds we have now. The exit funnel outcomes of the 11,686 companies first funded 1991 to 2000 14 % 35 % Went/Going public Acquired 33 % Known failed Still Private or unknown (of these, most have quietly failed) 18 % ! Biggest success = go public/launched on a stock market (14%) Second preferred route = to have the company acquired by another company (33%). 18% of them are known to have failed. 35% are still private or unknown; but if we don’t have information it means that they have disappeared More than a half of the companies were not successful = high % ! the screening process is very important (what makes the difference between a good or a poor VC) VCs finance firms with good technology technology products and with an original business model. !7  2. Most Famous Examples of VC-backed Firms !Information Technology, Biotechnology (2 main sectors in which VCs invest money) ! Apple Computer, Microsoft, Compaq Computers, Sun Microsystems, Lotus Development Corporation !Genentech, Hybritech !Starbucks, e-bay !Digital Electric Company All those companies had a great potential for growth the time the VCs invested. VC investment are not only dedicated to high technology, but also services, production… 3. Evolution over the past 2 decades: a dramatic growth However, the size of this industry is modest, even compared to the R&D of some big industries, as Ford. (Look at the figures and graphs) The Committed Capital isn’t drawn yet, it can be drawn a few months/years later Divestment —> désinvestissement 4. Who are the Investors? Wealthy individuals and families Endowments: (Fondation) Example ! in the US, universities have endowments. They are funds created in order to collect money from former students or firms. This money is dedicated to investing in companies such as target companies. The returns are used by the Uni to invest in Research, high additional professors, build a new building. Pension funds Insurance companies and banks Dramatic growth: the arrival of pension funds Clarification of the Prudent Man rule (1979): a provision of the Employee Retirement Income Security Act (law prohibited pension funds from investing substantial amounts of money in PE or other high-risk asset classes) Consequence on the level of funds invested by pension funds: - 1978: $64 billion - 1986: $ 4,4 billion Institutional investors are neither qualified nor have the time to oversee the funds: they resort to investment advisors. to resort to = avoir recours à Investment advisors (gatekeepers) !Entered the market in the mid 80’s to advise institutional investors (pension funds) about VC. !8 !Pool resources from their clients, monitor the progress of existing investments, and evaluate funds. !By the 90’s, 1/5 of all the money raised by the new funds came from a gatekeeper. 5. The VC Cycle - Step1: A VC organization = a team of investors, they want to gather money from investors = the fundraising process. (step 1) - Step 2: Investing in portfolio in companies: Once the money is raised, then I can select portfolio firms in which the money is invested. The screening process is time consuming and is crucial to the job, they will select one company. (Remember that most of the firm fail) - Step 3: Exiting. The VCs don’t want to be equity holders in the firm for more than 5-6 years, they want to exit from their investment. The missions of a VC: there to help, his supporting role is crucial at the beginning of the firm. Then as the firm gets older, the impact of the VC is less essential, it’s essential that he invests in another start-up company. (Being acquired or going public) What is he going to do with the profit of his investment? ! Forbidden to invest in other companies. The agreement between the VCs and investors: not allowed to re invest, they have to return the profits to the investors ! SO that they don’t reinvest with the earnings into poor investments. Returning the money is a form of insurance —> we’re giving you back the money, because of some sort of lack of trust ! Why? To control and monitor performance Investors do not trust VCs; they don’t want them to reinvest money forever. If they’re satisfied with the performance, they will reinvest if the VC tries to reinvest in other funds. When they want to establish another fund, they have to raise again funds. ➔ The venture capital CYCLE (we start again and again) II. TYPES OF VCS 1. Independent VCs Private firms usually organized just like law firms or consultant businesses under the Partnership legal regime. Specialized in a given technology, they form a team a ! Greylock, Mayfield, Accel Partners, Warburg Pincus, Arch Venture Partners, Sprout Group Europe: Appolo; Appax; Amadeu,; IQ A VC firm is a firm that really relies on the settlement of one or 2 guys. !9  2. Corporate VCs The VC industry is also populated with corporate programs from large technology corporations. Firms like Microsoft, Intel, Lucent, Cisco Sysems, Novell all have Corporate VC program. Why ? they want to favor innovation —> financing start-up companies They invest directly or alongside with independent VCs in start-ups. ! Invest in own corporate programs; encourage their own engineers to establish firms outside the corporation. They give them incentives to develop their own technology outside the firm. By investing in other firms, It enables them to delegate R&D programs. ▪ Invest in some new technologies and eventually acquire the firm if these technology fits with the core business of the company. ▪ Stimulate some markets. 3. Branches of Financial Institutions Many banks have developed VC; VC represents for bank another type of financial intermediation. Ex: BancBoston Ventures, Baring Capital Partners, Merrill Lynch Private Equity Group, Morgan Stanley Dean Venture Partners In general, you can’t as a start-up company obtain a loan from a bank because: ♦ You don’t have cash flow to pay back the bank ♦ You don’t have any assets to use as a collateral (= what banks can cease if the firm is not able to pay what the firm owes to the bank) This means that contracts between VCs and entrepreneurs will not take the debts into account, instead the firm will take equity Why does it make sense for banks to establish VC? Suppose that the started company is successful, so the VC branch of the bank first bought equity; as the company is getting older, she exhibits sales, positive cash flow to pose as a collateral. When the company has a loan to contract, she does it with the same bank. It’s a way to capture some potential very interesting clients for the bank. Private Independent firms are