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Private Equity. Ian Armitage Chief Executive Mercury Private Equity. Dissecting Private Equity. What is Private Equity? Why Should Your Clients Do It? Why Should Your Clients Not Do It? Investment Routes Have new investors missed the boat?. What is Private Equity?. Venture Capital

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Private Equity

Ian Armitage

Chief Executive

Mercury Private Equity


Dissecting private equity
Dissecting Private Equity

  • What is Private Equity?

  • Why Should Your Clients Do It?

  • Why Should Your Clients Not Do It?

  • Investment Routes

  • Have new investors missed the boat?


What is private equity
What is Private Equity?

  • Venture Capital

  • Leveraged Buy-out (LBO) Business


Venture capital

Description

Idea

Prototype

Pre-operational

Business is operational

Initial sales encouraging

Fundingallows plannedflotation

Sells equityto investigatethe idea

Sells equityto provethe idea

Product development and market testing

Hire employees,buy equipment, fund working capital

WorkingcapitalDebt-ledfinance forfixed assets

Working capital and second-generation product

Debt-ledfinance forfixed assets

Application

Venture Capital

Seed

R&D

Start-up

Early Stage

Expansion

Late Stage

Expansion

Pre- flotation

Risk


Luminar venture capital

€000

Luminar - Venture Capital

Operator of theme bars


Receiver

Desperate

Family Shareholder

Regulatory Sale

Definitely Not

Incumbent

The LBO Business

Turnaround

Replacement capital

Institutional buy-out

Management

buy-in

Management

buy-out

__________ Orphan Assets ___________

__ Business with no Owner Succession __

Seller

No

No

Yes but supplement

Management

Risk


Dechra an lbo from gehe ag

€000

Dechra - An LBO From Gehe AG

The UK’s leading distributary vetenary drugs


Sources of capital risk profile

Seed

Start-Up

Expansion

Capital

Pre-flotation

LBOs

Private Investors “Angels”

Specialist VCs

Public Markets*

Generalist VCs

Public Markets*

Generalist VCs

Investment Banks

Fund Managers

Buy-out Firms

Investment Banks

* Temporary phenomenon

Sources of Capital & Risk Profile


The case for private equity
The Case For Private Equity

  • Private equity out performs over the long term

    Source: WM Company/BVCA Performance Measurement Survey

  • It is a loosely-correlated asset

    May be able to increase performance without materially increasing risk


1999 private equity returns
1999 Private Equity Returns

per annum % 3 years 5 years 10 years

Private Equity* 31.1 27.2 20.0

FTSE All-Share20.4 20.3 14.9

FTSE 100 22.2 21.8 15.6

FTSE SmallCap 15.5 15.6 10.8

* median return

Source: BVCA WM Company


1999 private equity returns1
1999 Private Equity Returns

per annum % 3 years 5 years 10 years

Total 31.1 27.2 20.0

Early Stage 15.8 16.6 8.7

Expansion Capital 30.3 26.9 12.6

Mid MBOs 19.9 22.1 17.3

Large MBOs 31.0 26.4 22.9

Source: BVCA WM Company


The case against private equity
The Case Against Private Equity

  • High Risk

  • Low Liquidity


Risk

  • Single company risk: Leveraged } Young } Moderate to high Smaller }

10 Year Record

Loss Ratio 7%

Returns 46.8% pa

  • Portfolio risk: Low


Liquidity

The cash flow for an investor in a private equity funds follows a J-curve

Cashflow of investment £

1 2 3 4 5 6 7 8 9 10

Years

Liquidity

50

0


Liquidity1
Liquidity follows a J-curve

  • Self-liquidating

  • Growing secondary market


Other issues
Other Issues follows a J-curve

  • MFR

  • Valuations


Private equity

5% to 10% of equities follows a J-curve

Private Equity

  • All UK pension funds should consider an allocation to private equity


How do you invest in private equity
How do you invest in private equity? follows a J-curve

  • Direct

  • Private Equity Manager

  • Fund of Funds

  • Quoted Investment Trust


How do you select a manager
How do you select a manager follows a J-curve

In the normal way:

  • People

  • Performance

  • Processes

  • Philosophy/Strategy



Europe is restructuring

Unquoted investment as % of GDP follows a J-curve

Source: EVCA

Europe Is Restructuring


Pii group
PII Group follows a J-curve


E-Commerce follows a J-curve

Profile

Example

* Portfolio company of Mercury Private Equity

New Channel

Fulfilment

Infrastructure

Dot.com

‘Bricks and mortar’.

Suppliers of equipment, software, services etc to Dot.com businesses.

Classic internetcompany -usuallyretail or portals.

‘Clicks and mortar’.

