1. PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS
Session 1. Private Equity landscape
March 2013
Alexey Milevskiy
Gleb Fomichev
The presentation is prepared solely for the purposes of master classes
at the Higher School of Economics
3. Speakers
Alexey Milevskiy
Alexey Milevskiy is an Investment Manager at UFG Private Equity,
leading Private Equity firm managing over $500 million across several
funds in Russia and CIS. He participated in all stages of investment
process: origination, due diligence, structuring and execution.
Prior to UFG PE Alexey worked at European Private Equity division of
GIMV in Belgium, KPMG Business Valuation group and ING Bank.
Alexey holds masters degree from Vlerick Business School, Belgium and
bachelors from Higher School of Economics. He is also the winner of
several McKinsey&Co business case competitions.
Gleb Fomichev
Gleb Fomichev is an Analyst at JSFC Sistema, major Russian
investment company. Gleb is one out of 7 investment professionals
running Sistema’s $2 billion portfolio of high technology assets. He is
engaged in strategy development and portfolio companies management
as well as in new deals origination.
Prior to Sistema Gleb worked at A&NN Group, one of the top performing
Russian family office, where he managed fund’s assets in retail,
telecommunications, logistics, publishing and financial services sectors.
Gleb’s other experience includes E&Y business valuation team. Gleb
holds masters and bachelors degree from Higher School of Economics.
3
4. UFG Private Equity
• Over $500 million of capital under management
• Strong and experienced team of 11 investment professionals
• 5 partners worked as CEO/CFO or had own businesses,
one partner is involved as CEO or a portfolio company
• Strong track record with 19 investments in FMCG, Consumer
and Business services, Metals and Mining, Banking, Specialty
Retail, TMT, Food and Beverages, Healthcare, Travel sectors
with aggregate transaction value of over $1 billion
• 7 projects were co-invested with other funds
• 8 exits performed with capability to create value
• International investor base including EBRD and well-known
US and Middle-Eastern state pension funds
• Part of UFG Asset Management group with $1.2 billion
under management in four investment areas: Private Equity,
Hedge Funds, Real Estate, Wealth Management
4
5. UFG Private Equity Fund II portfolio companies
Fund Size $225m
Yandex Partially realized
Rising Star Media Fully realized
Russian Fund II Portfolio
Towers company
Enforta Fund II Portfolio
company
Brunswick Fund II Portfolio
Rail company
Fund II Portfolio
KDL
company
Karo Film Fund II Portfolio
company
5
6. JSFC Sistema
• Top public investment company in Russia
• Market cap ~ $10 bln
• Assets under management ~ $40 bln
• Consists of 8 investment portfolios divided by
industry/investment team competencies
6
7. Session 1. Private Equity landscape
1st part
• Private Equity definition;
• Company funding lifecycle: FFF, business angels, venture capital, private equity, IPO;
• Organizational structure of a PE fund: LP-GP agreements;
• Typical activities performed by PE fund: fund raising, deal sourcing and originating, due diligence,
management of portfolio companies, exits;
• Key success factors for PE deals;
2nd part
• Russian PE/VC landscape: PE funds, captive funds and family offices, government-backed funds,
venture capital funds;
• Russian vs Foreign PE industry;
• Entry strategies: full buyout, growth capital, LBO, minority recapitalization, mezzanine, distressed
situations.
• Exit strategies: IPO, trade sale to strategic/financial investor, MBO, sale to other shareholder;
• PE careers.
7
8. Session 2. PE deal origination, execution and portfolio management
Industry analysis
March, 14 (6pm – 9pm)
• Investment strategies: buy-and-build vs bet-and-win;
• Industry KPIs and application for financial modeling;
• Multiples variation by industries.
Financial modeling and leveraged buyouts
• Financial statement analysis: application for private equity;
• Valuation methods: multiples approach, comparable transactions approach;
• Private equity returns calculations: IRR, cash-on-cash, exit sensitivity analysis.
• LBO and financing of M&A transactions: debt and mezzanine financing for PE deals.
Due diligence
• Commercial, financial and tax, legal due diligence
Deal structuring and negotiations
• Legal documents for deal execution: NDA’s, Term Sheets, SHA’s, SPA’s;
• Off-shore holding structures: English law, possible holding schemes.
• Deal structuring tools
• Deal negotiations: habits for effective negotiations.