the most important. Any bank with the same client firm can lend money and buy and equity stake In the US, banks were prevented from investing in private firms by buying equity; regulation have changed especially in the Clinton years. !10  4. Public and Community Development VCs Ex: Northeast Ventures Corporation (Minnesota), Local Economic Assistance Program, Inc. (NY city, California), Boston Community Loan Fund, Connecticut Innovations, Inc., SBICs Public programs play a very important decision role in fostering innovation when financing very small companies. Many contracts were given to industrial firms in the technology field. - During the last 15 years, over 100 states and federal initiatives - Combine social goals with or without profits - Substantial amounts of money involved: In 1995: Social venture capital programs provided $2.4 billion, compared to the $3.9 billion by traditional funds - Bulk of disbursements dedicated to early-stage firms (ex: sponsored Apple Computer, Chiron, Compaq, Federal Express, Intel) Private VCs are reluctant to invest in those kind of companies, and that justifies intervention from the government. It’s admitted knowledge that government intervention was necessary because private or corporate VCs were reluctant to invest during the first stages of those companies. 5. Business Angels ! Former or retired entrepreneurs or consultants, wealthy individuals with a management expertise ! Invest their own money in start-up companies or some promising young companies; max 1M In the 1950-60s, archetypes of venture investors were dominant. Then, they were replaced by professional venture capitalists in the recent decades. Nowadays, they represent a potent and increasingly larger part of the early-stage investments. Modification in the US legislation: The former legislation said that it wasn’t possible for a pension fund to invest in a start up company because it was too risky. But the regulator changed his mind = diversify investment was a good idea to obtain a good return or a return commensurate to risk. Pension funds are then allowed to invest in this risky market, but only through VCs (not directly) The arrival of pension funds changed everything, it allowed VCs to raise money from investors and the size of the pension funds industry is tremendous. 6. Several thousands professionals VC firm ≠ VC fund (a firm can set up many funds) In 2013: Working at about 875 firms in the U.S 1,331 funds in existence !11 5,891 professionals Average VC capital under management per firm: 220 700 000 III. TYPES OF PROJECTS FUNDED BY VCS AND THE STAGE OF INVESTMENT In the US, they invested: - 3% of committed capital into seed companies; - 34% of these investment were directed to early stage firms (from 6 months and 3 years) - 33%dedicated to expansion; when the firm is growing - 30% later stage If you relay on independent VC to invest in early stage or seed companies, you will be disappointed. They don’t want to take many risks. VCs are more and more reluctant to take risk. By industry (2013): ! Information technology: main target of VC firms ($20 bn) ! Medical/Health/Science life: $6.9 bn ! Non-High Technology: $2.7 bn These projects share the following characteristics: High level of risk (low survivorship level) Asymmetric information between parties: the entrepreneur has more information about his talent than the VC. The advantage is for the entrepreneur But a VC fund is specialized in a given industry = the VC investor has more information of a probability of success of a product (more experience). Because information is not even, it might create problems. Problem: the higher the value of the firm, the lower number of shares the entrepreneur will get for the same amount invested. Exhibit no or negative cash flows during the first years: the investors have problems to measure the success and the measure of cash flow is a good tool for that. When you start, you need money to build things, so you basically burn money. Outflows are way larger than inflows at this stage, it’s difficult to say whether the company is successful or not. The firm can’t sell debt, but only equity. Intangible assets (difficult to evaluate or re-sell): hard to evaluate the value, how to resell? Impacts on the contract. High-(and fast) growth industries When you consider fast growing industries, it’s difficult to make financial forecast or forecasts in terms of sales : there is a lot of uncertainty. Here we consider very specific investments, that’s why bankers are usually unable to finance that and it justifies that the VC industry populated by people specialized in finding young promising fast growing companies IV. THE VC’s MISSIONS !12 -Screen among projects – select investment projects; -Provide the entrepreneur with advice (sometimes send him a market specialist, accountant or contracts, networks = support side) -Discipline the entrepreneur (fire him if necessary) - Organize the exit (find buyer in the same industry, contact underwriter) Underwriter: a bank whose mission is to organize the process of going public; they want to raise more fund and only the general public can bring the money needed; they do it under the underwriting process: they organize the IPO of the firm, the bank will have to decide the price at which the stock will be sold. 2 main roads: go public or be sold to another company ! THE PARTNERSHIP I. THE PARTNERSHIP ➔ Between VCs & Investors 1. Definition Investment fund does not last forever = between 13 and 14 years. General Partners are usually the VCs. ! General Partners: —> the guy who run the firm, have a lot of experience. Not protected by limited liability. -Day-to-day management, (responsible for the losses, not protected) -Liability (losses, prosecution in some circumstances). Example: if a company is inventing a drug and before the approval by the administration, it is tested and everyone dies. There will be a trial and they will have to pay a fine = not protected by a limited liability. Limited liability: you can’t lose more than what you have invested. ! Limited Partners (mutual funds, pension funds, endowments and individuals or families). They contribute capital. They’re protected by limited liability. But to retain this limited liability, they have to stay away of the management of the firm -> give some advice, but it is not their decision to say !13 to invest in something. They are not involved in the day to day management of the firm. They only control that everything goes well, they have a seat on the advisory board but can’t give more specific things. The liability only extends to the capital they contribute. 