Introduction to PE and VC PDF

Private equity and venture capital: definitions, markets and characteristics Private equity vs debt Private equity Debt Provides medium to long time financing Characterized by variable time horizon...

Private equity and venture capital: definitions, markets and characteristics Private equity vs debt Private equity Debt Provides medium to long time financing Characterized by variable time horizon Has a fixed reimbursement schedule, no Does not have a fixed schedule payback matter how the company performs, and (for reimbursement). Sale of shares is short term loans are due upon request usually made to open market or to third- parties, and the company will not have Isn’t flexible and guarantees are required any additional costs Regular interest payments are It is a flexible source of capital in order mandatory, no matter the company's to fund growth processes performance, value of the assets is used A private equity investor is subject to the as collateral risk of the company and will only profit if the company grows Private equity players provide financial Consulting is only related to the and non-financial sources. They support financing. firms with their skills, competencies and know-how. 2 Definition and private equity players “The provision of equity capital by financial investors – over the medium or long term – to non-quoted companies with high growth potential” (Invest Europe) Private equity players: Are institutional players Raise capital mainly from institutional investors Invest in equity of non listed companies Remain as shareholders for a period of 4/5 years Private Equity players are not: Real estate funds Hedge funds 3  History of private equity The origins in the United States 1946: American Research and Development (ARD) Corporation, founded in Boston, raising capital from multiple institutional investors with the aim of providing equity and strategic and financial know-how to young enterprises. 1980s: the American market saw a period of strong increase, after the Department of Labour issued a clarification of the Employee Retirement Income Security Act’s “prudent man” rule that allowed pension funds to invest in private equity. First part of the 1990s: lower level of debt and many institutionalised private equity firms emerged. The economic recovery after the recession of 1990-1992 and the increasing interest in industries related to information technology generated a new boom phase. This expansion period abruptly ended in March 2000, when the Dot-com bubble burst, forcing many funds to write off their investments. The recovery of the private equity and venture capital industry began in 2003: between 2004 and 2007 the buyout sector underwent a great boom and the amount of money committed by institutional investors reached new peaks. The origins in Europe In 1945, the foundation of 3i, set up by the Bank of England and other British banks with the aim of providing equity and debt to companies with high growth potential, represents one of the first examples of private equity players in Europe. EVCA (European Venture Capital Association) was set up in 1983, with 36 full members and 7 associate members, to promote and develop the private equity industry in all European Countries. 4 The private equity process Fundraising Investments Managing and monitoring Divestments 5 Different type of players “CAPTIVE” Funds in which one shareholder contributes most of the capital. Captive funds can be subsidiaries of or departments in a bank, a financial institution, an insurance company or an industrial company INDIPENDENT Funds in which third parties are the main source of capital and in which no one shareholder holds a majority stake. An independent fund is the most common type of private equity fund. 6  Fundraising Fundraising is the promotion of a new equity investment vehicle within the business community, the purpose is to find money and create a commitment. Private Banks Pension funds Funds of funds Others individuals Private equity investment fund PE (investment fund) management company Portfolio/Target Portfolio/Target company 1 company 2 7  Evolution of fundraising in Europe Source: InvestEurope 8  Main sources of fundraising in Europe Total market Source: InvestEurope 9  Fundraising geographic breakdown Total market Source: InvestEurope 10  Main sources of fundraising in Europe Venture capital Source: InvestEurope 11 Fundraising: main terms & conditions Management fee: annual fee paid paid to the GP, in order to cover the basic costs of running and administering a fund. Carried interest: performance fee, share of profits that the fund manager is due once it has returned the cost of investment to investors. GPs begin to receive the carried interest once investors receive their preferred return (hurdle rate) Transaction fee: fees related to investments, including third parties consulting costs. 12 Investments Investing is the core of private equity business and the way to develop a business idea for the investor. There are two main areas of investing: Valuation and selection of opportunities and matching them with the appropriate investment vehicle. Target company valuation, the core competence of a private equity fund, is a proper blend of strategic analysis (about the business, the market, and the competitive advantage), business planning, financial forecasting, human resources, and entrepreneur and management team assessment. 