IMDADECTHESIS290902

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ABSTRACT
In the year 2001 investors in general had not too much to smile about, as their
investments in stocks listed at the major stock exchanges plummeted. Once high-flying
tech stocks fell to their all-time lows, with little hope for fast and consistent recovery ( as
their actual P/E multiple1
is even higher than in their “boom”-times).
Investments in US - government bonds provided “mere” returns, as the Federal Reserve
has cut key-interest rates to levels last seen some 40 years ago. Investments in high-
interest government bonds, out-side the US, ran “sour” quite often, as countries like
Argentina and Turkey failed to fully meet their obligations.
Corporate bond investments have not been a safe haven for substantial returns either, as
many companies, having issued High-Yield Corporate Bonds, filed for bankruptcy,
defaulting on the re-payment of the bonds issued.
Investments in European real-estate funds provided returns around 4.5 percent before tax
and faced an increasing risk-factor as many office – complexes failed to attract high-
quality tenants, accepting rates providing substantial returns for the land-lords.
The gold – price has run within a price-band of 265 US$ and 295 US$ a troy ounce,
making gold not a reasonable alternative investment going forward, as most analysts
predict that is not likely that the gold-price will “top” the 300 US$ threshold per troy
ounce by year-end 2002.
In the following table the author will compare the average performance of major US and
European stock exchanges within the last year (February 26th
2001 through February 26th
2002) with the average returns alternative investments, ranging from real-estate
investments to investments in gold and in private equity, provided.
1
P/E, also referred to as Price-Earnings Multiple, normally calculated by dividing the firm’s market
capitalization through the number of shares issued multiplied by the expected net-earnings at the end of the
next fiscal year by share.

2
The author has chosen this time-period, as the investments of the author’s private equity
holding in a portfolio of fast-growing companies also took place within this time- period
and comparisons of returns are only marginally distorted by the negative impacts from the
September 11th
2001 attacks.2
Taking into account that the investor invested 1 EURO on February 26th
2001 he could
generate the following returns on average by February 26th
2002:
Table 1: Return p.a. by Investment Category
Investment Category Febr,26th
01
Febr,26th
02 Return p.a. in % Comments
Dow Jones Industrial3
9.968.15 10.145.71 1.78%
NASDAQ4
2.328.05 1.769.88 - 23.97%
DAX5
6.342.54 4.921.01 - 22.41%
EURO STOXX 506
4.420.00 3.542.88 - 19.84% approx.26th
01
NEMAX 507
2.020.00 1.019.28 - 49.54% approx.26th
01
European Real Estate 4.50% author’s
expertise
Gold 265.008
296.009
11.69% per troy ounce
All Private Equity10
14.20% IRR
Private Equity Early Stage 22.50% IRR
Private Equity Development 29.20% IRR
Private Equity Buyouts 10.20% IRR
Average Return - 21.69%
Source: Author’s Research
2
Terrorist Attacks on the World - Trade Center Twin-Towers, led to Suspension of trading on the
NASDAQ and DOW Stock-Exchanges respectively
3
http:// money.cnn.com/markets/dow.html, February 26th
2002
4
http:// money.cnn.com/markets/nasdaq.html, February 26th
2002
5
http:// kurse.exchange.de/detailanzeige_indizes.html?sym=DAX, February 26th
2002
6
http:// kurse.exchange.de/detailanzeige_indizes.html?sym=SX5E.DJX, February 26th
2002
7
http:// kurse.exchange.de/detailanzeige_indizes.html?sym=NMPX.ETR, February 26th
2002
8
World Gold Council, London PM Gold Fixing (USD) 2001
9
http:// money.cnn.com/markets/commodities.html, February 26th
2002
10
European Private Equity & Venture Capital Association, Pan – European Survey of Performance, 2001

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As the table outlines above private equity investments in companies in the stages of early-
stage and development provided the highest returns. It has to be clearly stated that these
returns are stable and consistent and are not highly effected by stock-market fluctuations.
In this thesis the author will not only prove that private equity investments in a portfolio
of fast growing – businesses out-perform alternative investments, but will cover important
suitable concepts of corporate finance applicable to Strategic Asset Allocation and will
out-line the key-success factors to be fulfilled ranging from selecting the target industries
and companies to the development process of these companies towards out-standing
performance.
This proof will be delivered through the application of a case study, featuring real-life
investments and combining them with important concepts of “Investment Theory”.

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INTRODUCTION
The objective of this thesis is to prove that investments in fast growing private companies
outperform alternative investments.
This thesis not only illustrates that investments in fast growing companies provide higher
returns for the investors, but also outlines the necessary framework to be established in
order to generate these returns.
In order to illustrate the concept better and to combine investment theory with real
investment examples the author decided to use an actual case study related to the
investments in fast growing companies my private equity holding did in the last two
years.
The main chapters of this thesis will cover the following areas:
1. Investing in Private Companies
2. Private Equity and Leverage Financing
3. Financial Approaches related to Private Equity Investments
4. Applied Investment Criteria
5. The Quality of the Management
6. The Investment Process
7. The Process between Investment and Exit
In chapter one a general overview over the European Private Equity Industry, illustrating
that Private Equity Investments play an increasing importance in financing companies
growth, is provided.
Chapter 2 describes the concept of private equity, the aim of private equity investors and
the instrument of leverage deal financing, being crucial to increase the return on equity
for private equity investors.
The chapter dealing with financial approaches related to private equity investments will
describe how private investors can identify risk related to private equity investments and
to support them to apply modern “risk-and-return concepts” in their investment decisions,

5
as the potential investments have to generate returns being adequate to the individual risk
factors the investor is facing related to investments into these companies. Besides, this
chapter will explain how “wealth-creation” of the investment candidates can be measured
and traced permanently and applies the Net Present Value Method as the main parameter
if investments in the investment candidates should be done or not.
In the following chapter the author will describe which investment criteria were applied,
ranging from the selection of industries to the final selection of the investment candidates
and will cover the need for “strategy redirection” and the implementation of improvement
measures enabling the investor to generate adequate returns on our equity investments.
Chapter five will explain the importance of “management quality” being a major
investment criteria as “company-wealth-creation” can only be achieved through
knowledgeable and committed management teams.
The chapter “Investment Process” describes the needs for active and permanent
management of the individual investments and provides ways to stimulate the motivation
of the management teams through result-oriented compensation and stock option models.
In chapter seven the author will provide possibilities how a private equity investor can
secure his investment interests to the outmost possible extent and to generate his returns
on his investment through the divestment of the acquired stakes.

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1 INVESTING IN PRIVATE COMPANIES
According to Edoardo Bugnone, the present chairman of the European Venture Capital
Association 2001 was a year of reorganization and stabilization of private equity
portfolios in which valuations decreased from excessive levels of prior years to more
reasonable ones.
It should be stated that the private equity holding of the author restrained from investing
in private companies until entry evaluations reached a highly reduced level.
In 2001 EUR 24.3bn was invested in 8.104 companies11
, out of which EUR 11bn was
devoted to buyouts or acquisition financing, EUR 12.2bn was invested in venture capital,
during 2001.
Out of the EUR 12.2bn invested in venture capital, EUR 4.1bn was granted to 3.306
promising early stage companies and EUR 8bn was invested in 3.708 companies in the
expansion stage.
Close to 60 percent of the funds totally invested in 2001 was granted to companies in 3
European countries being the UK, Germany and France. The UK consumed 29 percent of
the total invested amount of EUR 24.3bn, while Germany ranked second with 18 percent
of the funds invested in 2001 and France ranked third with 16 percent of the funds
invested.
Although the amounts invested in 2001 are substantial there is still large potential for
private equity investments in Europe as commercial banks still provide most of the funds
needed by companies through “traditional” instruments being e.g. bank loans.
As of Year End 2001 European Private Equity Investment amounted only for 0.25 percent
of the respective Gross Domestic Product. In some countries involving Sweden, the UK
and the Netherlands this level was substantially higher but still peaked with Sweden at
11
Source European Venture Capital Association, Brussels May 28th 2002

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0.85 percent of the Gross Domestic Product. In Austria private equity investments are still
negligible as Austrian private equity investment ran at 0.08 percent of Austrian’s GDP.12
The following chart expresses the private equity investments as a percentage of the
countries Gross Domestic Product:
Table 2: Private Equity Investment as a Percentage of GDP in 200113
Source: European Venture Capital Association, 2001
12
EVCA Survey of Pan-European Private Equity and Venture Capital Activity 2001
13

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The following chart displays the distribution of private equity investments by
“development stage” during 2001.
Table 3: Stage Distribution of Investment by Percentage Amount Invested -200114
Source: European Venture Capital Association, 2001
The amount of divested private equity increased from EUR 9.1bn to EUR 12.5bn in the
year 2001. The main exit route was the trade sale, which accounted for EUR 4.2bn of
total divestments, followed by write-offs which represented 23 percent of total
divestment. Only a limited number of divestments took place through the course of an
initial public offering. The high amount of write-offs clearly outlines the increased
financing risk private equity investors are facing.
The funds raised for future investment amounted to EUR 38.2bn in 2001, meaning that
the raised amount for future investment was close to 36.4 percent higher than the invested
private equity in 2001. Pension funds provided 27 percent of the raised funds, banks
contributed 24 percent and insurance companies provided 13 percent of the funds raised
in 2001. The remainder of the funds raised was provided mainly by corporate investors,
private individuals and government agencies each accounting for roughly 6 percent of the
funds raised.
14