2. Investment/ Payoff The contract between the VC and the limited partners specifies 2 main features: ! The VC will receive management fees: in exchange of engaging in some administrative things, screening … The VC will receive a given % of the profits. This % (in general 20%) is quite different from the % of money invested by the VC. The VC invests 1% of the fence invested and receives 20%: It’s natural that the compensation is higher because of the risk; Also because they help the entrepreneurs and sometimes have to discipline them -> they have a supporting role. !14 Imagine that the fund invested x million dollars, 99% from the limited partners and 1% from the VC. The first thing to do if some companies goes public or are acquired by another firm: ▪ First repay/pay-back the limited partners the money they invested ▪ Then pay back the general partners so that at least everybody re-coops their money ▪ And only then you share the profits according to the 20%/80% rule that we described —> VC’s bear the risks + they will manage and help developing the company they’re investing in. Lock up clause: clause by which the VC agrees to retain/keep his shares of a company after the IPO for 6 months. —> OBJECTIVE: ensure that the price of the shares at the IPO is a fair price. In the case of the exercise, as soon as the IPO is completed, the VP can sell his shares. What is the intuition for the existence of such lock up clause? ! We don’t trust each other. Investors that can buy stocks at the IPO don’t trust VCs to reveal all the information they have about the future of the firm. The VCs will hide poor information if this is an interest of the VC to hide this information. Sold for $10, he knows that the fair price is $8; if he’s not obliged to keep the shares for a lock up clause, he’ll say ok this is worth $10 I sell it, and when the stock price is $8 I don’t mind. If he keeps it for a 6 months period, and the stock price goes down than the VC will know incentive that the stock is going to be $8, so they impose them to keep the shares so when the information becomes public, then he will suffer if he lied. It’s a protection mechanical for us who have no information on that. Example: you are VC and you have invested in firm A and it’s the time for A to be send to a public market. You have a lot of information regarding the future of the company = information advantages over the general public. There is a price at which the share are sold = $10 per share. !15 If you cannot trust, he has to lower the price = $9 or there is no IPO at all. If shares are really worth 10$ and the VC sells it for 9$, the VC loses money. !Need to find a way that the information is symmetric for both counterparties = lock up clause If the VC says that the shares are worth 10$ whereas they are worth 9$. Keep some shares in the firm for 6 months for example, during which the public will learn about the company and will have some notions about how the future will be for that particular company. If the VC was lying, those shares won’t be sold at 10$ even after 6 months = the VC has no incentives to lying the first place = no benefit from lying. II. TAKEDOWN SCHEDULE - It specifies how the funds committed by the LPs will be paid into the fund; -Consistent with gradual investment by the fund into portfolio companies; ex: we can invest 1 million now, then if it works well, invest another 2 million, and if we reach the objectives —> 5 more millions —> gradually. Takedown Schedule = Contract written between VC’s and LP —> calendar which specifies at which date the LP should invest money into the Partnership Typically, -Between 10% and 30% are disbursed at closing —> = refers to the creating of the partnership -Dates of subsequent disbursement set in the agreement are left to the GPs’ discretion (with some restrictions) -Penalties are incurred by LPs if they’re unable to provide the cash at the scheduled moment. -All funds are drawn (given by the LPs to the GPs) between the 2nd and the 4th year; Question Total investment —> $200 million 1) Carried Interest in 2011: None because there are no profits at this date. 2) Limited Partners Revenue in 2011: 150 millions US$. All the cash flows go to the Limited Partners until they recoup (=récupérer) their initial investment. RULE 1: First obligation of the fund/partnership —> return to the investors the money they invested. RULE 2: Once the LP have recoup heir investment —> return the money to the GPs RULE 3: share the profit according to the agreements. 3) 2012 profit: 4 million shares x $25 = $100 million. RULE 1 —> we give the $48 million left to LPs so that they recoup their initial investment RULE 2 —> recoup the GPs —> $2 million PROFIT = 100 - 48 - 2 = $50 million. !16 RULE 3 —> share the profit. Carried interest in 2012: (21% x 50) = 10,5 millions US$ of carried interests And 2 millions to reimburse the capital invested. So the General Partner gets 12,5 millions. 4) Limited Partners Revenue in 2012: They got 48 millions US$ to reimburse their capital. + 39,5 millions US$ (79% x 50) as carried interests. So they get 87,5 millions US$ HOMEWORK —> Use the same case, Question 2 but: the LPs pay management fees (3%) out of committed capital there’s a hurdle rate of 10% Hurdle Rate —> the LP’s must recoup their initial investment PLUS a minimum profit of 10% This is what a hurdle is: Thus, GP’s must give back to the LP: their initial investment + 10% profit BEFORE recouping their (GP’s one) initial investment. III. AGREEMENT BETWEEN THE GENERAL PARTNERS -Vesting schedule of the GPs’ interests (usually, early leaving implies forfeiting all or some of the profits) Objective as a junior partner —> working hard and creating your own fund. So you might want to quit the current partnership to create your own stuff with your experience … SO: It prevents successful young GPs to exit the partnership to establish their own = not good for the functioning of the current organization. That is why the contract sometimes specify that if you leave early, you will renounce to some fractions of profits. -Division of ∏ (usually, the older GPs receive the bulk of the ∏ even though younger GPs provide the bulk of the day-to-day management) Objective as a junior partner —> working hard and creating your own fund. So you might want to quit the current partnership to create your own stuff with your experience … IV. PARTNERSHIP AGREEMENT 1. Restrictions placed on fundraising -Minimum size of LP’s investments: limits the number of partners It avoids complex regulatory and disclosure requirements (1940 Investment Company Act) It caps the administering costs of the fund -Explicit minimum and maximum size for the fund The minimum size insures against adverse selection, and the maximum size avoids GP’s overload. !17 It’s in the interest of GPs to have a fund as big as possible as they’ll get more profit. But, not good for LPs who’ll have to share their profit with other LPs and on potentially less profitable projects. -Late LPs They must pay the same up-front and organization fees as the original ones, and they are restricted from a share of the interest. 