Portfolio companies management
• Fund representation on the board of directors: strategy formulation, veto and approval rights, audit and
compensation committees;
• Companies monitoring: weekly/monthly management reporting packs, frequent interaction with
management;
• Value creation strategies: fund raising, building corporate governance, management appointment, solving
operational issues, attracting consultants, finding clients, exit preparation, synergy identification among
portfolio companies.
8
10. Private Equity definition
Private equity is a:
• medium to long-term financing
• provided in return for an equity stake
• in potentially high growth
• unquoted companies
10
11. Private Equity value creation formula
Multiple
EBITDA growth Leverage
Expansion
Topline Efficiency
growth improvement
Superior returns
11
12. What value Private Equity fund brings
PE Entry Value creation within 3-5 years Exit
Financial support
- Raising new equity rounds and debt financing
- Financial planning and cost control, IFRS implementation
- Introducing transparent reporting system
M&A support
- Developing M&A strategy
- Search and valuation of attractive acquisition targets
- Legal support and deal structuring
- Integration assistance
Operational support
- Help in bringing top experienced people to the team to bridge personnel gaps
- Attracting independent board members and industry experts
- Motivation schemes implementation
- Development of tax and legal structure, IT-systems
- Access to a new partner and client network, help in expanding abroad
- Optimization business processes and internal decision-making
Help in forming/ adapting company strategy
- Business model adaptation to changing market realities
- Implementing company development plan and setting KPI’s
Preparing company for an IPO or trade sale
- Improvement of corporate governance
- Substituting investment banks at exit
- Legal support and deal structuring
12
14. Private Equity fund types
FUND
DESCRIPTIONS
By stage By size Ownership Specialization Purpose
• Venture funds: • Large-cap • Captive/semi- • Specialized • Funds-of-funds:
invest in early stage funds: large LBO captive: funds funds: funds funds created to
or expanding funds (could be established by and focusing on a invest in a range of
businesses that greater than $20bn) with strong links to a portfolio companies other private equity
generally have particular investor, in specific segments funds
limited access to • Mid-cap funds: e.g. a financial (e.g. IT/ real estate)
other sources of usually invest in institution
funding deals worth • Regional funds:
between $10m and target investments
• Buyout funds: $300m in a particular region
invest in mature
businesses, usually
taking controlling
interest and
leveraging their
equity investment
with substantial
amount of third
party debt
14
15. Specialist/ generalist funds
Specialist funds
• May be attractive to certain investors, i.e. those seeking to:
I. Increase their exposure in a particular sector (healthcare, IT)
II. Diversify their existing geographical/sector focus
• Small funds may increase specialization to differentiate themselves
• Disadvantages:
I. May be more risky due to the lack of portfolio diversification
II. May be difficult to raise a fund if there is little investor appetite
III. Niche/hot sectors may lose favor
Generalist funds
• Most private equity funds are generalists
• General fund may have specialist teams who may source and execute deals within certain
market sectors
• Generalist funds have the advantage of being able to limit their exposure to declining sectors
and have more flexibility
15
17. Investment approach and key success factors
1 Market leaders are typically winning
2 Strong and motivated management team
3 Fair entry price
4 Proper deal structuring
5 Proactive monitoring
6 Clear exit strategy
7 Industry growth and deep market expertise
17
18. Investment approach and key success factors
Market leaders are typically winning
Market leaders How to
are determine
winning market leader?
UFG cases:
• Yandex
• RSM
• Russian Towers • Industry leader
• Brunswick Rail • Industry segment leader
• Russian Alcohol
• Leader by market share
• Leader by margins
• Leader with first-mover advantage
• Leader with the most known brands
• Potential market leader through M&A
or business scalability
• …
18
19. Investment approach and key success factors
Strong and motivated shareholders and the management team
Goal alignment
• Important to chose a partner you can
Typical PE fund is
deal with. High personal integrity, strong
not a turnaround commercial instincts, transparency,
team which is flexibility should be among the qualities of
coming and taking the counterparty in the deal.