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In 2001 slightly above USD 40bn got invested in the US in venture capital, a figure which
will drop significantly in 2002, as the first quarter of 2002 shows a close to 50% drop in
venture capital investments compared with the first quarter of 2001.15
However as a percentage of GDP private equity investments amounted to 0.60 percent of
US GDP, by far higher than the 0.25 percent of GDP in Europe on average.
In the second quarter of 2002 venture capital investments decreased by 11 percent
compared with Q2 2001.16
Only the life sciences field consisting of companies in the biotechnology and medical
devices arena experienced a substantial growth in venture capital investments. The
biotechnology industry, which captured the second highest dollar amount at $958 million
realized a strong 15 percent increase in dollars invested compared with the first quarter
figure of $836 million. The medical devices sector also showed significant growth with
investment totaling $556 million, a 43 percent increase over the first quarter. Taken
together, the life sciences industries accounted for 27 percent of all venture capital
investing, the highest allocation in the last five years.17
The sectors semiconductor and media & entertainment experienced the biggest declines
with 31 percent in investment drop and 47 percent drop in venture capital investments
respectively.
Two thirds of all venture capital invested in the US for Q2 2002 was allocated to
companies in the expansion stage, a significant higher proportion than in Europe, where
only 33% of total funds invested went to companies in the expansion stage.
15
Venture Economics, Thomson, US,2002
16
National Venture Capital Association, VENTURE CAPITAL INVESTMENT IN Q2 2002, Washington,
D.C., July 2002
17
PriceWaterhouseCoopers, Life Sciences Industries Buck Trend, Washington, D.C., July 2002

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2 THE CONCEPT OF PRIVATE EQUITY AND LEVERAGE
FINANCING
2.1. What is Private Equity
Private Equity provides equity capital to enterprises not quoted on the stock market.
Private Equity can be used to develop new products and technologies, to expand working
capital, to make acquisitions or to strengthen a company’s balance sheet. It can also
resolve ownership and management issues related to a succession in family – owned
companies, or the buyout or buy-in of a business by experienced managers may be
achieved using private equity.18
The European Venture Capital Association identified over 1.300 private equity and
venture capital companies providing Private Equity.19
Private Equity is a long-term investment alternative (usually 1 to 4 years on average),
generating returns by far outperforming alternative investments. As Private Equity is a
long-term investment category, the private equity provider or investor should consider an
investment in Private Equity as being part of its investment portfolio, aside of more liquid
investments being e.g. investments in bonds, money-deposits and stocks in listed
companies.
The best performing European Venture Capital Funds (top 25 percent of the venture
capital funds) achieved an Internal Rate of Return (IRR) in 2000 running at 34.00
percent.20
The best performing funds, investing in early stage as well as development portfolio
companies achieved an Internal Rate of Return of 40.90 percent in 2000.21
18
http://www.evca.com/html/PE_Industry/question_faq.asp
19
http://www.evca.com/html/PE_Industry/question_faq.asp
20
European Private Equity & Venture Capital Association, Pan – European Survey of Performance, page 6,
2001

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2.2. Important Definitions
As I will refer to certain terms in the chapters later on, a thorough definition of Private
Equity specific terms is provided below.
A Private Equity / Venture Capital Company is the corporate entity which advises
and/or is responsible for managing the investment capital supplied to it by the founders
(founder is the source of investment capital for the venture capitalist). It undertakes or
makes recommendations about the selection and monitoring of investments and the
divestment process.22
A Private Equity/Venture Capital Manager is a person (a venture capitalist) or team
responsible for managing the investment capital which has been supplied to the Private
Equity/Venture Capital Company by the founders.23
A Portfolio Company, or investee company, is an organization which is in receipt of
venture capital from a fund advised or managed by a Private Equity/Venture Capital
Company.24
21
2001
22
2001
23
2001
24
2001

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Private Equity is normally provided to different types of companies differed based on
their “development stages” :
A Seed Stage Company is receiving Private Equity to research and develop an initial
concept before a business has reached the start-up stage.
An Early Stage Company has a developed business concept and in most cases modest
revenues.
Expansion Financing is provided to companies for the growth and expansion of the
company. This development capital is provided to companies which are fast-growing
(more than double-digit growth rates), normally not profitable at the time of investment,
to finance increased production capacity and or for financing market development and
working capital.
2.3. The Aim of the Private Equity Investor
Needless to say the Private Equity Investor tends to achieve returns out of private equity
investments, which are higher than the ones he could generate out of alternative
investment categories.
A Private Equity investor must be aware that investments in Private Equity are considered
as being long-term.
In Private Equity we have to differ between “materialized” and “non-materialized”
returns.
Materialized Returns can derive from the following cash inflows (cash provided by the
portfolio company to the investor):
• Paid interest on loans provided by the Private Equity Investor (PEI) to the
portfolio company
• Dividends paid out by the portfolio company on the equity provided by the PEI
• Divestment receipts through the sale of the stake the PEI holds in the portfolio
company to Strategic Investors or in the course of an Initial Public Offering (IPO)

13
Non-materialized Returns derive from the present value of the valuation of the
unrealized portfolio25
(this part of the portfolio which is not divested yet).
In the Private Equity / Venture Capital business the internal rate of return method (IRR) is
considered as being the most appropriate performance benchmark for Private Equity
Investments.
2.4. Is Private Equity available for the selected Investment Opportunities
After having applied the above outlined Investment Criteria the holding company of the
author ended up with 5 target companies, potentially justifying an investment.
As the author has pre-selected companies with extreme growth rates and or growth-
potential, but companies not providing free-cash-flow on an on-going basis, as the cash
generated needed to be re-invested in order to finance growth and market development,
the author had to ask the question either if it is possible, to structure financing with
adequate equity proportions.
25
2001

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In order to perform this task the following steps were taken:
• Identification of total funds needed by target company
• Creation of an adequate financing-mix (loans, subsidies plus equity) by target
company, reflecting the specifics of the industry the target company is operating
in
• Can sufficient equity being raised from private equity investors or venture capital
funds?
• Can the needed equity being raised on time( not too late to potentially endanger
“market-success” of the target company?
Table 4: Funding Structure for Portfolio Companies
TARGET FUNDS
needed.
Loans Subsidies Equity poss. raise on-time GO/NOGO
CLABS 3.000 1.500 N/A 1.500 yes yes go
LCT 1.000 0.505 N/A. 0.495 yes yes go
HD 0.182 0.092 N/A. 0.092 yes yes go
NN1 5.000 N/A N/A 5.000 no no no go
NN2 6.000 N/A. N/A. 6.000 yes no no go
Source: WECOS Managementberatung GmbH, Vienna, Austria
All figures in ‘000 EUR.
Although target companies NN1 and NN2 had promising business models and growth-
prospects, the author had to take the decision not to proceed further with a potential
investment in these two companies as the needed equity could not and or not being raised
on-time.
The equity needs for the CLABS investment were provided by a consortium consisting of
the private equity company of the author, funds provided by other private individuals and
an Austrian venture-capital fund, being specialized in funding technology and or growth-
oriented companies.

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The equity needs for the LCT investment were provided by a consortium consisting of the
private equity company of the author and an Austrian venture-capital fund, being
specialized in funding companies in the development stage.
The equity needs for the HD investment were provided by a consortium consisting of the
private equity company of the author and other private investors.
2.5. The time – frame applicable to the search of Private Equity
Attracting Private Equity is in general an energy-and time-consuming undertaking.
In the following the author will try to illustrate a “typical” process companies need to go
through if they are willing to attract funds from a Venture Capitalist:
• Elaborate a “sound” business plan, outlining amongst other specifics ( reflecting
the industry specifics and characteristics) in detail the company’s strategy, the
company’s competitive environment, its organizational structure including
resumes of the top management, its sales & marketing strategy and plans, its
product or service proposition and the company valuation the management sees as
being acceptable. It normally takes between 2 and 3 weeks to elaborate a business
plan, given the full attention and commitment of the management.
• Preparation of detailed plan profit & loss statements, plan balance sheets, plan
cash-flows, loan and investment schedules for the next 5 years ahead. This
preparation normally can be concluded 2 weeks after the start.
• Pre-Selection of potential private equity investors and or venture capital funds.
Note that private equity investors and venture capitalists normally only invest in
certain industries (based on their expertise and or their investment regulations)
and development stages of a company. This process normally takes between 1 and
2 weeks after completion of the business plan and the plan financials.
• Submission of an information memorandum/package, consisting of the business
plan and the plan financials to the pre-selected Private Equity Investors or Venture
Capital Funds. Total time needed approximately 1 week.

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• Arranging management presentations (Presentation of the Value Proposition by
the company management) to the private equity investors or venture capital
managers, who decided to proceed with a potential investment, after having
analyzed the submitted information package (about 30 percent of pre-selected
investors). This is a time consuming process ranging from 3 to 6 weeks.
• With about 10 percent of the once pre-selected private equity investors or venture
capitalists a letter of intent (LOI) is negotiated and signed. This LOI is basically
nothing else than to grant the right of access to the interested investor or investor
representative to all relevant company details and documents related to legal,
financial, patent and market issues. This process taking place now is often referred
as being the due-diligence process consuming 6 weeks on average.
• After the due-diligence process is concluded the company finally enters into
negotiations with no more than 1 to 2 percent of the pre-selected investors to
negotiate and conclude the “investment contract”, which details amongst others
the terms and conditions of the step-in of the investor, the time-period involved
for submitting the defined and agreed upon funds, special rights granted to the
investor. The negotiation process normally takes 6 weeks. On behalf of the
venture capitalist this contract is often signed subject to the approval of the
supervisory board of the venture capitalist, which follows or not within 2 weeks
after the investment contract was concluded.
After all is said and done 23 to 26 weeks are over from the decision to attract Venture
Capital to submitting the agreed upon funds.
Experienced private investors, providing private equity can shorten above mentioned
process to 8 or 10 weeks.
2.6. Leverage Deal - Financing
Investors tend to increase the return on equity (ROE) on the equity they are providing to
the portfolio company in the course of a Private Equity or Venture Capital Investment by

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offering an “investment-package” to the portfolio company consisting partly of equity
and of loans, meaning they submit a “leveraged-offer” to the portfolio company.
The investors do so because interest expenses on loans provided to the portfolio company
are tax-deductible in the investor’s P&L (Profit & Loss Account) in contrast to the equity
proportion they provide.
In many cases (in case of non-default)providing loans on top of equity to the portfolio
company generates constant and immediate returns for the investor as the lending-rate
granted to the portfolio company on the loan proportion by far over-exceeds the re-
financing rate of the investor, thus positively effecting the IRR of the investor.
Banks are normally willing to provide loans up to 65 percent of the total investment for
transactions related to stable companies, having a strong balance sheet and cash-flows,
without personal guarantees to be provided by the investor.
In the case of an investment into a high-growth or technology company, banks are only
willing, if so, to provide loans to the portfolio company which are backed up by personal
guarantees of the investor, protecting the bank in cases of a potential default of their
creditor, the portfolio company. “Investment Leverage” related to technology and or
growth-oriented companies normally does not exceed 25% of the total investment.