2. Restrictions based on the GPs activities LPs fear opportunistic behaviour on the part of the GPs, and cannot be involved in the day- to-day management (if they want their liability to remain limited). Limiting the size of the investment in one firm avoids: ! Inefficient follow-on investment in poorly performing portfolio companies; ! Risk-taking by GPs (% of committed capital in the firm) Co-investments with the GPs’ earlier or later funds to avoid GPs’ opportunistic behavior (salvaging poor investments, manipulating returns to raise new funds) —> GPs could invest LPs money in order to « test » companies and projects, and then invest with their money into projects that are interesting (learned this thanks to the first investments with LPs money) Reinvestments of ∏ is limited because GPs could re-invest to obtain higher management fees and the extension of the fund’s life. Activities of the GPs ! Investments of GP’s personal funds in the portfolio firms is controlled: to avoid GPs investing in the more promising companies, investing at a lower valuation than the LPs later invest, or not terminating these firms if they are ailing (size or % of the I is limited/ permission is required). ! Sales of the GPs’ interests in the partnership is restricted because it would their incentives to monitor investments. ! Future fundraising is controlled because it can contribute to GPs’ involvement in the current fund. ! Outside activities (consulting, running other firms) are restricted during the 1st year of a fund. ! Addition of new GPs is addressed because hiring less experienced GPs can help alleviate the GPs’ burden but it also the quality of oversight. 3. Types of investments Usually, the PE fund is allowed to invest no more than a set % of capital (or asset value) in a given investment class. Problems: ! GPs could have larger compensation than deserved as compared to money managers specializing in public securities, or investment managers investing in PE funds; !18 ! GP could lack expertise in certain asset classes they want to invest to gain experience; VALUING A FIRM I. COMPARABLES Comparables give a quick and easy way to obtain a “ballpark” valuation for the firm. Step 1: Identify firms with similar characteristics = same risks, growth rate, capital structure, size and timing of cash flows -> hard to find in practice Step 2: Search for potential measures of value that can be sensibly applied from one company to the next. In public markets, common ratios are: !Price earnings ratio (P-E ratio): share price divided by the earnings per share !Market value of the firm divided by total revenue !Market value of the firm’s equity divided by the shareholder’s equity on the balance sheet (market-to-book ratio) Step 3: Just multiply! For Microsoft, we considered the number of patents as a ratio. This may be a more suited ratio than accounting measures (price earning ratio for example) for young companies. To summarize, the price-earning ratio allows us to compute the market value of equity. The market value of a firm divided by total revenue allows us to compute the market value of assets. This difference can be meaningful when there is a lot of debt in the company. When we compute the value of young corporations, some accounting measures might not be available. The solution is to look for measures of value that depend on physical factors: if you want to compute the value of an Internet Business, you might use the number of subscribers enrolled by a firm. If you want to compute the value of a biotechnology firm, you can consider the number of patents awarded. ! Non-financial, industry-specific measures. Problems with private firms Difficult to ascertain that valuations have been assigned to other privately held firms. If companies are private, so is the information regarding them = difficult to assess the value of your own corporation. Key ratios may not be calculable: because accounting and other performance information on private firms are often unavailable. Valuations assigned to comparable firms may be misguided: if the real ratio is 10 and not 8 (people made mistakes about the computation of a ratio) – when valuing your company, you will be wrong = use a ratio of 10 and overestimate the company (creation of a bubble on the stock market) !19  The best alternative is to rely on the fundamentals of the firms = CF that the firm will yield in the future. Use of public market comparable to value private companies: people don’t attribute the same value (the value of a private firm is < value of a public firm = you can resell the stock afterwards directly on the stock market ≠ find someone that wants to buy them) Because shares in private firms are less marketable than those of publicity traded firms, it may be appropriate to apply a discount for liquidity = the norm is to apply a lack of marketability of 25% or 30% to private companies as a compensation for the lack of liquidity. II. NPV METHOD ! Net value: subtract outflows to inflows ! Present value: there is a difference between a CF that arrives in a year and in 20 years. We will discount the flows of money that arrive in the future to make comparisons available. 1. Compute the cash-flows DEPR = Depreciation (taxes are an outflow here so we subtracted the DEPR and now we add it) Other = variation in taxes or wages payable, etc. t = corporate tax NWC = BFR Some logics in the formula: The EBIT serves as a basis for computing the taxes that we will pay. Since taxes are outflows of money, we need to take them into account. We need to add the depreciation, although it is not a real flow of money = match the real capital expenditures to the date that they occur. When you compute the EBIT, you subtract costs from revenues, but depreciation is already included into the costs. Including depreciation into the costs section makes you overestimate the real costs. It is not a neutral operation: in the operation, you reduce the amount of taxes that you pay to the government. Then we subtract capital expenditures as well as the ∆NWC = because they are not inflows of money, they should not be there. When, in the past, we faced losses, the government gives us the opportunity to pay fewer taxes in the future by carrying forward the losses. 