operational • Choice of the trusted management team
management is important
• The company should not be 100%
dependent on 1-2 key shareholders/
managers
We are all in the same boat • Goal alignment should be in place to
motivate managers and other
PE The management,
shareholders:
fund founders
Upside sharing scheme may be in place
to motivate management on:
I. Growing the company
II. Exit
19
20. Investment approach and key success factors
Fair entry price
Entry
Fair entry price should be
negotiated
• Clear exit path should be overseen
from the beginning
• Fair entry multiple is needed to
x5 EBITDA* x10 EBITDA*
avoid multiple contraction at exit
+ Full downside
and achieve good returns
protection and
• It is always a trade-off between: corporate rights
I. low multiple
II. high multiple and protection
Exit
mechanisms
35% IRR, 3x cash multiple
* example 20
21. Investment approach and key success factors
Clear exit strategy
Exit types To consider at the time of entry
• Trade sale • Clear exit path should be foreseen at
• Secondary buyout the time of entry
• Sale to other shareholders/ • Partner should be focused on exit
management and not to prevent it
• IPO • Exit obligations may be in place to
guarantee exit for the Fund in worst
• Break-up
case scenario
• Share redemption
• IPO should not be the base case:
partial exit, continuing risk, lock-up
period
• The exit should be identified in the
investment documents in terms of
timing, profit-sharing, liability to exit
21
22. Investment approach and key success factors
Clear exit strategy: trade buyers exit scorecard example
Financial Fit Strategic Fit
1. Revenue 2. Net Debt/ EBITDA 1. Product fit
> 1 bln USD < 0x 1.1. Companies with services portfolio complementary
500 mln to 1 bln USD 0x to 1x to ABC which aim to:
• enter ABC segment;
250 mln to 500 mln USD 1x to 3x • complement offerings for the current clients.
100 mln to 250 mln USD 3x to 5x 1.2. Companies already present in ABC segment
(<50%), which aim to:
< 100 mln USD > 5x • strengthen ABC segment.
1.3. Companies which aim to:
Only companies with a low
Large firms are more likely to • realize cost synergies;
Net Debt/EBITDA ratio will • build market share.
acquire ABC and leverage its
have willingness and ability to
capabilities
acquire 2. Geographical fit
3. Organic revenue growth 4. EBITDA 2.1. Companies which aim to enter Russian/
emerging markets
< 5% > 200 mln USD
5% to 10% 100 mln to 200 mln USD 3. Acquisitions growth fit
10% to 15% 75 mln to 100 mln USD 3.1. Companies with expressed intention in M&A
3.2. Companies which have successful past track
15% to 20% 50mln to 75 mln USD record of doing acquisitions
> 20% < 50 mln USD
4. Client fit
Companies with limited ABC is more appealing to 4.1. Companies which want to access new
organic growth opportunities companies with a positive clients of ABC
are more focused on EBITDA and aiming to 4.2. Companies which want to provide support to
acquisitions maintain high margins existing multinational clients
22
23. Investment approach and key success factors
Proper deal structuring
Proper deal The following deal structuring
structuring is key elements could be used:
to align parties
• Put and call options, redemption
and establish
rights
downside
• Deferral consideration and earn-outs
protection
• Covenants
• Drag along and Tag along
• Share ratchets
• Preferred shares and liquidation
preference
• Right of first refusal
• Board representation and approval
rights
• …
23
24. Investment approach and key success factors
Proactive monitoring
Proactive • Building 100 days plan and clear 3-5
monitoring of years roadmap
portfolio • Building proper corporate governance
companies is • Fund active involvement on the Board
important of Directors
• Monthly reporting from portfolio
companies
• Monthly review of budgeted and actual
numbers
• Early warning of issues
• Frequent interaction with
management
• Strengthening CFO/ financial controller
24
25. Investment approach and key success factors
Industry growth and deep market expertise
Examples of attractive sectors in the current environment
Sector Investment rationale
1 Undeveloped industries/ sectors
with high growth potential
• Internet tech companies • High Internet growth rates
• E-commerce • Service infrastructure is still
• Medical Services underdeveloped
• Fast Food • Limited modern private medical services
• Logistics
2 Traditional sectors
• Food retail • Import substitution
• FMCG • M&A opportunities, important to find right
• Pharmaceutical industry platform for consolidation
• TMT • Regional growth potential
• New formats/ products development
• Room for improvement (margins, working
capital)
25
26. Investment approach and key success factors
Industry growth and deep market expertise
Two investment strategies
“Bet-and-win” “Buy-and-build”
• Industry with high growth potential • Good industry knowledge
• Investment in market leader • Building market leadership through M&A
• Investment in strong management • Strengthen management team
team • “Discount entry price”
• “Fair entry price” • Majority stake buy-out
• Minority investment
Undeveloped industries/ sectors with Traditional sectors
high growth potential
Common principles
• The market in which the Company operates should be at least $100 million
• The demand for the Company products or services should be justified by macro trends
• The business model should be proven/ sustainable/ scalable
26
27. Sequoia Capital investment approach
ELEMENTS OF SUSTAINABLE COMPANIES
Start-ups with these characteristics have the best chance of becoming enduring
companies. We like to partner with start-ups that have:
1 CLARITY OF PURPOSE
Summarize the company’s business on the back of a business card.