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3 FINANCIAL APPROACHES RELATED TO PRIVATE EQUITY
INVESTMENTS
3.1. Risk & Return
As investments in small non listed companies face a tremendous amount of risk, different
models available, aimed at defining the required risk adjusted returns, need to be
analyzed.
There are reports available, being e.g. the Ibbotson report, which provide an indication
about the relationship between risk and return across different asset classes.
In the 1997 Yearbook, which contains data for 71 years (1926 through 1996) the Ibbotson
report provides the following total return information data for small-company stocks:26
Investment aver. Annual Return Highest Annual Return Lowest annual return
Small-company stocks 17.7% 142.9% - 58.0%
The main problems an investor is facing by setting the “risk-adjusted” return benchmarks
for our intended investments in fast-growing small non-listed companies can be
summarized as follows:
1. Most of the data available on the market concerns listed companies by asset
category and on a limited basis by industry.
2. There is basically no relevant and precise information available for fast growing
companies (facing double digit growth rates).
3. There is no reliable benchmark data available for individual corporations being in
the early-stage or start-up development stage.
4. Basically all data available on the market reflects past performance of asset
categories and industry sectors.
26
Brigham Eugene F. , Louis C. Gapenski, Michael C. Erhardt, Financial Management-Theory and
Practice, page 201, Ninth Edition, Harcourt College Publishers, Fort Worth Texas, 1999

19
How can these main problems outlined above being resolved?
Literature provides us with main concepts measuring the correlation of risk and return.
All financial assets are expected to produce cash flows, and the riskiness of an asset is
judged in terms of the riskiness of its cash flows.27
In general investors can be considered as being risk-averse, therefore an investment
alternative facing a high degree of risk must provide high and attractive expected returns
to the investor.
In “risk” theory we differ between stand-alone and portfolio risk.
An investment’s stand-alone risk is the risk an investor would face if he or she held only
this one investment.28
An investment therefore is normally made only if the expected rate of return on this
investment is exceeding the expected risk of this investment.
As the private equity holding of the author experiences a “high-deal-flow” (numerous
potential investment alternatives), stand-alone risk for each of the investment alternatives
is key, as the possibility is there to “compose” a portfolio most likely providing the
highest risk-adjusted return mix.
For investment purposes the author considers not only the amount received on each Euro
invested but also the timing of the return.
27
Keat Paul G. and Philip K.Y.Young, Managerial Economics, Economic Tools for Today’s Decision
Makers, page 158, Third Edition, Prentice Hall, New Jersey, 2000
28

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The basic rate of return formula, taking both aspects into account is expressing the return
as a percentage of the amount invested and reads as follows:29
Rate of return = Dollar Return / Amount Invested
For the pre-selection investment process the author decided to apply the expected rate of
return formula solely and has analyzed the probability of expected risk and return per
investment alternative in a probability matrix as follows:
Table 5: Risk and Return Evaluation of Investment Candidates
Alternative Total Loss No return Return of 30% Return of 50% Return 50-75% Return exc.100%
CLABS 5% 20% 30% N/A. 20% 25%
HD N/A 5% 5% 15% 20% 55%
LCT N/A. 5% 10% 8% 40% 37%
NN1 25% 20% N/A. N/A. 20% 35%
NN2 22% 10% N/A. 20% 20% 28%
NN3 50% 20% N/A. 20% N/A. 10%
NN4 40% 30% N/A. 15% 15% N/A.
NN5 60% 25% N/A. 15% N/A. N/A.
NN6 55% 20% 15% 10% N/A. N/A.
All Return brackets are returns per annum.; total loss meaning complete write-off of the
investment
29

21
The author continued the pre-selection process by using the expected rate of return
formula:
N
Expected Rate of return = ∑ Piki.
I=1
ki is the ith possible outcome, >Pi is the probability of the ith outcome and n is the
number of possible outcomes.
For the investment alternatives of the author’s holding company the expected rate of
return is calculated as follows:
CLABS: 0.05 x (-100%) + 0.2 x (0) + 0.3 x (30%) + 0.20 x (62.5%) + 0.25 x (100%)
= 41.5%
HD: 0.05 x (0%) + 0.05 x (30%) + 0.15 x (50%) + 0.20 x (62.5%) + 0.55 x (100%)
= 76.5%
LCT: 0.05 x (0%) + 0.10 x (30%) + 0.08 x (50%) + 0.40 x (62.5%) + 0.37 x (100%)
= 69.0%
NN1: 0.25 x (-100%) + 0.2 x (0%) + 0.20 x (62.5%) + 0.35 x (100%)
= 22.5%
NN2: 0.22 x (-100%) + 0.1 x (0%) + 0.20 x (50.0%) + 0.20 x (62.5%) + 0.28 x (100%)
= 28.5%
NN3: 0.50 x (-100%) + 0.2 x (0%) + 0.2 x (50%) + 0.10 x (100%)
= - 30.0%
NN4: 0.40 x (-100%) + 0.3 x (0%) + 0.15 x (50%) + 0.15 x (62.5%)
= - 23.12%
NN5: 0.60 x (-100%) + 0.25 x (0%) + 0.15 x (50.0%)
= - 52.5%
NN6: 0.55 x (-100%) + 0.2 x (0%) + 0.15 x (30%) + 0.10 x (50.0%)
= - 45.5%

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Based on their negative expected rate of returns the author skipped investment
alternatives NN3, NN4, NN5 and NN6 and continued the selection process solely with
the other potential portfolio companies.
3.2. The Risk Premium
In a market dominated by risk-averse investors, riskier securities must provide higher
expected returns, as estimated by the marginal investor, than less risky securities, If this
situation does not hold, buying and selling in the market will force it to occur.30
The same statement obviously applies to investments in non-listed companies. The
difference in expected returns between two investment alternatives is a risk premium
(RP), which represents the additional compensation investors require for assuming the
more risky investment.
The main reasons why the author has decided to invest in a portfolio of small non-listed
companies holding stakes representing each over 10 percent of the share-capital of the
respective companies instead of having invested into securities of listed companies are
the following:
1. The possibility to bring in the author’s core-expertise and know how in
successfully building and reorganizing companies in various industries.
2. Having the chance to form strategic alliances within the network.
3. Implementing synergies between the portfolio companies.
4. Permanent monitoring of operational and financial performance.
5. Control over main strategic and operational decisions.
6. Permanent updates on future expected performance.
7. Right to remove existing management.
30

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Most of these rights would not be given, if the author would have invested in a portfolio
of listed companies, as funds available by the author would not have been sufficient to
acquire stakes in these companies being large enough to reach the thresholds necessary to
have a similar level of control and guidance over the companies the author is
experiencing now.
Related to the author’s portfolio companies individual company risk can not only be
anticipated without any delay, but pro-active steps aimed at reducing the risk-exposure of
each portfolio company and thus of the whole portfolio can be taken.
3.3. Cost of Equity
Defining the cost of equity for the author’s planned portfolio companies is not an easy
undertaking, as all of the firms are non-public small enterprises, making it impossible or
at least very difficult to apply business concepts, suitable to define the cost of equity of
listed corporations. In general terms small firms generate higher returns than large size-
listed corporations, but find it more difficult to attract capital on the capital markets, thus
the market is requiring an “illiquidity-premium” from this companies.
The standard Cost of Equity calculation formula is defining the cost of equity as follows:
Ke = Rf + (β * Rp)
Ke = Cost of Equity
Rf = Risk Free Rate
Rp = Risk Premium
β = the volatility (market risk) of the return of an individual stock relative to the return on
a total stock market portfolio
Applying this formula the author calculated the following return on equity for the
portfolio companies:

24
CLABS: β = 1.96 (CISCO Beta, as part of peer-group)31
adj.β = 2.94
Rf = 5.9% (average return on US treasuries in 2000)32
Rp = 9%
Into the risk premium the author factors in the individual company risk.
The author’s holding company strictly uses the adjusted β, being the “size-adjusted
market risk” reflecting the fact that investments in small non-listed companies are
effected, as the non-adjusted β only reflects a large size listed corporation.
CLABS: Ke = 5.9 + (2.94 * 0.09) = 32.36%
HD: β = 1.50 (SAP Beta, as part of peer-group)33
adj.β = 2.25
Rp = 6%
HD: Ke = 5.9 + (2.25 * 0.06) = 19.40%
31
www.yahoo.marketguide.com/MGI/mg.asp?, March 5th 2001
32
Amgen Form 10-K for the fiscal year ended December 31,2000, Note 7 to consolidated financial
statements
33
34
statements

25
LCT: β = 1.05 (TELEFONICA Beta, as part of peer-group)35
adj.β = 1.575
Rp = 6%
LCT: Ke = 5.9 + (1.575 * 0.06) = 15.35%
Out of the common concepts to calculate the cost of equity: the Discounted Cash Flow
(DCF), bond-yield-plus risk-premium and the Capital Asset Pricing Model (CAPM) the
most suitable concept, with all its limitations, is the Capital Asset Pricing Model (CAPM)
which the author will outline below in its theoretical point of view.
3.3.1 Capital Asset Pricing Model (CAPM)
The Capital Asset Pricing Model (CAPM) is an important tool used to analyze the
relationship between risk and rates of return.37
Although CAPM is specifically tailored to
common stocks, the application of this model, with all its limitations, extends to capital
budgeting of non-listed corporations.
The relevant riskiness of an individual stock is its contribution to the riskiness of a well
diversified portfolio, meaning the riskiness of an individual stock is partly eliminated by
diversifying or holding the stock in a portfolio, then its relevant risk, which is its
contribution to the portfolio’s risk, is much smaller than its stand-alone risk.38
35
36
statements
37
38