2. Calculate the terminal value ! Using the perpetuity method (Gordon-Shapiro Formula) With g = growth rate in perpetuity !20  r = discount rate (r > g) 3. Determine the discount rate ! Using the WACC formula t = corporate tax rate, re = discount rate for equity, rd = discount rate for debt We need to use target values for D and E if the firm is not at its target capital structure. 4. Compute the expected rate of return on equity ! Using the Capital Asset Pricing Model (CAPM) to find re (rentabilité des capitaux propres) rf = risk free rate, rm = market rate of return, E(rm) – rf = market risk premium The ß in this equation is not the current ß but the target ß, which may be unknown. The more debt the company has, the riskier the return is for the equity holders. 5. If necessary, compute the relevant ß If the firm is not at its target capital structure, it is necessary to unlever and relever the beta. ! Unlever the beta: ! Relever the ß 6. Calculate the NPV !21  7. Some problems Lack of comparable companies To find ß or to estimate the target capital structure. A valid comparable company should have financial performance, growth prospects, and operating characteristics similar to those of the company being valued. A public company with these characteristics may not exist. Terminal value sensitivity Typical start-up company cash-flow profile (large initial expenditures followed by distant inflows) ! the bulk of the value is in the TV. TVs are very sensitive to assumptions about both discount and terminal growth rates. Is ß the proper measure of firm risk? Numerous studies suggest that firm size or the ratio of book-to-market equity values may be more appropriate. Few have tried to implement these suggestions in a practical valuation context. How to share out bargain between the entrepreneur and the VC? Proportionally to their investment but: ✓ Difference due to the fact that they will share the company’s value in XX years ! discounting ✓ Difference deleted to the delay between now and the moment where the pie will be shared. Other investors will come and finance the firm. The part that the VC is bargaining will be divided as other investors will come III. VENTURE CAPITAL METHOD ! Takes into account that investments are characterized by negative CFs and earnings, and highly uncertain but potential substantial future rewards. 1. Computing the final value ! Typically, using a multiple at a time in the future when the firm is projected to have achieved positive cash-flows and/or earnings (typically shortly after the venture capitalist foresees taking the firm public). Also, other techniques (perpetuity method for example) are possible. 2. Discounting the FV The “final value” is discounted back to the present using a target rate of return = yield the venture capitalist feels is required to justify the risk and effort of the particular investment (between 40 and 50%) 3. Computing the required final percent ownership !22 The VC uses the DFV and the size of the proposed investment to calculate her desired final ownership interest in the company: 4. Taking into account future dilution 5. Required current % ownership The VC computes the required current % ownership necessary to realize her target rate of return: STRUCTURING THE DEAL I. UNDERSTAND THE INCORPORATION (AND TERMINATION) PROCESS OF A FIRM Incorporation/Creation A corporation must apply for a corporate charter: describes the corporation’s purpose, place of business and officers. Corporations must file the application for the charter (often called Articles of Incorporation) with the Secretary of State to being the incorporation process. After the charter is authorized, corporate officers draft and sign the bylaws. Bylaws: states how the company will operate and specifies the rights or powers of its stockholders, directors, officers or employees, so long as the provision is lawful and consistent with the certificate of incorporation. Bylaws set forth: - The responsibilities of the directors and officers - The number or range of number of directors. Generally, a young firm starts with a board of 5 directors and as the firm grows more directors are elected by the founder of a company. The VC has the majority and as the firm grows the majority goes from the VC to the entrepreneur (if the VC is satisfied, he accepts to release control to the entrepreneur) - The manner of calling meetings of the stockholders and directors. - The maintenance of corporate records - The issuance of reports to stockholders, voting and proxy procedures. - The regulation of the transfer of stock and other general corporate matters. If one party wants to sell stocks, he musts propose equity to the other existing shareholders in priority. !23 Bylaws generally may be adopted, amended or repealed by either the board or by a vote of the stockholders. Termination ! Liquidation: sell the fixed assets or inventory (convert them into cash) - ∏ go to the stockholders – the board of direction ceases to exist. ! Winding up: includes paying taxes, … leading to the proper time and conditions for dissolution. Some states require a waiting period (to make sure that the rights of the employees or stockholders are respected for instance), and it may vary for different types of companies. !Dissolution: a corporation ceases to exist legally. The term sheet will specify what are the right and duties to the VC and the Entrepreneur in case of a liquidation, a dissolution, or a winding up. II. UNDERSTAND THE RATIONALE OF STAGE FINANCING Keep the entrepreneur on a tight leach The firm grows step by step (research, development, small-scale commercialization) – so the VC doesn’t give the whole investment at the beginning. If a firm need $20 M during the first year, it has to build first a prototype, start the production… = no reason for the VC to invest this kind of money right away. If the entrepreneur is spoiled with too much money, he might waste it. VCs have some control on what he’s doing with it, they can stop financing if he’s not successful. VCs fear the entrepreneur opportunism, who might use the money for other purposes than the ones agreed on, or quit the firm sooner than expected. A solution: Stage financing The usual way when writing a term sheet is to specify different