13 Private equity investments Private equity Early stage Development Change Infrastructure - Seed - Buy out - Start up - Expansion - Replacement - Turnaround Venture Capital 14  Company life cycle and private equity investments Sales Early Stage Financing Cumulative cash Expansion Capital Pre-Seed Seed 10/50 Euro Mln 0,1 Euro Mln 0,5/1 Euro Mln Second Round Private Equity Incubators 5/20 Euro Mln Stock Exchange Business Angels Venture Capital Start up Domestic Capital Private Equity 1/5 Euro Mln Public Players Venture Capital Analysis and Consolidation of Increasing innovation of the product evaluation of Product Company the product Consolidation of the organization the concept definition establishment Sales force Marketing and trade investments Business Product structuring plan completion Partnership and acquisitions Strategic Market First commercial partnership analysis results 15  Evolution of investments in Europe Source: InvestEurope 16 Early stage investments Seed financing: financing provided to research, asses and develop an initial concept before a business has reached the start up phase. Start up financing: financing provided to companies for product development and initial marketing. Companies may be in the process of being set up or may have been in business for a short time, but have not commercialized their product. 17 Early stage investments: characteristics Financing of the start up of a new venture that moves from the idea to the operations. Money are used to buy all DEFINITION what is necessary to start (equipment, inventory, building, etc...). Money is used to finance a firm. Risk is very high because of the uncertain of the future RISK-RETURN PROFILE development of the business. It is possible to calculate the expected IRR even if the maturity of the investment can be very long. To give strong support to the business plan; CRITICAL ISSUES TO To offer capability in deeply understanding the nature and MANAGE the assumptions of the business plan; To realize strong valuation of the team. Very strong and related to all activities which are MANAGERIAL INVOLVMENT necessary to produce the business plan. The percentage of shares could be also very high. 18  Venture capital in the US Source: IHS Global Insight, NBCA, Venture Impact: The Economic Importance of Venture Capital-Backed Companies to the U.S. Economy 19 Expansion investments Expansion financing: financing provided for the growth and expansion of an operating company, which may not yet be breaking even or trading profitably. Capital may be used to finance increased production capacity, market or product development, and/or to provide additional working capital. 20 Expansion investments: characteristics Financing of the fast growth phase of a firm that aims to consolidate the position in the market. DEFINITION Money is used only to sustain the gap existing between cash flow and money needed. Money is used to finance sales growth. Risk is moderate (and linked to the business) because RISK-RETURN PROFILE the trend of development of the business is well known. It’s possible to calculate the expected IRR. To give strong support; To face risks linked to a fast process of growth (i.e. CRITICAL ISSUES TO accurate selections of the new markets to enter, inventory MANAGE choices, etc…). Mentoring and advisory activity in defining the right assumptions of strategic decisions. MANAGERIAL INVOLVMENT The percentage of share is not very high and it does not represent a specific characteristic in this type of deal. 21 Minority investments: some rules A payment system consisting of a postponed payment of a part Earn out agreement of the original acquisition price. This is done at the realization of defined performance indicators fixed a priori. The holder of the venture-backed company’s stock has the right to buy or sell it at a pre-determined price and a specific date. Stock option These stock options can be assigned both to the management and to the entrepreneur to motivate and increase their desire to maximize the company’s value. An agreement between investors, existing shareholders and the Lock up management that prohibits them to sell their quote to third parties. 22 Minority investments: some rules Motivation method for the entrepreneur and manager that provide an exit when the company’s shares are re-allocated Exit ratchet between the entrepreneur and the venture capitalist to allow the entrepreneur to obtain a part of the capital gain realized by the private equity investor. If the venture capitalist wants to sell his stock, this mechanism Drag along provides the right to ask all other shareholders to sell their stake at the same conditions and to the same buyer. If the majority shareholders sell their partecipations, the private equity investor has the right to join (pro-quota) the deal so he Tag along can sell his minority stake in the venture-backed company at the same terms and conditions to the same buyer. 23 Replacement and turnaround investments Purchase of shares in a company Replacement capital from another private equity investment organization or from another shareholder or shareholders. Financing made available to existing business, which has Turnaround financing experienced trading difficulties, in order to re-establishing prosperity. 24 Buy out investments Management buy out: transaction in which one or more members of the incumbent top management team acquire all or a part of the shares of their firm that the parent company wants to sell because of financial, strategic, and/or other reasons. Leveraged management buy out: the acquisition of a company or division of a company with a substantial portion of borrowed funds. 