26
The basic CAPM formula reads as follows:39
kj = Rf + β (km – Rf)
kj = Required rate of return on stock j
Rf = Risk-free rate
km = Rate of return on the market portfolio
As above formula assumes constant growth the author did not find it suitable for the
planned investments in high-growth companies.
Even the adopted version of above formula, namely the one taking supernormal growth of
dividends expected into account, is not applicable for the planned investments, as fast
growing companies in their early-stage or expansion cycle re-invest the generated cash-
flows for market-penetration and the funding of expansion and are therefore not in a
position to pay dividends.
Taking the main ideas of CAPM into account, the author decided to invest in a portfolio
of non-listed small companies in different industries and in different stages of their
business development stage in order to maximize the returns at a given reduced level of
riskiness.
The author had to take two facts into account, namely the fact that available funds for
making investments are limited (due to the fact the Private Equity Company of the author
is strictly privately held ) and the attitude towards personally taking risk.
The author took the strategic decision only to invest the available cash-on hand plus the
expected free-cash flow being generated out of the author’s consulting business into
39

27
investments in a portfolio of non-listed companies, thus limiting total investments to EUR
500.000 only. This limitation set by the author obviously led to the fact that not all
possible investment alternatives could be pursued and the fact that the author’s holding
company had to team up with other equity investors in order to fund the needed equity for
the individual investment opportunities.
From a portfolio point of view the author took the decision to invest in a portfolio
consisting of at least 3 companies, thus reducing expected portfolio risk substantially.
From a risk-return perspective the author we took the approach to construe an efficient
portfolio, defined as the one that provides the highest expected return for a degree of
risk.40
3.4. Cost of Debt
In its simplified version the cost of debt is simply the interest rate that must be paid on the
debt. As interest expense is tax deductible, the actual cost of the debt to the company is
the after-tax cost. The formula applied to calculate the cost of debt therefore reads as
follows:41
Interest Rate x (1-Corporate Tax Rate)
40
41
Keat Paul G. and Philip K. Y. Young, Managerial Economics, Economic Tools for Today’s Decision

28
The interest rate to be achieved depends on various factors, some of them lie beyond the
control and influence of the creditor. According to the author’s opinion the most
important of these factors are outlined in the table below:
Table 6: Factors influencing Interest Rates
Factor Influenced by the debtor Comments
Key-lending rates no Set by Fed and ECB42
Industry Sentiment no In same cases banks refuse to
finance specific industries
Creditworthiness yes protecting the bank in terms
of default
Ability to pay back
the loan
yes Sufficient free Cash-Flow
generated by the Company to
pay back the loan on-time
The Federal Reserve sets the key-lending rates for re-financing of the banking sector in
the US, the European Central Bank does so for the European Union. The key-landing
rates set by the Central Banks are defining the cost for re-financing for the banks and can
therefore be considered as the cost of capital for the banks. On top of this rate the
crediting bank adds the risk premium (consisting of an industry and company related risk
premium) and the margin, calculating the rate offered to the debtor.
The company related risk premium depends heavily on the creditworthiness of the debtor
and its ability to pay back the granted loan in full and on due time. Companies facing a
strong balance sheet, meaning having a low financial leverage, and generating sufficient
free-cash flows receive the most favorable interest rates.
42
FED = Federal Reserve, ECB = European Central Bank, both setting the key - lending rates for re -
financing for the banking sector

29
It is often the case that lending institutions add an industry risk premium to their cost of
capital, which is increasing the cost of debt for a whole industry, meaning that even
companies with a strong balance sheet and strong free cash-flows are negatively effected.
Industry sentiment within the banking sector plays a major role as well, as some banks
refuse to grant loans to specific industries (based on write-offs of the past), limiting the
number of alternatives to attract bank debt for companies in these industries.
It must be made clear, that the cost of debt not only involves the element of the interest
payable. Important cost items being e.g. issuing costs of corporate bonds, consulting fees,
legal fees and bank charges applicable must be added to calculate the total cost on the
debt raised.
Corporations can “raise” debt financing by taking a bank loan but can also use other
important instruments being e.g. Corporate Bonds.
A bond is a long-term contract under which a borrower agrees to make payments of
interest and principal, on specific dates, to the holders of the bond.43
A bond issued by corporations is called a Corporate bond.
Corporate Bonds are exposed to default risk-if the issuing company gets into trouble, as it
may be unable to effect the promised interest and principal payments. Different corporate
bonds have different levels of default risk, depending on the issuing company’s
characteristics and on the terms of the specific bond. Default risk often is referred to as
“credit risk”. The larger the default or credit risk, the higher the interest rate the issuer
must pay.44
43
Eugene F. Brigham, Louis C. Gapenski, Michael C. Erhardt, Financial Management-Theory and Practice,
page 286, Ninth Edition, Harcourt College Publishers, Fort Worth Texas, 1999
44
Eugene F. Brigham, Louis C. Gapenski, Michael C. Erhardt, Financial Management-Theory and Practice,

30
When it comes to corporate bonds we have to mention the following most common types
of corporate bonds:
“Coupon Interest Rate” Bonds: requires the company to pay a fixed amount of interest
each year. If you divide this coupon payment by the par value of the bond, you can easily
calculate the coupon interest rate.
“Floating Rate” Bonds: In the case of a floating rate bond, the bond’s coupon payment
often varies over time, linked with development of key-lending rates.
In general a corporation should issue “Floating Rate” bonds when it expects that key-
lending rates are likely to drop going forward, benefiting from the general reduction in
interest rates. On the other hand the corporation should issue “Coupon Interest Rate”
bonds if it expects the key-lending rate to increase going forward, as it reduces its
exposure to “interest risk”.
Due to the fact that the Federal Reserve has lowered key-lending rates to lows last seen
some 40 years ago, many corporations have re-organized their bond portfolio by issuing
new bonds at lower coupon rates and repaid bonds issued in the past with higher coupon
rates, thus reducing their interest burden.
Investors should carefully monitor these “exercises” as these transactions often led to
“windfall profits” having had a non repeatable one-time effect on the profit and loss
statements of these corporations and distorted the true financial performance of these
corporations.

31
3.5. Weighted Average Cost Of Capital
One key question an investor should answer before he invests in a company is if the
company in question is a wealth creator.
Conventional performance indicators, being e.g. the net income do not answer this
question sufficiently, as the cost of equity is not reflected.
Consulting Company Stern Stewart & Company designed a suitable tool, namely the
Economic Value Added Model (EVA) aimed at measuring a corporation’s true
profitability for a given year.45
According to EVA firms are truly profitable and create value if and only if their income
exceeds the cost of all capital they use to finance operations. Managers create EVA by
developing and implementing projects that generate returns greater than their costs of
capital.46
As most companies employ several types of capital (capital components), involving
common and preferred stock, long-term bank debt, short-term bank debt, corporate bonds,
depending on the company’s capital structure, the cost of capital needs to be calculated.
45
Brigham Eugene F., Louis C. Gapenski, Michael C. Erhardt, Financial Management-Theory and Practice,
46

32
In Corporate Finance a “four-stage-process” is commonly applied in order to calculate the
cost of capital:
Stage 1: Identification of corporation’s capital components
Stage 2: Identification of the required rate of return on each capital
component (its component cost)
Stage 3: Identification of corporation’s corporate tax rates
Stage 4: Creating the Weighted Average Cost of Capital (WACC)
In order to better illustrate this process the author will outline it below on the basis of the
portfolio companies
Company Equity in %47
Long-term % short-term % Tax Rate WACC
CLABS 50.00% 50.00% N/A. 34% 18.325%
HD 42.50% 43.40% 14.10% 34% 10.424%
LCT 49.50% 39.50% 11.00% 34% 9.874%
Portfolio Average 49.50% 47.20% 3.30% 34% 15.931%
WACC Calculation:
CLABS: Equity 0.5 x Ke 32.36% plus long-term debt 0.5 x 6.50% - tax rate of 34% =
16.18% plus 2.145% = 18.325%
HD: Equity 0.425 x Ke 19.40% plus long-term debt 0.434 x 5.50% - tax rate of 34% plus
short-term 0.141 x 6.50% - tax rate of 34% =
8.245% plus 1.575% plus 0.604% = 10.424%
LCT: Equity 0.495 x Ke 15.35% plus long-term 0.395 x 7% - tax rate of 34% plus short-
term 0.11 x 6.20% - tax rate = 7.60 plus 1.824% plus 0.45% = 9.874%
47
All percentages based on overall company’s capital budget post-funding

33
Weighted Portfolio Average: Equity 1.500.000 x 32.36% + 90.000 x 19.4% + 492.000 x
15.35% plus long-term (1.500.000 x 6.50% + 92.000 x 5.50% + 392.000 x 7.00%) x
(0,66) plus short-term ( 30.000 x 6.50% + 109.009 x 6.20%) x (0.66) / 4.205.000 =
578.382 plus 85.800 plus 5.747 / 4.205.000 (total capital of portfolio companies) =
15.931%
As the weighted WACC portfolio average is quite high the author has initiated the
following measures which will be executed by YE 2002:
1) A reduction in equity capital at Clabs by shifting a higher proportion of total
capital towards long-term loans.
2) Substantial dividends LCT will provide to stake-holders at YE 2002.
Both measures will bring the weighted WACC portfolio average in the neighborhood of
11.00%
As the author’s holding company has investments in fast-growing and high-tech
companies solely, the WACC can not be reduced further as banks are not willing to
provide higher loans to these company types.
3.6. Return on Common Equity
The ratio of net income to common equity measures the return on common equity (ROE),
or the rate of return on stockholder’s investment, were the net income is divided by the
invested equity:48
ROE = Net income to investor / Invested Equity
48