2 LARGE MARKETS
Address existing markets poised for rapid growth or change. A market on the
path to a $1B potential allows for error and time for real margins to develop.
3 RICH CUSTOMERS
Target customers who will move fast and pay a premium for a unique offering.
4 FOCUS
Customers will only buy a simple product with a singular value proposition.
5 PAIN KILLERS
Pick the one thing that is of burning importance to the customer then delight
them with a compelling solution.
Source: Sequoia Capital 27
28. Sequoia Capital investment approach
6 THINK DIFFERENTLY
Constantly challenge conventional wisdom. Take the contrarian route. Create
novel solutions. Outwit the competition.
7 TEAM DNA
A company’s DNA is set in the first 90 days. All team members are the smartest
or most clever in their domain. “A” level founders attract an “A” level team.
8 AGILITY
Stealth and speed will usually help beat-out large companies.
9 FRUGALITY
Focus spending on what’s critical. Spend only on the priorities and maximize
profitability.
10 INFERNO
Start with only a little money. It forces discipline and focus. A huge market with
customers yearning for a product developed by great engineers requires very
little firepower.
Source: Sequoia Capital 28
30. Private Equity fund structure terminology
Investors which allocate money to PE/VC
funds. They commit money directly (e.g.,
Limited Partners (LP) Family Offices), or on behalf of others (e.g.,
Pension funds)
PE/VC fund manager who raises
General Partners (GP)
money through a fund legal vehicle
Investee companies or entrepreneurs who get
Investee company money and generate returns for GPs and LPs
30
31. Private Equity fund structure
Limited Partners Distribution
Institutional investors of proceeds
• Pension funds
• Sovereign wealth funds
• Financial institutions
HNWI
Disbursement
of commitments Carry
Fund
General Partners
PE or VC firm
Equity Exit
Investment proceeds
Investee company
31
32. Private Equity fund landscape
LP LP LP
GP GP GP GP GP GP
C C C C C C C C C
32
33. LP-GP relationship
Limited partnership structure entails arms’ length relationship and a five-ten year
commitment
• LPs choice comes out of a solving a broader asset allocation problem, which includes:
risk/return, liquidity, transparency
• LP makes three decisions:
1. Alternative assets among all investment options
2. VC/PE within alternative assets
3. Choice of the fund manager (GP) - the most important!
• Once a GP is selected LPs want to ensure they will earn high returns. This requires that:
1. GPs do not act opportunistically
2. GPs devote full effort to the ‘fund’
3. Right companies are selected
4. GPs report their returns faithfully
5. Exits from companies are efficient
• GPs have to raise funds and choose LPs.
• They also need to manage long-term relationships, as fundraising is repeated.
• For this, they need to generate high returns (at least the perception of them)
• GPs want LPs to provide commitments on time and keep their investment decisions as
independent as possible
33
34. LP-GP relationship
Criteria for selecting GPs in first funds
Partners' previous success in PE
Proposed investment strategy
Quality of the partners' network of contacts
Partners' previous experience in working together
The level and structure of fees
Partners' previous experience in non-PE jobs
The fund's size
Partners' quality of education
Commitments to this fund by top LPs
The opportunity to access follow-on funds
Co-investment opportunities
The advisor opinion
0 1 2 3 4
Source: Marco Da Rin 34
35. LP-GP relationship
Criteria for selecting GPs in seasoned funds
Proposed investment strategy
Stability of the team at partner level
GP's reported aggregate multiples on previous funds
GP's reputation
GP's reported IRR on previous funds
Quality of the partner network of contacts
The level and structure of fees
Renewed commitment to this fund by its existing LPs
The fund's size
Valuation of unrealized investments (NAV) in GP portfolio
The change in fund size from previous funds
Commitments to this fund by top LPs
Partners' quality of education
Co-investment opportunities
The advisor opinion
0 1 2 3 4
Source: Marco Da Rin 35
36. LP-GP relationship
Reasons for refusing re-investment
30%
20%
10%
0%
The fund's size Strategy changed Disappointing Key GP partners left Other reasons
increased too much performance
36
37. Typical PE/VC fund remuneration structure
Management fee 2%
LP GP
Carry 20%
Management fee of 2% is charged on the total amount of committed/invested
capital.
