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Legal Aspects of International Finance > Introduction to Private Equity > Flashcards

Introduction to Private Equity Flashcards

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1
Q

What are the four types of private equity?

A
  • Venture Capital
  • Buyout
  • Mezzanine Capital
  • Special Situations
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2
Q

What are the alternatives for investors in making an investment?

A
  • Direct Investment in Companies
  • Investment in PE funds
  • Invest in fund of funds
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3
Q

Concept of private equity

A

Is an asset class consisting of equity securities in operating companies that are not publicly traded on stock exchange.

It also refers to an industry in which several players align their interest in order to make investments in private companies, that would be realized within a limited perior of time with the objetctive of obtaining high returns.

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4
Q

What are some advantages of “private equity backed companies”?

A

-Small numer of larger shareholders
-Investors often on the board and involved operationally
-Shareholders usually have the same agenda
-Management is highly incentivized
Shareholders not concerned about taking tough decisions if that is the optimal strategy.
-Quick decisionmaking process
-Happy to employ large amounts of leverage
-Very easy to effect management change
-Less regulation and disclosure.
-Attracts very talented individuals due to high rewards.

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5
Q

What is the typical investment process?

A
  1. Contacting the PE investor
  2. Preliminary Assesment
  3. Additional information and negotiations.
  4. Due diligence and evaluation
  5. End negotiations
  6. Period ownership and development
  7. Exit
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6
Q

What is the life cycle of a company?

A
  1. Seed stage -> Seed capital
  2. Start up stage -> startup capital
  3. Expansion stage -> E or P capital
    4 Maturity -> IPO or trade offer
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7
Q

What are the basic characteristics of venture capital?

A
  • New companies and industries (unproven)
  • Technology/industry bets
  • New business models with potentially high margins
  • High operational risk
  • High growth
  • Negative cash flows
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8
Q

What are the basic characteristics of buy-outs?

A
  • Mature companies and industries (proven)
  • Proven technology/industry
  • Low or declining margins, scope for increased efficiency.
  • Outdated/ill-suited ownership structure
  • Need for industrial change and consolidation
  • Experienced management
  • Low operational risk
  • Low/moderate growth
  • Postive cash flows
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9
Q

What is the whole process of the activity of private equity firms?

A
  1. Raise Capital
  2. Evaluate Market Segment
  3. Generate Deal Flow
  4. Select investment candidates
  5. Negotiate and structure investments
  6. Nurture Portfolio Companies
  7. Liquidate/ Sell Portfolio Companies
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10
Q

What is a private equity fund?

A

It is an investment vehicle used for making investments in various equity securities according to one of the investment strategies associated with private equity

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11
Q

What is the legal structure of equity firms?

A

Most equity funds are structured as limited partnerships and governed by the terms set forth in the “limited partnership agreement”.

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12
Q

Who are the investors of equity funds?

A

They are normally cash-rich institutional investors such as pension funds, insurance companies, financial entities.

By investing the funds, they become “limited partners” (LP) of such funds.

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13
Q

What is the typical life of a private equity fund LLC

A
  • Industry standard is 10 years.
  • GP/managing members may have the right to extend for three or four one-year periods.
  • Limited partners/members may have the right to terminate the Fund early under certain conditions with supermajority approval.
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14
Q

What are management fees?

A

It is an annual fee investors pay to general partners to manage a private equity fund.
-The fee is usually 1 to 3 percent of the total commitment an investor has made to a fund.

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15
Q

What are the characteristics of management fees?

A
  • Cover salaries of principals and other fund operating costs
  • Paid quarterly or semiannually.
  • Often reduced after the funds investment period by 10% per year or 1% to 2% of the Fund’s assets on hand
  • May be reduced to the extent that fees are received by the GP from portfolio companies
  • May be reduced in exchange for a greater allocation of the long term capital gain profits.
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16
Q

What is carried interest?

A

It is the share in the capital gains of venture capital funds which is allocated to the GP. Typically, a fund must return the capital gien to it by limited partners plus any preferential rate of return the GP can share in the profits of the fund.

The GP will typically receive 2-% carried interest, although some successful firms receive 25%-30%.

Typicall the primary source of income for the manager in private equity funds.

Pay-for-performance served to provide incentives to make all transactions profitable and limits incentives to invest in risky transactions.

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17
Q

Allocation of profits

A

The proits from the investment made by the PE fund are splitted between the GP and the LP according to the terms agreed in the LPA.