34
Taking this formula into account for the author’s investment alternatives the following
misleading picture would arise:
Target Investment Net Income ROE
CLABS 40.000 1.730.000 4.325%
HD 35.000 795.000 2.271%
LCT 144.000 993.000 689%
Taking the Return on Equity concept into account, the author would have just invested in
one investment alternative, namely CLABS as it provides the highest ROE.
The author obviously did not follow these calculations, as the risk associated with the
investment opportunities as well as the “timing” of the net-income flows is not factored
in.
3.7. Payback-Model
The payback period, defined as the expected number of years (periods) required to
recover the original investment, was the first formal method used to evaluate capital
budgeting projects:49
Payback = Year before full recovery + (Unrecovered cost at start of year/ Cash flow
during the year)
49

35
For the described investment alternatives payback could be reached after:
CLABS: period 0 period 1 period 2 period 3 period 4
Net cash flow 40.000 0 0 1.650.000
Cumulative NCF 40.000 40.000 40.000 1.690.000
For CLABS payback or full recovery in the first period could be reached, providing a
payback-period of some months.
LCT: period 0 period 1 period 2 period 3 period 4
Net cash flow - 59.000 -42.000 150.000 800.000
Cumulative NCF - 59.000 -101.000 49.000 849.000
For LCT payback or full recovery would be reached at the end of the second period (as
dividends are granted at the end of period 2).
A full recovery after 2 years is still favorable in the Private Equity business, as the normal
pay-backs, if any, are normally reached between 4 and 6 years.
HD: period 0 period 1 period 2 period 3 period 4
Net cash flow -35.000 15.000 30.500 750.000
Cumulative NCF -35.000 -20.000 10.500 760.500
For HD payback or full recovery would be achieved at the end of the second period (as
dividends are granted at the end of period 2).
All investment opportunities met the pay-back period, which the author set
internally at 3 years maximum and were pursued therefore going forward.

36
3.8. Future and Present Value
The present value is the amount on hand prior to the investment.
The process of going from today’s values, or present values (PVs), to future values (FVs)
is called compounding.50
The main formula applicable for compounding the future value on an investment reads as
follows:
FVn = FV1 = PV + INT = PV + PV(i)= PV(1+I)
PV = present value or starting amount
INT = interest amount or dividends amount earned during the year
I = Interest Rate
FVn = future value, or ending amount
n = number of periods within the analysis period
The author benchmarked the present value of an alternative investment in US
Government Bonds yielding 5. percent against the present value to be generated out of the
potential investment alternatives.
Investment in US-Government Bonds (taking the whole investment in 2000 of 142.000
into account):
2000 2001 2002 2003 2004
Initial deposit - 142.000
Interest earned 5.90 6.25 6.62
7.01
Amount at the end 150.378 159.250 168.645 178.595
50

37
of each period = FVn
Portfolio Investments consisting of the acquisition of stakes in CLABS and LCT in 2000:
2000 2001 2002 2003 2004
Initial deposit - 142.000
Interest earned
Amount at the end 123.000 123.000 278.000 2.728.000
of each period = FVn
Delta of FV bond - 19.000 - 27.378 +118.750 +2.559.355 +2.549.405
vs. Portfolio
Comparing the future values of both asset categories, the decision was taken to go ahead
with the investments, as starting from 2002 the future values on the investments in
portfolio companies by far out-perform (even by neglecting the returns out of re-
investment of available funds from 2002 onwards) the ones generated by investments into
US- Government bonds, without endangering the author’s liquidity position in the periods
2000 and 2001 substantially.

38
3.9. Net Present Value Method
One key instrument applied by the holding company of the author in order to figure out if
an investment in a company should be effected is the Net Present Value (NPV) method.
The equation for the NPV reads as follows51
:
NPV = CF0 + CF1 / (1+k) + CF2 / (1+k)² + CF3 / (1+k)³ + CFn / (1+k)n
Here CF is the expected net cash flow at the relevant period , k is the project’s cost of
capital (related to the portfolio investments the WACC) , and n is its life. Cash outflows
are treated as negative cash flows.
To illustrate the calculation of NPV the author will focus below on the calculation of the
NPV for the chosen investment alternatives only:
HD: Cash-outflows: End of February 2001: EUR - 10.000.-
End of September 2001: EUR - 25.000.-
Cash-inflows: YE 2002 EUR 15.000.-
YE 2003 EUR 30.500.-
YE 2004 EUR 750.000.-
51

39
LCT: Cash-outflows: End of June 2000: EUR - 32.000.-
Cash-inflows: ME 6/00: EUR 43.000.-
YE 2002 EUR 150.000.-
ME 6/ 2003 EUR 800.000.-
CLABS: Cash-outflows: End of May 2000: EUR - 15.000.-
Cash-inflows: YE 2000 EUR 80.000.-
YE 2003 EUR 1.650.000.-
Taking the already defined WACC for these 3 companies into account the Net Present
Value can be calculated as follows, taking all cash-inflows and cash-outflows until the
planned divestment into account:
HD: - 35.000.- + 15.000 / (1+ 0.10424) + 30.500 / (1+ 0.10424)² + 750.000 / (1+
0.10424)³ = - 35.000 + 13.584 + 25.014 + 557.040 = NPV EUR 560.638.-
LCT: -59.000 + (-42.000) / (1+ 0.09874) + 150.000 / (1+ 0.09874)² + 800.000 / (1+
0.09874)³ = - 59.000 – 38.225 + 124.254 + 603.136 = NPV EUR 630.165.-
CLABS: 40.000 + 1.650.000 / (1+ 0.18325)³ = NPV EUR 1.035.991.-
The NPV, calculated above for the three companies only relates to the stake the Private
Equity Company of the author holds in these companies.
It has to be mentioned that the standard Private Equity Investor does not generate cash
inflows within the first three years after the respective investment, as all of the cash-
generated by the companies is normally withheld in the portfolio companies for funding
expansion financing needs.

40
The early cash-inflows for the author related to the portfolio companies derived from
placement fees generated for structuring the equity tranches via Venture-Capital rounds
as well as from pushing the management teams to funnel back dividends to the investors
in case the company could not come up with investment projects exceeding the required
Internal Rate of Return, which was set at 30 percent p.a. on average.
It has proven to be successful, that the availability of cash in the portfolio companies got
limited. By doing so the management was not only forced to pursue only projects with
the highest Net Present Value, but to strictly honor the implemented cost control and
working-capital mechanisms. In case of excess cash (cash beyond funds needed for
pursuing the agreed upon projects) the management teams were forced to funnel back
these funds by providing “extra” dividends to the shareholders, or to repay loans provided
by the investors partially prior to their respective due dates, positively impacting the Net
Present Value of the author’s portfolio.
3.10. Marginal Cost of Capital (MCC)
The marginal cost of capital (MCC) is defined as the cost of the last dollar of new capital
the firm raises, and the marginal cost rises as more and more capital is raised during a
given period.52
For the author this concept has an important meaning, as the decision was taken to limit
the total equity commitment for the use of Private Equity Investments in portfolio
companies.
52

41
3.11. The Concept of Internal Rate of return (IRR)
The most common measure of performance within the private equity and venture capital
sector is the internal rate of return or IRR. Not only does this measure take the time value
of money into account, as well as the ability to measure returns on group of investments,
but it also expresses the return as a simple percentage. The IRR is that rate of discount
which equates the present value of the cash outflows associated with an investment with
the sum of the present value of the cash inflows accruing from it and the present valuation
of the unrealized portfolio.53
The Gross Return on Realized Investments takes account of the cash outflows
(investments) and inflows (divestments, including realization values, dividend and
interest payments, repayments of the principal of loans, etc.) which take place between
the Private Equity investor and its realized investments.54
The Gross Return on all Investments takes account of all of the following:
• the cash outflows (investments) and inflows (divestments, including realization
values, dividend and interest payments, repayments of principal of loans, etc)
which take place between the Private Equity investor and:
1. its wholly realized investments;
2. its partially realized investments;
3. its wholly unrealized investments.
• the valuation of the unrealized portfolio (consisting of wholly unrealized
investments and the unrealized portions of partially realized investments but
excluding cash and other assets held in the portfolio).55
53
European Private Equity & Venture Capital Association, EVCA Valuation Guidelines, page 9, 2000
54
55

42
Before the annual rate of return can be calculated the monthly rate of return by applying
the following formula has to be computed by applying the following formula:
INi – OUTi = NCFi
The monthly net cash flow of a specific month is calculated by subtracting the monthly
cash outflow from the monthly cash inflow
After having calculated the net cash flow of the month the monthly internal rate of return
is calculated using the formula below:
N
Σ NCFi / (1+ IRRm)i
= 0 F(IRRm) = 0
i
56
To arrive at the annual rate of return IRRA the following formula is applied:
IRRA = (1 + IRRm)12
– 1
56

43
4 APPLIED INVESTMENT CRITERIA
4.1. Industries with sound growth rate expectations
The author strongly believes that a portfolio company can only provide outstanding
returns to its investors, once the company has executed a profitable growth strategy.
A company has a profitable growth strategy according to the authors benchmarks, if
revenue growth rates run at 35 percent minimum p.a. and free-cash-flow (operating cash-
flow plus investing cash-flow) growth exceeds the revenue growth rate by at least 20
percent p.a.
To illustrate this concept better the following key-data on one portfolio company is
provided benchmarking these targets for this company with the actual results
experienced.
LCT
99 2000 2001
Revenue growth actual 261% 269% 102%
Revenue growth benchmark 35% 35% 35%
Free Cash Flow growth actual 20% 325% 403%
Free Cash Flow growth benchmark 42% 42% 42%
According to the author’s opinion these tough benchmarks can only be achieved in fast-
growing companies having a favorable market environment, meaning that the overall
market has to grow at a Compound Annual Growth Rate of at least 10 percent to justify
an investment.
To calculate the CAGR “market-reports” published by market research companies being
e.g. Frost & Sullivan, Gartner and reputable consulting companies being e.g. McKinsey
were consulted.