milestone that the entrepreneur will have to reach. Reaching the milestones is a prerequisite for obtaining additional cash from the VC. Obtaining additional cash necessitates bargaining over the terms a new contract. III. COMPUTE A PRE-MONEY VALUATION AND A POST-MONEY VALUATION The fundamental reason of the difference is the fact that the value of the firm changes as the firm grows. Example: We’ve got a company Scorpio with 100 shares. WCP, a VC fund, makes a $10 million investment into Scorpio in return for 20 newly issued shares. Implied post-money valuation: ($10 million) * 120/20 = $60 million. So, the company is worth 6 times the VC investment of $10 million. The VC obtains 1/6 of the firm. From the post-money valuation of a company we can infer the pre-money valuation of the firm (post-money valuation – investment). In that case the pre-money valuation is $50 million ($60 million - $10 million). !24 Dilution: Initial shareholders dilute their ownership from 100% to 100/120 = 83,33%, after the round of financing. The dilution is the fact that some additional investors comes in reduces the percentage of shares you own. Second round of financing = AXA Private Equity agrees to make a $20 million investment for 30 newly issued shares. The new investor gets 30/150 = 1/5 of the firm and he contributed to $20 million dollars. 2nd round implied post-money valuation: $20 million * 150/30 = $100 million 2nd round implied pre money valuation: $100 million - $20 million = $80 million 2nd round dilution: Initial shareholders further dilute their ownership to 100/150 = 66,67%. IV. DECIDE WHEN TO CONVERT PREFERRED EQUITY INTO COMMON STOCK Convertible preferred equity ! Something between debt and equity – type of claim received in exchange of your investment. Debt light features unsure that when the firm is not doing well, VCs obtain something also. Example: Scorpio issues 1 million convertible preferred shares priced at $100. As preferred shares (like fixed income securities), they give their holders priority over common stock. !The level of dividend is fixed in the contract. They receive 5% dividend before any dividend is paid to common shareholders. This instrument looks like debt = the fact that this 5% dividend is paid before any distribution of dividends, it is like the payment of a debt. When the firm is not doing well, the preferred stockholders have a priority over common stockholders during the liquidation. They rank ahead of common shareholders if Scorpio ever went bankrupt and its assets had to be sold off. This is some kind of protection for preferred stockholders. Absent bankruptcy, the worst investors would ever do is receive a $5 annual dividend for each share they own. As convertible shares, they offer their owners the possibility of even higher returns: if the convertible preferred shareholders see a rise in Scorpio’s stock, they may have the opportunity to profit from that rise by turning their fixed-income investment into equity. ∏ of converting Conversion ratio: number of common shares shareholders may receive for every convertible preferred share. The conversion ratio is set by management prior to issue, typically with guidance from an investment bank. CR = 6, so for each preferred share, the investor can obtain 6 shares of common stock if he converts. One preferred equity share is worth $100, you can convert this share into 6 common stocks. Conversion ratio shows what price the common stock needs to be trading at in order for the shareholder of the preferred shares to make money on the conversion. !25 Conversion price = purchase price of the preferred share, divided by conversion ratio. Scorpio: $16,66 ($100/6). Shares need to be trading above $16.66 for investors to gain from conversion. Participation with common stock on an as converted basis Suppose there are 9 million common stocks of Scorpio and 30 million dollars to be distributed among the shareholders. Number of preferred stocks: 1 million. 100$ per share. Conversion ratio: 6 Special dividend: 5% How much will the preferred stockholders get when these 30 million dollars are distributed? Because the preferred shareholders have a priority, the first thing to do is to pay the special dividend to them. They will receive 5% of 100$ over 1 million shares = 5%*100$*1 million = $5 million and 30-5=25 millions are still to be distributed. Common stockholders: 9 million common stocks Preferred stockholders: 1*6 = 6 million common stocks. We are going to work under the assumption that there are 15 million shares and 25 million $ to be distributed. The common stockholders receive $25m*9/15 = $15m The preferred stockholders receive $25*6/15 = $10m The proportion of common stocks held by employees before the 2nd round of financing is important. The VC will obtain a part of the company thanks to cash infusion. For the employees, we see the counterparty as an intellectual infusion in the company. Non-participating preferred stock: The original purchase price refers to the price at which the VC bought the shares initially. RESTRUCTURING DEBT Definition: Renegotiation of existing debt contracts In general, the decision to restructure debt is imposed to the firm: because it is not able to make debt payments as they come due; or the firm violated debt covenants that give lenders the right to ask for an immediate repayment of their claims. Examples of troubled-debt restructurings: Alstom, Eurodisney, Eurotunnel, Ferruzzi Group… I) WHEN IS DEBT RESTRUCTURING APPROPRIATE? Economic distress: the firm has negative NPV projects or registers a decline of its operating performance. Financial distress: the firm defaulted on its payment obligations (or violated debt covenants). Pure financial distress: debt restructuring is “natural”. !26 Financial + Economic distress: debt restructuring is not enough and can even be counterproductive for lenders When a lender is faced with a defaulting firm, it is essential to sort viable firms (that can survive if debt renegotiation) from non viable firms. Sorting is difficult due to the interaction between eco. and fin. distress Direct costs of financial distress: lawyers’ fees, consultant fees, transaction costs to liquidate assets... Example: when Macy’s department stores went bankrupt in 1992, it spent $100 million on “lawyers, accountants, investment bankers, and other highly paid advisors” (The Economist). ! Represents 2-3% of the value of assets for large US corporations, 20-25% for smaller firms. Indirect costs: debt ! reluctance by non-financial stakeholders to do business with the firm (customers, trade creditors, employees...) (Opler and Titman 84) But empirically, it is very difficult to identify indirect costs due to the « inverse causality problem ». II) PRIVATE WORKOUT VS. RESTRUCTURING IN BANKRUPTCY What triggers debt restructuring? ! Payments that are not made by the firm to the debt-holders as they come due. Covenants that are violated by the firm. Usual covenants -Stock (amount of debt): Max. debt to EBITDA – Max. debt to tangible net worth -Flow: Min. Interest Coverage ! Usually specified in the contract Covenants in Eurotunnel’s 1987 debt agreement ! General covenants Commercial opening of the tunnel after 07/94 Rational expectations of lenders that a delay in the opening or a cost overrun might occur ! Junior / Senior debt service covenant (NPV of net CF until 2005)/ (Junior bank debt): Default if < 1 3 cases of the covenant: ! Global debt service covenant (NPV of net CF until 2020)/ (Total debt): Default if < 1.3 ! Operating Cash Flow covenant (Annual net CF)/ (Annual interests charges + repayments): No refinancing if < 1.1 ! Dividend covenant (NPV of net CF until 2005)/ (Junior bank debt): No dividend if < 1.25 If those covenants are not respected, then: !27 ! Private workout: negotiation between the management of the firm and the syndicate (creditor). The management tries to convince the creditor that they will have issues. Private refers to the fact that information is not public (only between management and creditors) ! Bankruptcy filling: if private workout doesn’t work, then the bank goes to the judge and asks for the payment. The firm is going to be ask for a reorganization plan, if it is accepted by the judge then the firm has the chance to recover – if not, then the firm is liquidated. How is the management supposed to chose between those 2 options? More expensive if that goes through the private workout. With the time, the worth is going to be less than before. The US Bankruptcy Code: the firm can choose between those 2 chapters: ! Chapter 7: the bankruptcy court selects a trustee from outside the company who liquidates the assets and distributes the proceeds to debt-holders (absolute priority rule). ! Chapter 11: debt and equity holders receive new financial claims. Reorganization’s plan is imagined by management, submitted within 120 days to the creditors who can accept or reject it. Each class of impaired creditors as well as the equity holders must vote on it. The plan is adopted by the judge if nondiscriminatory, fair and equitable. The shareholders and creditors do not have to accept. More often chosen by firms. Advantages of private workouts and formal bankruptcy ! Advantages of private workouts: -Lower legal and professional fees -Average length of workout is shorter -No intervention by a judge no delays (120 days) ! Advantages of restructuring under bankruptcy: -In workout, all bondholders have to agree with the restructuring plan / Not needed in formal bankruptcy -Less informational asymmetry between claimants (because it is the mission of the judge inform all the parts) -Judge intervention to protect some claimants The decision to file for bankruptcy vs. private workout: Anticipated viability of the firm and the deterioration of liquidation values (L1>L2) Costs and orientation (pro-debtor (not in favor of bankruptcy) vs. pro-creditor) of the bankruptcy procedure Difficulty to implement a private workout (nature & number of lenders) Workouts more frequent for... !28 ! Firms with less numerous lenders / more concentrated debt ownership / a higher proportion of bank debt ! Firms with a higher proportion of intangible assets (then the process will be quite low). Example: The collapse of Eastern Airlines (pro-debtor bankruptcy law) 03/09/89: Eastern Airlines files for bankruptcy. At the time, its value was $ 4 billion. In 1991, Eastern Airlines was liquidated. The claimants only received $ 2 billion. Reasons? ! The judge authorized Eastern to use the proceeds of asset sales (more than $ 2.3 billion) to fund unprofitable operations ! Asset sales benefited marginally to claimholders (they received only $ 867 million from asset sales) III) DIFFERENT FORMS OF DEBT RESTRUCTURING The lender can be: soft (reduces interest payments/principal amounts, extends maturity, substitutes equity for debt) or tough (increases interest payments/collateral, asks for a partial repayment of its claim) = accelerates liquidation. But it doesn’t necessarily accelerate liquidation if the lender’s tough behavior is compensated by soft behavior from other lenders. A problem of Time inconsistency: ex ante or ex post option ! If managers (acting on the behalf of shareholders) anticipate that lenders will not renegotiate in case of default: incentives to decrease the probability of default......True if and only if the lenders’ commitment to liquidate the firm in case of default is credible But creditors may prefer to save the firm when default materializes. Debt restructurings of small firms The dynamic behavior of banks and trade creditors during the process of distress: -Banks are not soft: they reduce their loan exposure during the time separating the first signs of distress and the beginning of the recovery. -At the same time, trade trade creditors expand their credit (for each £1 decrease in bank credit, they increase their loan by £0.78). Large companies’ debt restructurings Banks accept to abandon the debt for a fraction of the equity of the firm. ! Debt for equity swaps « Capital reorganizations in which creditors exchange or convert a proportion of a company’s indebtness for one of more of its share capital » swap: retain some debt and some of the precious debt is transferred into equity. After the restructuring, same amount of debt but the value of the new equity holders is lower. The bank accepts a lower equity of debt: because it thinks that the firm will recover and will reimburse. The bank is now an equity holder so if the firm is going better - the bank will also improve from that. Bank will share a fraction of the wealth of the company. !29 Some empirical evidence on large companies’ debt restructurings IV) COORDINATION PROBLEMS Bank run -debt 100, liquidation value 50. -debtor has all the bargaining power. -what happens when the debtor tries to renegotiate the debt? Single creditor: the creditor will accept an offer down to 50 – if the debtor proposes 51 = the creditor refuses, the firm goes bankrupt and the assets are liquidated and everything goes to the creditor because he has a right from its initial investment of 100. Two lenders (each