Carry is received upon exit from portfolio investments.
• First, LPs get total commitments at cost plus hurdle rate (8-10% annual).
• Second, remaining exit proceeds split while 80% goes to LPs and 20% to
GPs.
Carry is the main part of total remuneration and its existence ensures that the
interests of LPs and GP are aligned and GP focused on value maximization
and successful exits.
37
38. Typical PE/VC fund remuneration structure: simplified example
Management fee 2%
LP GP
Carry 20%
$300mln fund
1 Management fee
300*2% = $6mln annually
2 Carry
Assumption that the fund makes 3x cash-on-cash over 5 years
Exit proceeds 3*300 = $900mln
1) Cost plus hurdle goes to LP: 300*(1+0.08)^5 = $441mln
2) LP gets 80% of remaining proceeds: 80%*(900-441) = $367mln
3) GP gets carry of 20%: 20%*(900-441) = $92mln
38
39. Alternative structure of Family Office or captive PE fund
PE/VC fund integrated with an investor
LP • Family office
• Captive fund
May have different goals:
• No need to raise funding
• Non-financial goals
GP
Companies
39
41. Company funding lifecycle
Revenue
IPO
Private Equity
Venture Capital
Business
angels
FFF Time
Start-up Early Growth Mature
41
42. VC funding lifecycle
Funding stage Source of investment Use of proceeds Size, USD
Start-up competitions, grant Incorporation of a company, building
Grant
programs prototype, first sales
Angels, seed stage VC firms,
Seed Developing product to first sales up to 1m
qualified investors
Primarily VC firms, other qualified
Round A Scaling operations 1m-3m
investors and sometimes angels
Primarily VC firms, other qualified
Round B Scaling operations, new markets entry >3m
investors and sometimes angels
Scaling operations, strengthening brand,
Round C and Primarily VC firms, other qualified
new markets entry, technology >3m
later rounds investors
improvement (ERP, CRM, etc.)
Expanding business, providing exit for early
IPO Equity capital markets undefined
investors
Source: Fast Lane Ventures 42
44. What value Private Equity fund brings
PE Entry Value creation within 3-5 years Exit
Financial support
- Raising new equity rounds and debt financing
- Financial planning and cost control, IFRS implementation
- Introducing transparent reporting system
M&A support
- Developing M&A strategy
- Search and valuation of attractive acquisition targets
- Legal support and deal structuring
- Integration assistance
Operational support
- Help in bringing top experienced people to the team to bridge personnel gaps
- Attracting independent board members and industry experts
- Motivation schemes implementation
- Development of tax and legal structure, IT-systems
- Access to a new partner and client network, help in expanding abroad
- Optimization business processes and internal decision-making
Help in forming/ adapting company strategy
- Business model adaptation to changing market realities
- Implementing company development plan and setting KPI’s
Preparing company for an IPO or trade sale
- Improvement of corporate governance
- Substituting investment banks at exit
- Legal support and deal structuring
44
45. Typical activities: big picture
Pre-deal Deal origination Deal screening Due Diligence
Deal Negotiation Structuring
Deal sourcing
Company
Post-deal management, Exit
value creation
45
46. Deal sourcing
Reputation
Proactive research Investment strategy
Deal sourcing
Direct approach Intermediaries
Personal/ professional
network
46
47. Deal origination and execution
1 2 3
Deal teaser received Quick screening Signing NDA
- Proactive search - Meeting with
- Conferences management/
- Proprietary connections shareholders
- Investment bankers
4 5 6
Reviewing info pack Market research Financial modeling
- Information memorandum - Expert interviews - Returns calculation
- Business plan - Sensitivity
- Additional meetings - Stress tests
7 8 9
Negotiations Investment Committee Due diligence
- Deal price - Preparing docs - Consultants tender
- Deal structure - Working with consultants
- Reviewing VDR
10 11 12
Final negotiations Deal docs drafting with Deal closing and
- Final price and terms lawyers and signing payment
adjustment based on DD - SPA - party
findings - SHA
3-12 months
47
48. Deal screening example
Number of
deals
Deal received 500
Signing NDA 200
Investment Committee 20
Due diligence 3
Docs drafting and 2
closing
48
49. Initial screening process 1
Market Size, growth, major trends, macro drivers, competition
level, technologies, industry historical overview,
overview
seasonality and cyclicality, capacity, concentration level
Product What are the product’s characteristics, value
added/commodity, key value differences
Fragmentation, product positioning, vertical integration,
Competitors size and growth rates of competitors, profitability,
leverage level, strengths / weaknesses
Entry barriers Economies of scale, brand identity, proprietary
and substitution technologies, capital requirements, switching costs,
threats access to distribution, learning curve, government policy
STOP. Is it an attractive industry? Project team discussion.