44
For CLABS a CAGR (Compound annual Growth Rate) for the period between 2000 and
2005 of 67 percent was calculated.
For HD a CAGR for the period between 2000 and 2005 of minimum 50% was identified
across all the reports available.
For LCT a CAGR for the period between 2000 and 2005 of minimum 12 percent was
compounded.
As all target industries are likely to experience a higher CAGR than set by the author the
investment process proceeded further.
4.2. Investment Opportunities meeting the required rate of return
4.2.1 CLABS
CLABS features the following main USP’s having attracted the investors:
Product Superiority. CLABS has developed a Multimedia-over-Internet Protocol
Multimedia over Internet Protocol- communications platform, by far outperforming the
competitors’ systems. It can be installed in all different type of networks including
CATV, telecommunications and corporate networks and will be capable to run on mobile
and ISDN networks beginning of August 2000.
Tremendous Market Growth. Reputable market-research companies like Gartner
Group, Frost & Sullivan, amongst others, predict the market for Multimedia-over-IP
services and devices to explode in the next couple of years. According to Gartner Group
by YE 2003 close to 50% of the actual CATV end-users (app. Mio. 50.5 users in 1999)
are likely to install multimedia platforms and devices enabling these services. This will
result in a market potential of close to 25.3 Mio. units with a wholesale revenue potential
of close to 7.000 Mio. EUR by YE 2003 in the western European CATV market alone.

45
Table 7: Internet Revenues – Western Europe57
Table 8: Internet Connections-
Western Europe58
As the CLABS MMoIP platform is capable to run on all different networks, the market to
be penetrated by CLABS is even close to ten times larger than the CATV market.
First Mover advantage. The CLABS team has developed the first Multimedia-over-IP
platform being capable to provide all services ranging from voice, data, video and internet
communication on all various types of networks.
The CLABS team has implemented the first full-service Application Service Providing
(ASP) installations in CATV networks, which enables CLABS the direct access to the
Business-to-Consumer (B2C) market.
57
C-Quential, Commercial & Technical Due-Diligence Communications Laboratories, November 2000
58
Demand for Internet services will continue to grow strongly
Market Internet growth
Internet Connections – Western EuropeInternet Revenues – Western Europe
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
20,000
1998 1999 2000 2001 2002 2003
$million
Home
access
Business
access
VAS
W holesale
0
10
20
30
40
50
60
70
80
1998 1999 2000 2001 2002 2003
Million
Residential
Business
– fixed
Business
– dial up
Source: IDC 1999
CAGR 1999–2003: 30%

46
Table 9: Residential Broadband Subscribers59
Table 10: Residential Broadband
Revenues - Europe60
59
60
Residential broadband access is forecast to grow, driven by ADSL and cable
Market Broadband growth
Residential Broadband Revenues – EuropeResidential Broadband Subs – Europe
0
5
10
15
20
25
1999 2000 2001 2002 2003 2004 2005
Million
ADSL
Cable
modem
Other
Source: Yankee Group 2000
0
1,000
2,000
3,000
4,000
5,000
6,000
1999 2000 2001 2002 2003 2004 2005
$million
CAGR 2000–05: 59%

47
4.2.2 HD
The HD management has created an integrated E-Commerce solution for commercial
bakeries and implemented it in 4 bakeries as a test-version successfully, before the
investors decided to provide the expansion capital for the market penetration to the
company.
The main reasons why the investors decided to invest were the following:61
• The size of the market and the market-potential for state-of-the art and convenient
home-delivery systems (total market for bread and bakery products EUR 1.1
billion p.a. in Austria alone).
• The existence of an integrated E-Commerce platform, which successfully
completed the test-installations.
• The developed licensing model, allowing for constant revenue and cash-streams,
once the licensee was signed.
• The fact that each licensee/bakery can individually design its offering and pricing
• Each licensee is using its existent logistics system (delivery-trucks).
• The fact that each licensee can offer home-delivery to its customer base on a
regional basis under a common umbrella brand-name.
• The fact that the platform not only provides the licensee access to the end-
consumer with a state-of-the art “Home-Delivery-Platform” for Internet, SMS or
WAP orders, but provides the licensee with an Office Management System,
providing him with a tailored Software-System covering all main functions,
needed for successfully running a bakery , ranging from order-planning,
production planning, tour-planning to Accounts Receivables Management.
• The fact that the developed E-Commerce platform can be easily transferred into
other fields, being e.g. Home-Delivery of farm-products, dairy products, coffee,
tea, all types of catering, wine and even consumer hard-goods.
61
Gutenmorgen-Service, Company Presentation for Print-Media, December 2001

48
4.2.3 LCT
Prior to the investment provided by an Austrian Venture Capital Funds and the Private-
Equity company of the author, LCT, which has been providing intelligent
telecommunications services to business clients in Austria had the following key-
strengths, motivating the investors to provide the required funds for the market
penetration:62
• Existing delivery contracts signed with numerous reputable telecommunications
companies, ensuring supply of high-margin services to LCT’s customer base.
• An existing customer base of more than 600 business customers.
• A strong sales-team, exclusively compensated on a variable commission basis,
covering the whole of Austria.
• The acquired customer base features long-contractual binding periods (on average
36 months), ensuring constant cash-flow and income streams going forward.
• Low fixed cost structure, ensuring low-break even levels.
• The existence of sophisticated tailor-made billing and support systems.
62
WECOS Managementberatung GmbH, Offering Memorandum Least Cost Telecom GmbH, November
2001

49
4.3. Initial Strategies versus actual Strategies of Investment Opportunities
As already pointed out the initial strategy set for each investment opportunity needs to be
monitored permanently, re-thought and amended if alternative ways provide a higher
shareholder value for the investors.
In order to illustrate this process better a comparison between the strategy defined
originally and the actual version of the strategy of the respective portfolio company is
provided below:
Original Strategy Revised Strategy
CLABS OLD CLABS NEW
Sole Focus on the Austrian CA-
TV market
Focus on all broadband networks
across Western-Europe
No product offering for ADSL
and XDSL networks
Additional Offering for these
markets
International large account sales
of end-units, increased working
capital
License Agreements to be
concluded solely, avoiding
working-capital build-up
Faster roll-out of product
offering
Slightly delayed roll-out of
products/systems with
more/added product features
securing our product superiority
All R&D internally Selective utilization of qualified
external development partners
HD OLD HD NEW
Catering to the bakery market
exclusively
Additional markets, caterers,
food retailing
In-house sales-team Network of sales-agents
Solution only catering to the
end-consumer
Creation of a B2B module,
covering purchasing processes as
well
No E-Commerce project-
assignments
E-Commerce projects creating
additional cash-flow
Solution only providing the end-
consumer access via Internet
Additional access via SMS,
WAP and Call-Center

50
LCT OLD LCT NEW
Focus on large volume
customers only
Creating offering aimed at
catering to medium-volume
customers as well
No focus on the mobile phone
market
Creating offerings tailored for
the Mobile Phone market
No Strategic partnerships on the
distribution side
Conclusion of selective
distribution partnerships
Focus on the Western regions of
Austria only
Covering all of Austria
No offering for ADSL Additional offerings for the
ADSL market
No in-house sales efforts Creation of bonus schemes for
Customer Service Reps to
motivate them to conclude
additional contracts

51
4.4. Improvement Measures Implemented
In order to build a company successfully towards creating the outmost possible share-
holder value for its shareholders not only the business-strategy and the business model
need to be monitored permanently and revised if needed, but also key-value creating
measures implemented.
As it is basically impossible to outline all measures implemented within 18 months after
initial investment, only the most important ones are summarized by portfolio company as
follows:
4.4.1 HD
The management of HD planned to roll-out the key-product, the E-Commerce and
Fulfillment platform for bakeries much faster on the Austrian market.
6 months after the foundation of the company, the number of license contracts concluded
was 70% behind the planned numbers, creating serious problems the author had to face
and resolve together with the management team:
1. Due to the shortfall in the number of license contracts, the planned revenue-streams
and cash-flows did not materialize, creating serious financial and liquidity problems
2. The delay in the roll-out of license contracts created also a major burden for future
cash-flows, as the variable license-fees are calculated on the revenues the licensee is
generating
The action plan designed and implemented without any delay consisted of the following
main measures:
- Change-over in the sales-team (80 percent of sales people were replaced)
- Increase in number of sales-agents by 200 percent
- Additional incentive system for the sales-force, aimed at additionally rewarding them
for concluding a stretched number of license contracts within 3 months

52
- Decision not to hire the planned customer-service team and administration staff, but
to out-source these functions to external companies at roughly 50% of the cost
planned previously
- The original plan to increase the fixed salary of the Top-Management in several
stages modestly was frozen completely
- Planned advertising expenditure was reduced by 60%, by re-defining the advertising
mix, the use of new advertising and PR-companies as well as by producing the main
part of the advertising material in-house
- Main opinion leaders were brought on-board providing their services free-of-charge,
enabling press-coverage, seminars successfully attracting awareness for our service-
offering and leads for new license contracts
- The platform was enabled to provide access for the end-consumer not only via
Internet but also SMS (Short-Message Service) and WAP (Wireless-Application
Protocol ) mobile-services
- New platforms/applications for other customer segments being e.g. food-retailers,
fast-food channels were created and implemented
- Cooperations with mobile-phone operators and the print-media were sought and
entered in
- Securing a long-term credit-line, guaranteed by the State of Austria

53
4.4.2 LCT
3 months after the initial investment of the investors the author had to face and re-solve
main problems due to the fact that the average revenue by phone-customer dropped
significantly as the offered rates by minute needed to be reduced by up to 65 percent
partially reacting on the price-war on tariffs initiated by alternative carriers , by now
being out of business.
Amongst others the following main measures were implemented within a 6 months
window, aimed at re-gaining profitability, in one of the toughest business climates being
imaginable:
- Reduction in Selling General & Administrative expenses by 38 percent.
- Reduction in top-management compensation (less 65 percent).
- Reducing the average commission by contract by some 51 percent by re-defining
sales- agent contracts.
- Development of new service offerings for the mobile, internet and ADSL ( Advanced
Digital Subscriber Line) sectors, as the “traditional” phone business in dollar terms
did not grow any longer, although the number of phone minutes increased heavily.
- Replacement of 65 percent of the alternative-carriers used, providing a gross margin
increase of some 50 percent, although selling-rates dropped significantly.
- The “supernormal-growth rates” of 320 percent p.a. were revised to more normal
growth rates of 100 percent, leading to a profitable growth strategy.
- Strict working-capital management systems were implemented covering amongst
others paying sales-agents commissions on collection and reinforcing the A/R
collection team.
- Even facing above mentioned revenue growth-rates the average working-capital “ tied
stayed at traditional level, resulting to a huge increase in operating free cash-flow.
- Planned hardware investments were either cancelled, re-negotiated or delayed, so that
less in hardware could be spent than the depreciation amounted to, positively
effecting our investing cash-flow.