25 Typical structure of an LBO STEP 1 (creation) STEP 2 HOLDING (subordinated debt) CREDITORS STEP 4 STEP 3 (merger) (payment) TARGET TARGET SHAREHOLDERS 26  Distribution of investments by stage Source: InvestEurope 27  Distribution of investments by sector Source: InvestEurope 28 Different approaches Hands-on approach Active approach: in addition to advising on strategy and development, including in such areas as entering new markets, overseas expansion, acquisitions and hiring new management, the private equity firm will have many useful business connections to share, possibly including introductions to potential customers, suppliers, headhunters, acquisition candidates and even to other private equity firms in connection with syndicating financing rounds. The private equity firm aims to be a business partner. The investor can act as a coach or mentor. Backing from a private equity firm can provide credibility and status in dealing with third parties. A hands-on investor is particularly suited to a company embarking on a period of rapid expansion. However, day-to-day operational control is rarely sought. The private equity firm will expect to: Receive copies of management accounts, promptly after each month end. Receive copies of the minutes of the board of directors’ meetings. Often private equity firms will expect to participate through a seat on your board. Be consulted and involved in, and sometimes have the right to veto, any important decisions affecting the company’s business. This will include major capital purchases, changes in strategic direction, business acquisitions and disposals, appointment of directors and auditors, obtaining additional borrowings, etc. 29 Different approaches Hands-off approach Some investors will have a less active role in the business, a “hands-off” or passive approach, essentially leaving management to run the business without involvement from the private equity firm, until it is time to exit. They will still expect to receive regular financial information. 30 Managing and monitoring After closing the deal, both the investor and the venture-backed company need to organize, plan and manage their partner. The goal shared is the creation of value. Managing and monitoring selected vehicles help to create value and control opportunistic behaviours of the financed venture firm. Private equity players provide financial sources, but also non-financial sources like: Help to carry out firm’s development strategy; Support firms with financial and accounting skills, reputation and know-how complementary to the entrepreneur’s one; Chance to make partnership with other entrepreneurs of the same or other sectors and meet partners for international acquisition or joint venture; Contribute to a professional day-by-day management; Provide companies with more credibility with banks and the market; Attract brilliant managers. 31  Private equity involvement in company’s activity Of which: Of which: TYPE OF INVOLVEMENT All companies Seed/Start up Expansion Start an international activity 67% 63% 80% Technical advice 11% 14% 0% Financial advice 84% 82% 64% Definition of strategies 81% 92% 50% Human resources management 41% 36% 36% Marketing advice 26% 30% 10% Improvement in contacts with suppliers 27% 31% 27% Improvement in relationships with banks 76% 85% 60% More chances to access to the stock 70% 40% 64% exchange market Source: Banca d’Italia 32 Divestments Exiting is the final step in the investment process made by the venture capitalist. This step is very important because the venture capitalist sells his stake to gain the value added created by the investment and managing and monitoring activities of the venture. This phase in critical and a good time and the best way to exit must be identified. 33  Evolution of divestments in Europe Source: InvestEurope 34 Different type of divestments Trade sale: sale of company shares to industrial partners Secondary buy out: sale to another private equity player IPO: stock market quotation Buy-back: repurchase of a company by its existing shareholders Write off: total or partial write-down of a portfolio company’s value to zero, with the subsequent exit from the company or reduction of the share owned 35 Distribution of divestments by type 36 Distribution of divestments by type 37  The private equity investment process Source: BVCA 38  The skills along the private equity investment process Skills Company Legal & Promoting & People Governance Reporting Recruiting Valuation Fiscal Selling Management Phases Fundraising Investing Managing & Monitoring Exiting 39 Selection of target companies First point of contact with the venture capitalist (prepare Executive Summary and/or Business Plan). Private equity investors want to learn what the entrepreneur and his management team are planning to do. Private equity firms receive hundreds of business plans every year. It’s important to convince them that the business activity prospected have something special. If the first contact is satisfactory a letter of commitment is submitted. 40 Selection of target companies 2-3 investiments 10 projects selected Due diligence 20 projects selected In-depht analysis 50 projects selected First screening 100 business plans presented 41 “Growing” companies With a good growth path (product/market combination) Lead by a brilliant entrepreneur and characterized by a managerial approach Transparent Open to contribution from third parties With a defined way of exit 42  Some information about the PE and VC market www.privateequitymonitor.it Italy www.aifi.it www.aifi.it/private_capital_today www.k4g.it www.ventureup.it www.investeurope.eu Main private equity and venture capital associations in Europe Spain United Kingdom Germany France Netherlands Sweden www.ascri.org www.bvca.co.uk www.bvkap.de www.franceinvest.eu www.nvp.nl www.svca.se 43