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1. Private Equity
BY
VIJAY MEHTA

2. Dissecting Private Equity
 What is Private Equity?
 Why Should Your Clients Do It?
 Why Should Your Clients Not Do It?
 Investment Routes
 Have new investors missed the boat?

3. What is Private Equity?
 Venture Capital
 Leveraged Buy-out (LBO) Business

4. Venture Capital
Early Late
Pre-
Seed R&D Start-up Stage Stage
flotation
Expansion Expansion
Description Idea Prototype Pre- Business is Initial sales Funding
operational operational encouraging allows planned
flotation
Application Sells equity Sells equity Product Hire employees, Working Working capital and
to investigate to prove development and buy equipment, capital second-generation
the idea the idea market testing fund working product
capital Debt-led
Debt-led
finance for
finance for
fixed assets
Risk fixed assets

5. Luminar - Venture Capital
99 2000
Operator of theme bars
98
97
PBIT
96
95
94
93
92
91
000
000
000
000
000
0

6. The LBO Business
Replacement Institutional Management Management
Turnaround
capital buy-out buy-in buy-out
Seller Receiver Family __________ Orphan Assets ___________
Shareholder
Desperate __ Business with no Owner Succession __
Regulatory Sale
Management Definitely Not Incumbent No No Yes but
supplement
Risk

7. Dechra - An LBO From Gehe AG
2000
The UK’s leading distributary vetenary drugs
99
PBIT
98
97
96
000
000
000
000
000
000
000
0

8. Sources of Capital & Risk Profile
Seed Start-Up Expansion Pre-flotation LBOs
Capital
Private Investors Specialist VCs Generalist VCs Generalist VCs Buy-out Firms
“Angels”
Public Markets* Public Markets* Investment Banks Investment Banks
Fund Managers
* Temporary phenomenon

9. The Case For Private Equity
 Private equity out performs over the long term
Source: WM Company/BVCA Performance Measurement Survey
 It is a loosely-correlated asset
May be able to increase performance without materially
increasing risk

10. 1999 Private Equity Returns
per annum % 3 years 5 years 10 years
Private Equity* 31.1 27.2 20.0
FTSE All-Share 20.4 20.3 14.9
FTSE 100 22.2 21.8 15.6
FTSE SmallCap 15.5 15.6 10.8
* median return
Source: BVCA WM Company

11. 1999 Private Equity Returns
per annum % 3 years 5 years 10 years
Total 31.1 27.2 20.0
Early Stage 15.8 16.6 8.7
Expansion Capital 30.3 26.9 12.6
Mid MBOs 19.9 22.1 17.3
Large MBOs 31.0 26.4 22.9
Source: BVCA WM Company

12. The Case Against Private Equity
 High Risk
 Low Liquidity

13. Risk
 Single company risk:
Leveraged }
Young } Moderate to high 10 Year Record
Smaller } Loss Ratio 7%
Returns 46.8% pa
 Portfolio risk: Low

14. Liquidity
The cash flow for an investor in a private equity funds follows a J-curve
Cashflow of investment
£
1 2 3 4 5 6 7 8 9 10
50
0
Year
s

15. Liquidity
 Self-liquidating
 Growing secondary market

16. Other Issues
 MFR
 Valuations

17. Private Equity
 All UK pension funds should consider an allocation to private equity
5% to 10% of equities

18. How do you invest in private equity?
 Direct
 Private Equity Manager
 Fund of Funds
 Quoted Investment Trust

19. How do you select a manager
In the normal way:
 People
 Performance
 Processes
 Philosophy/Strategy

20. Have Investors Missed The Boat?

21. Europe Is Restructuring
Germany
Italy
France
Scandinavia
NL
USA
UK
0.00% 0.05% 0.10% 0.15% 0.20% 0.25% 0.30% 0.35%
Unquoted investment as % of GDP
Source:
EVCA

22. PII Group

23. E-Commerce
Dot.com New Channel Fulfilment Infrastructure
Profile Classic internet ‘Clicks and mortar’. ‘Bricks and mortar’.
‘Bricks and mortar’.
company -usually New secondary on-line Outsourced back equipment, software, services etc to D
Suppliers of
retail or portals.
revenue streams. office (e.g. logistics)
of Dot.com
businesses.
Example Amazon.com Tesco, Dell, Clinphone* Bertrams* IBM
QXL.com MapQuest.com*, Irish Express Cargo CISCO
Freeserve 1-800 Batteries*, Trados* Braitrim* BT, Vitria*
Global People Network* Wincanton Agora*
* Portfolio company of Mercury Private Equity

24. Bertram Group

25. Private Equity
 Long-term out-performance
 Risk & liquidity concerns are overplayed
 Use to increase returns without materially affecting risk
 Expert funders of change at a time of restructuring