54
4.4.3 CLABS
The investment got under pressure from two sides:
1) Planned Strategic Partnerships and license agreements with other telecommunications
equipment and consumer electronics manufacturers did not materialize in 2000/ 2001,
as their profits were eroding leading their focus on re-organization rather than to
focus on investing in a new state-of-the art technology
2) Other competitors once thought having less superior products and offerings, launched
new improved products, potentially endangering product-superiority
The situation the author and the management were facing can not be described as being
“heaven”. A war on two fronts had to be fought, namely to re-establish product
superiority by partially re-doing the specifications for the versions 1.0, creating additional
pressure on our R&D budget, and to seek and enter into license agreements with other
third parties than originally planned.
The key steps taken in order to get there are summarized below:
- Non-Execution of planned hires (3 additional hires instead of 10 )
- Even the planned hire of a CFO was frozen, as the private equity company of the
author provides the services together with the auditing company at about 50 percent
of the relative compensation of the planned CFO
- Reduction in Selling General & Administrative expenses by 60 percent
- Selective outsourcing of R&D tasks to a number of qualified outside partners, leading
to the fact that the new product-version is by far outperforming the ones of the
competitors at 90 percent of total R&D expenses than planned in the budgeting
process
- Build up of high-level opinion leader team, providing their services on a success fee
basis only
- Re-enforcement of the key-account management team

55
- Implementation of pilot installations in “friendly-customer” environments providing
the chance to demonstrate the real-time performance of the system to other potential
customers
- Conclusion of high-volume license agreements with high-level companies providing
constant cash-flow streams out of the license fee
4.5. Facing and Resolving additional Financing Needs
During the course of the investment period 2 of the portfolio companies faced additional
financing needs, as the planned cash-flow levels did not materialize at the budgeted time-
period, namely HD and LCT.
Besides taking the improvement measures, aimed at significantly increasing the cash-flow
situation significantly additional bridge financing needs needed to be resolved. A
situation which is happening quite often, when it comes to private equity investments
especially the ones in fast-growing or technology oriented companies.
Every prudent Private Equity Investor should therefore build in reserves for future
financing, beyond the budgeted levels, prior to the investment decision.
The author normally builds in reserves of roughly 25 percent for potential future investing
needs, when the WACC per investment opportunity is calculated, to come up with the
NDCF per investment opportunity.

56
The main goal therefore was to keep future financing needs below the set maximum
“reserve-border-lines”, in other case the NDCF calculated prior to the investment would
present an “non-true” picture.
The author managed to do so, because tough and efficient measures as already outlined
were taken, to improve the cash-flow situation of the respective portfolio companies.
As the WACC concept perfectly demonstrates additional financing needs should be
resolved by using a financing mix, with low equity proportions.
Prior to YE 2000 banks were quite willing to provide credit-lines, loans or lease-
financing to fast-growing and technology oriented companies (representing our portfolio).
During 2001 this situation changed dramatically, as more and more of these companies
faced financial problems and quite often filed for bankruptcy, changing the financing
environment tremendously.
Many banks did not grant once of a sudden credit-lines or other financing to these
company types, creating additional problems for us in the process of “securing”
additional funds.
For LCT for example 10 banks needed to be consulted in order to secure the needed
additional funds.
Additionally the bulk of the existing LCT lines needed to be renegotiated , as the lending
institution called the granted lines once of a sudden with 2 months notice, after the
decision was taken to fund the expansion with venture capital funds linked with another
banking institution. This instrument of retaliation occurs quite frequently in Austria, we
can only hope that this “system” is not happening in other countries.
Related to HD a bank willing to provide the additional lines could only be found, after a
state-controlled R&D institution “backed” the long-term line with a guarantee. As already
outlined the cost of the guarantee must be factored into the financing costs, as it has to
borne by the respective company.

57
4.6. Resolving Tensions with the Top Management
Implementing tough measures like the ones outlined creates an enormous amount of
hardship for both sides the Private Equity investor on the one side and the management
teams on the other side.
The freeze in hiring additional personnel, created increasing pressure for the management
teams, as the same workload, in some cases even a higher one, had to be fulfilled with
less than planned personnel levels. The management teams needed to be convinced to
accept to buy in, after having made a series of personal discussions with the respective
teams and to provide an outmost of support level by us, going so far that problems which
came up needed to be resolved even during on-site sessions, late-night phone calls or e-
mail sessions. In other words the author had to clearly demonstrate to the teams that he is
in this together with the management and not willing to shift the workload and
responsibility to management.
To convince the management teams to buy into a reduction of their compensation was a
quite tricky one. They finally bought in accepting so after a series of personal discussions
took place and after the author made clear that the private equity investor will provide
more support services, than planned originally, to the management teams of the respective
companies at no-cost for the companies.
The author is convinced that the implementation the above mentioned measures could
only be managed due to following facts:
1. Our role as an experienced mediator
2. We led by example demonstrating the role of a proactive and supportive investor
3. The creation of an entrepreneurial environment, by granting stakes of the companies
to the respective management teams

58
5 THE QUALITY OF THE MANAGEMENT
5.1. Industry Background & know-how of the Management
The industry background and know-how of the management team of the investment
opportunity should be key for every investor.
The author only invests in a company when he is convinced that the management team is
capable of “driving” the company into the right direction, meaning creating out-standing
and consistent share-holder value for its investors.
He focuses herewith on four main aspects:
• Has the management team the needed industry background
• Has the management team proven in the past to successfully provide share-holder
value
• Is the management team trustworthy
• Is the management team willing and capable to successfully work in teams
The author developed an own matrix in which he evaluates these mentioned criteria in a
point system (10 points highest correlation, 1 point lowest correlation):
Table 11: Evaluation of Management Quality
Target Industry
Background
Shareholder Value
Contribution
Trustworthy Team-Approach Points
CLABS 10 5 6 7 28
HD 10 8 10 10 38
LCT 10 8 9 10 37
The author only invest into a company, if the overall number of points, measuring the
above outlined criteria exceeds 25 points.
As “only” 28 points were calculated for CLABS, additional pre-caution steps were taken
involving the creation of a syndicate with the other investors (beyond the management

59
team) securing the investors absolute control, by Controlling the company with a two-
thirds majority.
5.2. Organizational Weaknesses of Investment Opportunity
Not only the quality of the management, but also other key positions needed to be
analyzed within the respective organizations of the target companies if they are occupied
by committed and capable individuals.
The main emphasis hereby laid on identifying the team members being willing to act as
an entrepreneur and leader. The philosophy follows the human investment model and
argues that it legitimates and promotes the creation of the proactive competence needed
by the spherical organization.63
The human investment philosophy focuses on current abilities but places special
emphasis on the potential of organization members to develop a potent package of
technical, business, and self-management skills.64
Following this philosophy the author’s main aim is to create empowered jobs, meaning
that the investors give the “position-holders” the outmost possible freedom in performing
their responsibility within the frame-work of overall strategy and the defined “share-
holder-value-creation plan”.
In all portfolio companies, management and key personnel is not only highly involved in
the budgeting process, but also in the definition of mile-stones to be achieved by function.
The goals set , both financially and operationally, are stretched, but achievable, once the
team is willing and committed to achieve them.
The author believes that by involving management and key personnel in important
decisions, and by allowing broad self-direction, managers and employees would directly
add value to the firm’s out-pout.65
63
Schuler Randall S. and Susan E.Jackson, Strategic Human Resourse Management, page 453, Blackwell
Publishers Ltd, Oxford, UK, 2000
64
Schuler Randall S. and Susan E.Jackson, Strategic Human Resourse Management, page 454,
Blackwell Publishers Ltd, Oxford, UK, 2000

60
In the author’s portfolio companies an environment of maximum involvement and co-
operation is created of both the key managers as well as the key personnel and
compensation is heavily tied with the achievement or over-achievement of the agreed
upon goals.
In this respect the top management and the key management of the portfolio companies
were analyzed whether the managers have the necessary entrepreneurial spirit, the
capability and the potential.
Table 12: Evaluation of Management Capabilities of Portfolio Companies
Target/Key Position Entrepreneur Capabl
e
Potential Weaknesses
CLABS
CTO Hardware YES YES YES Highly Emotional
CTO Software YES YES YES Lack of self-confidence
Managing D. Sales YES YES YES Emotional
HD
CTO Software YES YES YES Lack of Management
Expertise
Managing D. Sales YES YES YES Weaknesses in Controlling
LCT
Managing D. Sales YES YES YES Weaknesses in Controlling
Finance /
Controlling
YES YES YES Lack of Decisiveness
A/R Collection NO NO NO Need for Replacement
65
Schuler Randall S. and Susan E.Jackson, Strategic Human Resourse Management, page 457, Blackwell
Publishers Ltd, Oxford, UK, 2000