If “yes”, continue
49
50. Initial screening process 2
Management Overall impression, experience, motivation, goals vs. historical
team and achievements, what are the hidden agendas and are your
shareholders interest aligned
• Operations: key business units, cost position, productivity,
Company technology, capacity utilization, capex requirements, equipment
• Financials: look at the crisis years, top-line growth per business
unit, one-time revenue, profitability levels in comparison with the
industry, identify money-generating and loss-making units,
operating leverage, Capex, WC, tax liabilities, capital structure,
debt financing terms, historical performance vs. historical
budget, accounting, ROIC, ROE, ROA, break-even, payback
period, etc.
• Sales/Marketing: brand, product positioning, marketing
efficiency, customers acquisition costs, sales efficiency,
distribution channels, logistics
• Personnel: productivity, turnover, compensation level, earn-outs,
parachutes, pension liabilities
• Technology/Engineering: IT system, Intellectual property,
technological advantage, development skills, product renewals,
product pipeline
50
51. Initial screening process 2
Differentiation of inputs, switching costs, substitutes,
Suppliers supplier concentration, volume-cost function, integration
threats
Buyers’ concentration, volumes, switching costs,
Customers information, threat of backward integration, substitute
products, share in total purchases of the buyer, buyer
profits
STOP. Is it an attractive target? Project team discussion.
If “yes”, continue
51
52. Initial screening process 3
• Fund uses: construction, marketing, m&a etc.
Build • Forecasted efficiency of fund uses vs. historical: focus on
business case ROE, ROIC for the project in comparison with historical data
and industry standards
Comparables • Create comparables set in order to understand valuation
metrics
• Identify key value drivers. Understand possible
Financial improvements, issues
model • Build several scenarios
• Model UFG returns
• Identify list of potential buyers and reasons for the interest
Exit scenarios
• Protect Fund position: put option, ratchet mechanisms,
Deal structure accelerated put, liquidation preference, drag/tag along,
• Add a sweetener: upside sharing, call option
STOP. Prepare presentation for team discussion
52
57. Russian vs Foreign PE sector performance
EBRD PE Portfolio
Cambridge EM VC&PE One year
Index Five years
Ten years
EBRD Russia/CIS PE
portfolio
0% 5% 10% 15% 20% 25% 30%
Source: Cambridge Associates, EVCA/ Thomson Reuters, Bloomberg and EBRD 57
59. Difficulties for LBO deals in Russia
In global: debt financing of PE deals is about 55%
In Russia: debt financing is less than 20%
Very few mezzanine funds operates in Russia
Central bank set strict limits for such deals (high reserves,
advance requirements for capital) for local banks
Prudent approach in apprising pledge
Off-shore payments
High inflation rate (so high bank`s credit rates)
Still high return opportunities for equity investments
59
61. Entry strategies. Overview
Target Stake Deal Deal Fund’s Type of
company acquired structure funding strategy fund
stage
Classical
Current PE funds,
Growth/ Debt/Self Buy and
Buyouts Mature
>50% shareholders
financed build
cash out mezzanine
funds
New issued stock Financial
Venture
Growth/ purchase/current Self investor
Growth capital Mature
<20%
shareholders financed (funds for
funds, PE
funds
partial cash out growth)
Financial
Venture
Development New issued stock Self investor
Early/Growth <20% funds, PE
capital purchase financed (funds for
funds
growth)
Financial
Current
Minority Growth/ Self investor Classical
<50% shareholders
recapitalization Mature financed (funds for PE funds
cash out
growth
Reorganizati Special
Distressed Mature/ Debt obligations Self
>50%/100% on and situations
situations Decline assignment financed
restructuring funds
61
62. Entry strategies. Rationale for LBO deals
Tax deductibility of debt interest
Cost of Lower cost of debt if compare with equity
capital
Cost of capital reduction as a result of company’s gearing growth
Substantial increase in equity value as a result of relatively small