with a liquidation right over the whole firm): the creditors will reject the offer and ‘run on the firm’ If they are 2 creditors, then why an agreement cannot be possible? Firm proposed 51 but they refuse. They will get if they accept half. Each of them has the right of 50. This is because they can’t sell the company. Because it is not possible to get an agreement because they want 50 not half of it. The holdout problem A firm has to pay €100 M in 2015 and €100M in 2016 to its bondholders (100 M) The firm is unable to meet its debt payment in 2015 and proposes to defer payments (exchange offer) in the future. Liquidation value = 80 million in 2015 and the probability of default in 2016 if the exchange offer is implemented is 10% (that the firm will be enable in 2016 to pay.) Collectively, bondholders have incentive to accept the offer Individually: if the offer is accepted !30 - Participating bondholder’s expected payoff: 90% chance of received - 2x0.9=1.8 - Non-participating bondholder’s expected payoff: 1+(1x0.9) =1.9 Conclusion: dispersion of liquidation rights might: Make the firm vulnerable to creditor’s run Prevent debt renegotiations (holdout problem) V) EUROTUNNEL CASE Idea: 1802 - Construction: 1986 A reality that looks like a nightmare For banks: Eurotunnel suspended the payment of interest on junior debt less than one year after the commercial opening. For shareholders: Two puzzles concerning Eurotunnel The largest project company in the history: Puzzle n°1: Project finance How can we explain the failure of this large project company? Theory: PF companies are the optimal type of organization to finance infrastructures One of the largest private workout in the history: Puzzle n°2: Financial restructuring and lender passivity How did Eurotunnel finalize a financial restructuring involving so many creditors? Why banks did not trigger bankruptcy despite Eurotunnel’s chronic distress? (why they accept to abandon some of their initial loan) Received Theory: Due to coordination problems, a highly dispersed debt ownership should lead to liquidation Puzzle n°1: Performance of project companies Typical projects: High EBITDA margins, few positive NPV, growth options and highly specific assets Why should project companies be more efficient? !31 Why was Eurotunnel not so efficient? Eurotunnel poor governance structure: conflicts between sponsors (banks unable to anticipate costs because of their lack of technical expertise – constructors underestimated costs to win the bidding offer) & change of equity ownership and transition from a project structure to a highly indebted public company (ownership of banks diluted 8% - they transferred their risk to ill-informed individual shareholders) Findings on puzzle n°1 ! PF companies have high debt, LT contracts and specific assets ! Specific features: dispersed equity ownership + powerful banks and sponsors ⇨ Governance problems associated to dispersed equity ownership may be worse in project companies which are by nature creditor-dominated Puzzle n°2: Financial restructuring/lender passivity Private workouts are more difficult to implement when there are numerous creditors. How to reach an agreement? !32 Restructuring plan: junior debt = £8 billion ! No real concessions from banks ! Eurotunnel was still over-indebted after the restructuring and the necessity of a new debt restructuring at the end of the stabilization period was highly probable Learnings on puzzle n°2 ! banks were concerned with avoiding bankruptcy (political pressure from the French gvt) while keeping the firm highly leveraged (the bank has a high bargaining power – gives her the possibility to wait for more precise info on the firm’s viability) Debt buy-backs (after 1998): because the market value of the debt < face value, Eurotunnel began a strategy of active balance sheet management through a series of debt repurchases. 2002 debt buy-back It reduced debt but not enough to avoid a new crisis at the end of the stabilization period. In October 2006, Eurotunnel was placed under judicial protection (French “safeguard procedure”) Characteristics of new debt: obtained from Goldman Sachs/Deutsche Bank – maturity extension (50% over 35 years at fixed interest rate, over 43 years at variable interest rates) – average interest rate 5,5% This restructuring was easier than the 1997 one? Hedge funds began to accumulate substantial holdings. Is it easier to negotiate with hedge funds (short-term players) rather than with the banks (long-term and heavily regulated players)? LEVERAGE BUY OUTS !33  I. WHY LBOs? ! Buying a firm with debt. The buyers can be LBO funds, managers or LBO funds + managers This firm needs to provide significant cash-flows (no matter its size) Initially, there is an incentive problem = a large fraction of the sale price is financed with debt. The LBO firm becomes private (ownership is concentrated) ! It generates management incentives: -High level of debt ! likely that the firm will go bankrupt (managers work hard) -Concentrated ownership ! managers enjoy the rewards from their efforts (work hard) French LBOs in 2002 10 largest LBOs in the 1980s and 1997/98 10 Largest LBOs in the 1980s and 1997/98 examples Acquirer Target Year Price ($bil) KKR RJR Nabisco 1989 $ 24,72 KKR Beatrice 1986 $ 6,25 KKR Safeway 1986 $ 4,24 Thompson Co. Southland 1987 $ 4,00 AV Holdings Borg-Warner 1987 $ 3,76 Wing Holdings NWA, Inc. 1989 $ 3,69 KKR Owens-Illinois 1987 $ 3,69 TF Investments Hospital Corp of America 1989 $ 3,69 FH Acquisitions For Howard Corp. 1988 $ 3,59 Macy Acquisition Corp. RH Macy & Co 1986 $ 3,50 Bain Capital Sealy Corp. 1997 $ 811,20 Citicorp Venture Capital Neenah Corp. 1997 $ 250,00 Cyprus Group (w/mgmt) WESCO Distribution Inc. 1998 $ 1 100,00 Clayton, Dublier & Rice North Maerican Van Lines 1998 $ 200,00 Clayton, Dublier & Rice (w/mgmt) Dynatech Corp. 1998 $ 762,90 Kohlberg & Co. (w.mgmt) Helley Performance Products 1998 $ 100,00 8 II. UNDERSTAND THE PROCESS: PRINCIPLES 1. Presentation Holding buys target – holding is highly leveraged = 30% equity & 70% debt – the holding’s debt is financed with the target’s dividends. 2. Dynamics of the game !34  Exemple Balance sheet (holding) at date 0 Target’s shares 700 Debt 500 Equity 200 Face value of debt: 500. interest payments: 6% 5-year maturity with the following pattern YearDebt Amount paid back Interest payments Annuity 1 500 100 30 130 2 400 100 24 124 3 300 100 18 118 4 200 100 12 112 5 100 100L. Batsch, mod. A. Renucci 6 10614 !35  3. Exiting IPO – Sell to another LBO fund – sell to an industrial partner !36