26. Appendices
 Definition of Terms
 Investment Return
 Detailed Schematic of MPE Investment Process
 MPE Organisation Structure
 Extract from MPE Business Planning Process

27. Appendices - Definition of Terms
 Venture Capital:
– Early Stage (“Seed to Start-up”): Capital for businesses in the conceptual stage or where products are not developed and revenues and/or profits may not have
been achieved
– Expansion Late Stage (“First stage to Mezzanine”): Growth or expansion capital for mature “businesses in need of product extension and/or market expansion.
Sometimes referred to as development” capital
 Buy-out Capital: Equity capital for acquisition or refinancing of a larger company
 Restructuring Capital: New equity capital for financially/operationally distressed companies
 Mezzanine (/subordinated) debt:
– Intermediate debt capital between equity and senior debt for acquisition or refinancing transactions
– The debtholder participates in equity appreciation through conversation features such as rights, warrants or options
 Carried Interest (“carry”): This represents the share of a private equity fund’s profit that will accrue to the general partners
 Fund of funds: Private equity funds whose principal activity consists of investing in other private equity funds. Investors in fund of funds can thereby increase their level
of diversification
 General Partner (“GP”) /Sponsor: Managing partner of a Limited Partnership, who is responsible for the operations of the partnership and, ultimately any debts taken on
by the partnership
 Hurdle Rate (or Preferred Return): A hurdle return allows investors to get preferential access to the profits of the partnership. In absence of reaching the hurdle return,
the general partners will not receive a share of the profits
 Limited Partnership: Most private equity firms structure their funds as limited partnerships. Investors are the limited partners and private equity managers the general
partners

28. Appendices - Investment Return
Private equity investment return in a partnership typically follows a “J-curve” e.g. in the early years while
investments are being made a Private Equity fund will show negative returns.
Harvesting
Illustrative data only
25% Value creation
20% Portfolio construction
20.0%
14.5%
15%
13.5% 15.5%
10%
5% 6.5%
Year
IRR 0%
0 1 2 3 4 5 6 7 8 9 10 11 12 13
-2.0%
-1.0%
-5%
-5.0%
-10%

29. Appendices - Detailed schematic of
MPE Investment Process: PII
Growth buy-out £105m
Support Services Sector
Deal introduced by ‘primary contact’
Initial Appraisal: Market and technology leader,
under managed, requiring
first class CEO
Conversion: British Gas wanted
speedy and comprehensive
response - certainty
Diligence: 3 month exercise: key issues were
long term contracts, intellectual property and R & D
Negotiation &
Structure: Transneft contract
Exit: 1) Sale to leading oil-services group: Dresser, Schlumberger
Baker Oil & Tool
2) IPO
Business Plan Core business - improve utilisation
Acquisition - acquire Pipetronix/Rosen
New Products - fitness for purpose services
Organisation - make market facing,
change culture
Financials - double EBIT in 3 years

30. Appendices - MPE Organisation
Structure
I a n A rm it a g e
M a n a g in g P a r t n e r
F ra n c e s J a c o b
H e a d o f In v e s tm e n t
S p e c ia lis t G e n e r a lis t B u s in e s s
S e c to r Team s A n a ly s t
Team s P ool
S u p p o r t S e r v ic e s M e d ia I n f o r m a t io n & H e a lt h c a re LB O F ra n k fu rt London
C o m m u n ic a t io n
T e c h n o lo g y
J e re m y N ic k T re v o r Ia n L in d s a y A n d re w N ic k T re v o r L is a
S h a rm a n M a r t in B a y le y A r m it a g e D ib d e n H ayden T u rn e r B a y le y S to n e
R ic h a r d B en T h ie r r y J o n a th o n Thom as R om an TB A J o a c h im P h ilip p e P o lle t
M a th e w s H e w e ts o n d e p a n a f le u R e g is M it a rd P e lk a P e ip e r
P h ilip p e TB A
S c h w a lb e r

31. Appendices - MPE Business Planning Process
Process: The investment process is different to that employed by public security investors. The best is data driven,
disciplined and designed to minimise judgement calls with the intent to add value. Here is the MPE process:
Deals do not Key skill Combine internal An important Legal completion Complete Identify and Detailed exercise Either float,
flow resources skill. Not all value output is: through strategy effect for exit, c.2 years trade sale
Decision to items measured in review and improvements ahead of time or recapitalisation
Requires allocate resource People £££’S agreement Shareholders business plan in operations
consistent
marketing Win confidence Accounting system Employment
of counterparties & controls contracts
Normal disciplines Banking documents
Market position
Get the first call dynamics Sale & Purchase
agreement
Technology
Warranties &
Facilities Indemnities
Environmental Other contracts
e.g. supply contracts
Insurance
Management incentives
Legal