Gearing increase in company’s enterprise value
effect Higher IRR for equity investors as the interest on a debt funding is
fixed
Cost High gearing – reduction of company’s cash flow
reduction Management is obliged to focus on driving costs down measures
trigger The problem of excess capex is eliminated
IRR for equity investors has a great upside potential
Managemen
Flexible ratchet mechanisms allow managers increases their stake
t incentives
in circumstances of higher IRR achievement
62
63. Entry strategies. LBO candidates
LBO
suitable
targets
Leading market
Strong&Stable Low capex
position/clear
cash flow requirements
niche
Extensive Margin
Strong Clear exit
growth increase
management strategy
opportunities potential
Volatile/poor cash flow
LBO
inconsistent Weak market position/search for a new niche
stories Unsuccessful management’s track record
Small size
63
64. Entry strategies. Forms of debt funding under LBO deal
Most common conditions
Lower Provided by bank/syndicate of banks
risk
Secured by firms assets
Structured in up to three tranches: A,B,C
Senior debt Repayment in equal installments
Period ~ 7-10 years
Floating rate of interest (LIBOR + 2-3% )
Looser covenant package as compared with
senior debt
Subordinated debt Higher lending costs as compared with senior
debt, fixed interest rate
Common form – high yield bonds
High risk subordinated debt (less provision,
looser covenants)
Interest include:
Mezzanine • Variable rate (LIBOR + 4%) – payable periodically
• PIK (4-5%) – roll up into the principal
• Equity warrant
Loan stork - notes convertible to equity at a
Loan stock/ fixed conversion ratio
Preferred stock – fixed dividend, higher
Lower
priority
preferred stock priority in case of liquidation as compared
with ordinary shares
65. Entry strategies. LBO deal basic structure
Ownership
Investor(s) Senior
level
(PE fund(s)) Debt Lender
investment
Equity and debt Loan notes Term loan
investment and shares
Holding level
Payment of
consideration
SPV Newco Seller(s)
Ownership Ownership
Operational level
Sale of shares
Target Target
Subsidiaries Subsidiaries
65
66. Entry strategies. LBO deal complex structure
Ownership
Investor(s) Mezzanine Senior
level
(PE fund(s)) fund Lender
Warrant
Equity
investment
Mezzanine
Topco1
Holding level
Loan debt
Senior debt
100%
Midco1
100%
Midco2
Payment of
100% consideration
Bidco Seller(s)
Ownership Ownership
Operational level
Sale of shares
Target Target
Subsidiaries Subsidiaries
66
67. Entry strategies. Growth and development capital
Minority investments
Form and Most common forms – preferred equity and mezzanine
structure Priority position in the capital structure relative to the common
equity owners
Business growth initiative enhancement/maintenance
Use of funding New markets expansion, M&A strategy implementation
No/insignificant cash out for current shareholders
No control on the Board of Directors
Corporate Certain controls on management decision concerning operating
governance and capital budgets, M&A strategy, funding attraction, capex
program
Certain exit plan requirement – put features (time/performance
Exit triggers)
opportunities
Defense mechanisms in equity agreements: tag along rights
Limited influence on company’s management in exchange for a priority in
proceeds distribution and a fixed return from investment
67
68. Entry strategies. Growth capital deal structure
New investor
Current New investor
(PE/mezzanine
shareholders (PE fund)
fund)
Equity growth
Funding level
capital
Ownership Mezzanine
growth capital
Equity pre-money valuation = $X
$Z Use of
proceeds M&A, capex
Target ($X) $Y $V
Operational level
program
Cash out Growth capital = $Y+V-Z
= $Y-Z
Equity post-money valuation = $X+Y-Z
Enterprise value = $X+Y-Z+V
68
69. Entry strategies. Distressed situations
Corporate
reorganization
Debt restructuring Change of
management
Entry value creation
Contract base Corporate governance
extension optimization
Synergies with other
investors’ companies
69
71. Exit strategies. Returns on exit
Unsuccessful Successful
Valuation
investment investment
Valuation
EV on exit
Management
equity
Management equity
PE fund equity