61
5.3. Can the Investors offset these Weaknesses
A Private Equity investor must be aware that only capable management teams taking an
entrepreneurial approach can produce the share-holder value maximization the investors
are looking for.
The holding company of the author acts as an active investors providing the needed
support to the management teams and supporting them to overcome their weaknesses
once they were identified in the above table.
Besides communicating the overall strategy and achieving the buy-in on behalf of the
management teams the specific mile-stone plans financially as well as operationally were
agreed upon and followed up with the management teams and the key personnel of the
portfolio companies. This was done successfully by providing scenarios with different
out-comes for each portfolio company to the management teams and by jointly
elaborating the scenario which provides the highest return for the investors (be aware that
also the management teams hold stakes in the portfolio companies). This in itself is a
time-consuming task for the Private Equity investor, which should set aside a
considerable amount of time for doing so. Meetings to elaborate and revise the companies
strategies have taken place off-site the company premises on average every 60 days, the
follow-up sessions, aimed at identifying variances to the agreed upon budgets and mile-
stones have been taken place once a month.
Besides preparing, attending and leading these meetings “special-support” was provided
to the management teams, to support them to overcome the weaknesses identified in the
table above.
Amongst others the following steps were taken to overcome the identified weaknesses:
CLABS

62
• Create a level of trust with the management team
• Focused meetings with a clear-time line and clear objectives
• Personal Discussions with the management team, pointing out their main
weaknesses and identifying specific measures
HD
• Specific Controlling lessons provided to the managing director sales
• Management training and practical management support given to the CTO
Software
LCT
• Specific Controlling lessons provided to the managing director sales
• Tough decisions were taken by the author directly and their implementation
executed by the Finance and Controlling manager together with the support
needed. By doing so the CFO experienced soon that even major tough measures
can be implemented and he created an increasing level of confidence in
implementing them with no support granted by the author at the end
• A new decisive A/R collection team was acquired on the labor market replacing
the old team
Needless to say an active Private Equity investor should be aware that he should be
available to provide support to the management teams nearly 24 hours a day, seven days a
week, in case specific problems are raised by the management teams and should attend
personally key-events being e.g. trade fairs, exhibitions, business-lunches with key-
customers and opinion leaders to demonstrate that he has the commitment towards the
company.

63
6 THE INVESTMENT PROCESS
6.1. Fine-Tuning the strategies of the Investment Opportunities
As already outlined in detail an active investor must constantly challenge and adopt, if it
deems to be appropriate to increase the investor’s return, the strategy once defined by
portfolio company.
The key-changes in strategy by portfolio company were described under paragraph 4.3.
already.
6.2. Redefinition of Financial Planning
Most of the management teams of companies seeking private equity appear in front of the
investor’s community with limited, in-accurate financial planning.
It is often the case that these management teams find it tough to understand, that investors
require detailed financial planning on a monthly basis for the total periods ahead of the
planned investment period.
To make comparisons between the portfolio companies possible and in order to compute
returns across a whole portfolio the author applies the same model of financial planning
for all the portfolio companies, providing him with detailed plan P&L’s, Plan Balance
Sheet Data, Plan Cash-Flow (operating, financing, free cash-flow) data, permanent
revision of WACC and company evaluations based on operating free cash-flow.
In order to come up with a realistic picture concerning the actual financial position of the
investment opportunity and its prospects going forward, the private equity investor has to
question and challenge the planning assumptions the management teams provide.
This requires not only thorough due-diligence and market research on behalf of the
investor, but also enormous experience to identify if the planning assumptions are

64
realistic, by benchmarking them with past experience of other private equity ventures or
with key-results a comparable peer group in the prospective industry achieves.
Even by doing so, an investor can never eliminate the risk of taking wrong assumptions
into account fully, he can only reduce his risk exposure.
Knowing all this the holding of the author applies the following ground-rules for all
portfolio companies:
1. Focus on profitable growth. Revenue growth without positive impact on the free-
cash-flow generated is restricted
2. Keep the fixed cost structure as low as possible, to make the portfolio company
less dependent on changes in market demand, by outsourcing non-key functions to
external companies, by entering into Strategic alliances and by implementing a
result-oriented compensation structure
3. Constantly monitor the working-capital levels
4. All investments in Property Plant & Equipment need to be pre-approved by the
author
5. Tie in the compensation scheme for the management with the free-cash-flow
generated
6. All long-term commitments (for rental and lease agreements and employee
contracts e.g.) need to be pre-approved by the investor, allowing the investor to
take counter-measures if needed without facing significant restructuring charges
7. The hiring of personnel is only allowed if the defined key-performance and
financial indicators are achieved

65
6.3. “Entrepreneurial” Top-Management Compensation
As already outlined the existence of a committed entrepreneurial management team is key
for taking an investment decision. The author would never invest in a company if it’s
management team has no shares or stakes in the company and or is not willing to acquire
them.
For each of the portfolio companies the author has identified prior to the investment and
the “formation” of the ownership structure outlined below, the key success factors, aimed
at “driving” the company forward towards maximization of investor’s expected returns.
These key success factors differ between the portfolio companies and are reflecting the
specific development stage the company was in prior to the investment.
For CLABS, as it was a start-up high-tech Company, developing state-of the art
Multimedia platforms and devices 3 key success factors were identified:
1. Finalize the development on the Hardware and Software to launch the
platform/devices on the markets on due time
2. Enter into Strategic partnerships on the R&D and Sales Area
3. Setting up of a distribution network
After these key success factors were identified, the CLABS management team needed to
be committed, who approached us with their Management Buy Out concept at the time
still working for a competitor to found a new company, in which the core management
team fulfilling best above mentioned key success factors, acquires a stake.
As the financial resources of the management team were limited special “valuations”
were agreed upon with them, which were about 80 percent below the valuation of
investors accepted.
On top of it the investors and the management agreed to set aside a Stock Management
Pool, to provide stock-options and shares for additional key management and key
personnel to be hired in the course of the development process.

66
For HD, as it was an early stage company, providing state-of the art E-Commerce
industry solutions for the home-delivery market 3 key success factors were identified:
1. Increasing the installed license base for the E-Commerce platform already
developed to reach market leadership in Austria by YE 2001
2. Add new features to the platform, supporting order processing via SMS or WAP
3. Develop new Industry solutions
Together with the management team a new company was found, in which the
management acquired stakes at valuations approximately 50 percent below the valuations
the investors accepted, but agreed to “bring” in the developed platforms, brand rights and
registrations.
For LCT, as it was a fast growing company tripling sales on a year to year basis,
providing telecommunications solutions and services to corporations and small and
medium-sized companies 2 key success factors were identified (after the investors
provided the needed expansion capital in the form of an equity increase and guaranteed
loans):
1. Implementation of a “profitable growth strategy”
2. Creation of new service offerings, catering to the mobile communications market
The managing director, responsible for sales and marketing, once owning the company
together with a private investor agreed to the capital increase proposition of the investors,
which reduced his stake in the company by half, as the company had a huge financial
leverage, due to the strong growth experienced, prior to the capital inflow provided by the
investors.
To illustrate an entrepreneur concept better the actual ownership structure of the portfolio
companies (after provided funding) is outlined:

67
CLABS: Managing Director Sales & Marketing 9.70%
Managing Director / CTO 9.70%
Head of Software Development 9.70%
Stock Management Pool not allocated yet 13.60%
Private Equity Company of Author 16.30%
Other Investors 41.00%
HD: Managing Director Sales & Marketing 24.00%
Managing Director Software Development 24.00%
LCT: Managing Director Sales & Marketing 31.50%
The author experienced that the entrepreneurial spirit of the management team got a
boost, once they became part of the ownership structure.
One problem remained: How can this “entrepreneurial-spirit” be consistently maintained?
In order to facilitate the achievement of this goal bonus schemes and stock-option models
were developed, agreed upon and implemented, which are described hereunder.

68
6.3.1 Applied Compensation Schemes
In all of the portfolio companies Total Compensation Package66
consisting of fixed pay,
variable pay, fringe benefits and long-term benefits was implemented.
Before total compensation package and its individual elements was “composed” the
above outlined key-success factors defined for each portfolio company had to be taken
into account and to calculate the market value for each key position into account.
Right before the investments the market values for the key positions of the portfolio
companies were defined as follows, applying industry comparisons by relevant key
function.
The market values ( total compensation p.a.) by key management position were calculated
as follows:
CLABS: Managing Director Sales & Marketing: EUR 250.000.-
Managing Director / CTO EUR 245.000.-
Head of Software Development EUR 270.000.-
HD: Managing Director Sales & Marketing EUR 170.000.-
Managing Director Software Development EUR 175.000.-
LCT: Managing Director Sales & Marketing EUR 140.000.-
The author entered into personal discussions with the key managers, in order to explore
their personal needs to tailor compensation packages on an individual basis aimed at
focusing the key managers on the achievement of the above mentioned success factors.
66
Röttig Paul F., „Total Compensation Package“, Imadec MBA Program 2001, MGMT 6730E,Human
Resources Management, Hewitt Associates, August 2000

69
All explored needs had one common denominator: Acquisition of shares in the respective
company and the right to acquire more shares going forward at favorable conditions once
the defined targets have been achieved. The applied stock-option models will be outlined
in chapter 6.3.2 in more detail.
Reflecting the overall company direction and reflecting the personal needs of the key
managers the following compensation packages were tailored, which had to be consistent
within one company, in order to avoid “in-fights” and de-motivation within the respective
management teams:
CLABS:
Fixed salary p.a. for all three key managers: EUR 72.000.- each
Bonus payments on achievement of individual
performance targets: EUR 25.000.- each
Company car (relevant cost for the company): EUR 10.000.- each
Stock option (respective value) EUR 110.000.-each
TOTAL: EUR 217.000.-each
Fixed Proportion by key manager p.a. in % of total
Compensation: 38%
Variable Bonus by key manager p.a. in % of total
Compensation: 12%
Value of granted stock options by key manager p.a.
in % of total Compensation: 50%

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