New secondary on-line

revenue streams.

‘Bricks and mortar’.

Outsourced back

office (e.g. logistics)

of Dot.com

businesses.

Tesco, Dell, Clinphone*

MapQuest.com*,

1-800 Batteries*, Trados*

Global People Network*

Bertrams*

Irish Express Cargo

Braitrim*

Wincanton

Amazon.com

QXL.com

Freeserve

IBM

CISCO

BT, Vitria*

Agora*


Bertram group
Bertram Group follows a J-curve


Private equity1
Private Equity follows a J-curve

  • Long-term out-performance

  • Risk & liquidity concerns are overplayed

  • Use to increase returns without materially affecting risk

  • Expert funders of change at a time of restructuring


Appendices
Appendices follows a J-curve

  • Definition of Terms

  • Investment Return

  • Detailed Schematic of MPE Investment Process

  • MPE Organisation Structure

  • Extract from MPE Business Planning Process


Appendices definition of terms
Appendices - Definition of Terms follows a J-curve

  • Venture Capital:

    • Early Stage (“Seed to Start-up”): Capital for businesses in the conceptual stage or where products are not developed and revenues and/or profits may not have been achieved

    • Expansion Late Stage (“First stage to Mezzanine”): Growth or expansion capital for mature “businesses in need of product extension and/or market expansion. Sometimes referred to as development” capital

  • Buy-out Capital: Equity capital for acquisition or refinancing of a larger company

  • Restructuring Capital: New equity capital for financially/operationally distressed companies

  • Mezzanine (/subordinated) debt:

    • Intermediate debt capital between equity and senior debt for acquisition or refinancing transactions

    • The debtholder participates in equity appreciation through conversation features such as rights, warrants or options

  • Carried Interest (“carry”): This represents the share of a private equity fund’s profit that will accrue to the general partners

  • Fund of funds: Private equity funds whose principal activity consists of investing in other private equity funds. Investors in fund of funds can thereby increase their level of diversification

  • General Partner (“GP”) /Sponsor: Managing partner of a Limited Partnership, who is responsible for the operations of the partnership and, ultimately any debts taken on by the partnership

  • Hurdle Rate (or Preferred Return): A hurdle return allows investors to get preferential access to the profits of the partnership. In absence of reaching the hurdle return, the general partners will not receive a share of the profits

  • Limited Partnership: Most private equity firms structure their funds as limited partnerships. Investors are the limited partners and private equity managers the general partners


Appendices investment return

Harvesting follows a J-curve

Illustrative data only

Value creation

Portfolio construction

Year

IRR

Appendices - Investment Return

Private equity investment return in a partnership typically follows a “J-curve” e.g. in the early years while investments are being made a Private Equity fund will show negative returns.


Appendices detailed schematic of mpe investment process pii
Appendices - Detailed schematic of MPE Investment Process: PII

Growth buy-out £105m

Support Services Sector

Deal introduced by ‘primary contact’

Initial Appraisal: Market and technology leader,

under managed, requiring

first class CEO

Conversion: British Gas wanted

speedy and comprehensive

response - certainty

Diligence: 3 month exercise: key issues were

long term contracts, intellectual property and R & D

Negotiation &

Structure: Transneft contract

Exit: 1) Sale to leading oil-services group: Dresser, Schlumberger

Baker Oil & Tool

2) IPO

Business Plan Core business - improve utilisation

Acquisition - acquire Pipetronix/Rosen

New Products - fitness for purpose services

Organisation - make market facing,

change culture

Financials - double EBIT in 3 years



Appendices mpe business planning process

Deal PII

Sourcing

Initial

Analysis

Appraisal

Diligence

Negotiation

Structuring

Exit

Planning

Operations

Completion

Strategy

SELL!

Appendices - MPE Business Planning Process

Process: The investment process is different to that employed by public security investors. The best is data driven, disciplined and designed to minimise judgement calls with the intent to add value. Here is the MPE process:

Deals do not

flow

Requires

consistent

marketing

Normal disciplines

Get the first call

Key skill

Decision to

allocate resource

Win confidence

of counterparties

Combine internal

resources

People

Accounting system

& controls

Market position

dynamics

Technology

Facilities

Environmental

Insurance

Legal

An important

skill. Not all value

items measured in

£££’S agreement

Legal completion

output is:

Shareholders

Employment

contracts

Banking documents

Sale & Purchase

agreement

Warranties &

Indemnities

Other contracts

e.g. supply contracts

Management incentives

Complete

through strategy

review and

business plan

Identify and

effect

improvements

in operations

Detailed exercise

for exit, c.2 years

ahead of time

Either float,

trade sale

or recapitalisation


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