Redeemable PE fund
stock Management equity equity
PE fund equity
Mezzanine/Su EV on
bordinated Redeemable
Redeemable
exit stock stock
notes Mezzanine
Mezzanine/Su Mezzanine/Su
Senior Senior bordinated bordinated
notes notes
Debt Debt
Time Senior Senior
Debt Debt
Time
71
72. Exit strategies. Overview
Acquisition of a target by it’s current management
Company team
size/maturity MBO Management’s stake before MBO - zero/
insignificant
Example: buyout of a non-core subsidiary
Disagreements on company’s development
Sale to other strategy
Dead lock danger
shareholder
Spin offs, non cash-deals
Acquisition by a new vehicle created
by new PE investor/strategic
Secondary buyout investor
The third, forth, etc buyout rounds
may also take place
Most IPO proceeds – growth
and development capital
IPO Only partial cash out of
current shareholders is
Likelihood
possible
of positive
target’s
performance
72
73. Exit strategies. MBO/MBI deal basic structure
Current
Equity
managers
investment
(MBO)
Investor(s)
Investor Senior
(PE fund(s))
(PE fund)
Debt Lender
New managers investment
(MBI)
Mezzanine and Loan notes Term loan
debt investment
Equity Previous round
investment Payment of investor
(“sweety consideration
equity”) Newco Seller(s)
Ownership Ownership
Sale of shares
Target Target
Subsidiaries Subsidiaries
16
73
74. Exit strategies. Secondary buyout: rationales
Rationales for seller and target Rationales for new PE investor
End of the fund life reach Possibility to obtain more value
out of the investment because
Next capital injection is needed in
of an exclusive sector expertise
order to achieve further growth
and etc
Change in investment
Investment in a proven
profile/strategy of a fund
business carrying stable
Good price and deal conditions dividends flow with a proven
proposed by secondary investor management team
74
75. Exit strategies. IPO process
Investment
Grooming a bank and Due Underwriting
company for legal advisor Diligence agreement
IPO appointment
The executive Pre-IPO research – Full commercial, Setting out in details
management team: educating potential financial, tax, legal the mechanics of the
• reliance on current investors about the business inspection fundraising and
CEO/CFO investment case Performed by admission process
• change of Investment independent
management presentation – key accounting firm and
marketing document for company’s legal
Potential due diligence presenting company’s advisers
issues – in-house DD in story to potential
order to prepare investors
company for a rigorous
Disclosure document –
pre-IPO inspection
prepared by
advisers/key part of a
marketing process
75
76. Exit strategies. IPO structure
Public
PE investor
investors
Post –
IPO
No full exit in an IPO stake
Cash-out IPO proceeds
The level of the retained
stake depends on the
investors demand (fixed
cash-in is needed, the Private equity backed
extent will result in a company
cash-out of current
shareholders)
New investors wish the
initial investor retains a
stake to assure the
alignment of their
interests
Private equity backed New shares
stake public offering issue
76
77. Exit strategies. IPO pros and cons
IPO advantages IPO disadvantages
Higher exit valuation Lack of complete exit
Increased liquidity PE stake to large to be fully sold
Management support Full cash out - negative message to new
investors
Better if IPO cash proceeds are
allocated to the company
Timing
Cost and distraction of
management’s attention
Info disclosure obligations
Loss of control
Risk of failure
Lock-up
77
79. PE careers
Entry strategy Exit opportunities
Partner Unlimited
Work experience in Top management
Investment director Unlimited
Private equity positions in industry
Successful completed Top management
deals track record position in fund’s
Recruiters, networking company/project
Own business/project
VP/Associate 1-3
Director launch
years
Work experience in Big4, Middle level management
IB, Industry is required 1-3 positions in industry
Recruiters, networking Associate/Invest years Upside position in
ment manager smaller fund
Own project launch
1-3
Analyst years
Last year students
Internships
Applications on career sites
79