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Private Equity 101. MBA Program Fall 2007. Private Equity Industry. Venture Capital. Seed F&F, Business Angels, Funds Start up F&F, B/A, informal VC , Funds Expansion VC Funds. Private Equity propre. Buyout PE Funds Turnaround Mezzanine .

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Private equity 101

Private Equity 101

MBA Program Fall 2007


Private equity industry
Private Equity Industry

Venture Capital

Seed F&F, Business Angels,Funds

Start up F&F, B/A,informal VC, Funds

ExpansionVC Funds

Private Equity propre

Buyout PE Funds

Turnaround

Mezzanine


Private equity governance structure
Private Equity Governance Structure

  • Equity Ownership

  • Management fee

  • Cash Flows

PE Firm

  • Proceeds (~20%)

  • ~ 1 - 5% of Equity

  • ~ 95 - 99% of Equity

Institutional Investors (LPs)

PE funds

  • Proceeds (~80%)

  • Proceeds

  • Equity Investment

Portfolio companies


Private Equity Governance Structure (2)

PE Firms have an unlimited life as they manage a sequence of limited-horizon PE Funds as General Partners

  • time (in years)

  • t0

  • 1

  • 2

  • 3

  • 4

  • 5

  • 6

  • 7

  • 8

  • 9

  • 10

  • 11

  • 12

  • 13

  • 14

  • 15

  • 16

  • 17

  • 18

  • 19

  • t + 20

  • PE Firm

  • PE-Fund A

  • Portfolio Company

  • Portfolio Company

  • Portfolio Company

  • Portfolio Company

  • A1

  • A2

  • A3

  • PE-Fund B

  • Portfolio Company

  • Portfolio Company

  • Portfolio Company

  • Portfolio Company

  • B1

  • B2

  • B3

  • PE-Fund C

  • Portfolio Company

  • Portfolio Company

  • Portfolio Company

  • C1

  • C2


Terminology
Terminology

  • A buyout can be defined as the purchase of a controlling stake in a business from its owners, typically with the following characteristics

    • Investment companies

      Investor-led buyout - IBO

    • Financed through a combination of equity and debt Leveraged buyout - LBO

    • Equity participation of current management

      Management buyout - MBO

    • Introduction of new management Management buy-in - MBI


Typical features of a buyout
Typical Features of a Buyout

  • Increased financial leverage

  • Limited investment horizon

  • Standalone acquisition (exception “buy-and-build” transactions)

  • Triggers substantial change in acquired company

    • Restructuring

    • Strategic reorientation

    • Changes in management team

    • Layoffs

    • Divestitures


Mechanics of a buyout
Mechanics of a Buyout

Debt Investors

Debt

Newco

Holding

Buyout Firm

Equity

Target

„Portfolio Company“

Buys Equity of


Mechanics of a buyout1
Mechanics of a Buyout

A consolidated view shows

the increased leverage factor

Previous Debt

Previous Debt

LBO Debt

Previous Equity

Debt Investors

Buyout Firm

Equity


The Buyout Manager’s Perspective

  • A buyout implies substantial changein the role of managers

    • Changing reporting relationships

    • New Incentives – Co-Ownership

    • Debt burden through leverage – Focus on Cash Flow

    • Changing responsibilities – Division Head -> CEO; CEO -> Owner

    • Higher clock-speed – working towards the exit

    • Greater identification with your company

    • Stretch budgets and ambitious targets

    • Need to work with advisors - consultants or GP investment managers



Levers of Value Generation in Buyouts

  • Generation of returns from differences in the valuation applied to a portfolio company between acquisition and divestment independent of changes in the underlying financial performance of the business ("buy low - sell high strategy").

  • Financial Arbitrage (A)

  • Financial Engineering (B)

  • Optimisation of capital structure and minimization of after-tax cost of capital of the portfolio company as consequence of the utilisation of financial knowledge and experience

  • Increasing Operational Effectiveness (C)

  • Implementation of measures that enhance overall productivity and effectiveness of operations. The configuration of a company's resources, i.e. how the different available resources are put to work, are being readjusted.

  • Levers of value generation

  • Increasing Strategic Distinctiveness (D)

  • Adjustment of the strategic objectives, programs and processes of the portfolio company

  • Reducing Agency Costs (E)

  • Decrease of the agency costs that arise of the owner-manager-conflict in the portfolio company

  • Mentoring or ParentingEffects (F)

  • Increase in revenues or decrease of cost due to the effect that the portfolio company benefits of being associated with the buyout association


The evolution of buyout value generation
The Evolution of Buyout Value Generation

Time

1980

1990

2000

Financial Arbitrage, Optimizing Corporate Scope, Financial Engineering

Reducing Agency Cost

Increasing Operational Effectiveness

Increasing Strategic Distinctiveness

Parenting Effect

Value Potential


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