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18
Q

What are the different phases in the process of private equity transactions? (5)

A
  1. Approach
  2. Enquiries/Negotiations
  3. Due Diligence
  4. Completion
  5. Exit
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19
Q

What happens iht approach/evaluation of the business plan?

A

Companies appoints advisers, prepares business plan and contacts the PE fund.

The PE firm reviews the Business Plan.

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20
Q

What is the Business Plan?

What does it cover (8)?

A

It’s main purpose it so market to the PE Firm the company’s .

It covers.

  1. Executive Summary
  2. Market and Competition
  3. Details of the Product or service
  4. Management Team
  5. Business Operations.
  6. Financial Projections
  7. Cost of Project and means of finance
  8. Exit opportunities for the investors
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21
Q

What happens during the enquiries/negotiations?

A

The company provides additional information.

Both parties meet to discuss business plan, build relationship and NEGOTIATE OUTLINE TERMS.

Document: Term Sheet

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22
Q

What happen in the due diligence phase?

A

The company discloses all the relevant information/documents

Liaise with accountants and external consultants

PE firm iniates external dude diligence

Consultant and Accountant reports are made.

23
Q

What does the due diligence consist on?

A

It consists in an in-depth analysis of several aspects of the business to which the investment may be direted, with the aim of detecting any contingencies and evaluate their impact on the future business performance as well as on the valuation of the business itself.

24
Q

What are the different types of due diligence (7)?

A
  1. Financial due diligence
  2. Operational Due diligence
  3. Market Prospects and technical feasibility
  4. Strategic due diligence
  5. Human Capital Due diligence
  6. Legal and environmental due diligence
  7. Systems due diligence.
25
Q

What happens inthe monitoring and exit phase?

A

Company provides periodic management accounts and communicates regularly with investors.

PE firm may have a seat on board, monitors investment, add constructive input and gets involved in major decisions.

26
Q

What does monitoring investments involve?

A
  1. Appointing of Directors
  2. Periodic financial reports
  3. Constructive input
  4. Participation in key decisions
  5. Strategic tie-ups
27
Q

What may be the different exit routes for private equity (6)?

A
  1. IPO
  2. Sale to another investor
  3. Repurchase by company
  4. Strategic/trade sale
  5. Recapitalization/partial exit
  6. Liquidation
28
Q

What are the most common investments in private equity? (7)

A
  1. Leveraged buyout
  2. Management buyout - management buyin- buy in management buyout
  3. Venture capital
  4. Growth capital
  5. Distressed and special situations
  6. Mezzanine Capital
  7. Secondaries
29
Q

What is a leveraged buyout

A

It is a type of PE investment in which a company, busnis unit or business asset is acquired from the current shareholder, typically with the use of financial leverage.

Mature companies in the industry are usually involved in these transactions

There is a financial sponsor agreeing to an acquisition without itself committing all the capital acquired by the acquisition.

The acquisition debt is in most cases “non recourse@ to the financial sponsor and has no claim on other investments managed.

30
Q

How does the LBO benefit the financial sponsor?

A
  1. The investor itself only needs to provide a fraction of the capital for the acquisition
  2. The returns to the investor will be enhanced
31
Q

What is the capitalization structure of a LBO?

A

Debt is around 70% which is divided in bank debt (with revolving credit and term debts) and mezzanine debts (with high yield and subordinated notes).

Equity is around 30% and it is divided in common stock and preferred stock.

32
Q

What are the key elements of the shareholders’ agreement suscribed in the LBO transactions for the private equity firm? (4)

A
  1. Control and monitoring of the performance of the management team.
  2. Continuance and non-competence of the management team
  3. Exit clauses
  4. Investment return
33
Q

What are the key elements of the shareholders’ agreement suscribed in the LBO transaction for the management team? (4)

A
  1. Management maneuver margin
  2. Incentives (envy ratios, ratchets)
  3. Institutional support
  4. Anti-dilution clauses
34
Q

What company makes a good target for a buy-out?

A
  1. Mature industry
  2. Mature company
  3. Strong management team
  4. Low leverage
  5. Low CapEx requirements
  6. Strong Cash flows
  7. Margins (gross and EBITDA)
  8. Growth rate
  9. Customer concentration
  10. Good exit options
35
Q

Why have the buy-out been so succesful?

A
  1. They are funded by a number of institutions/investor for +6 year periods that are always liquid and not affected by individual economic circumstances.
  2. Players are temporary and focused solely on their strategy of implementing their value-enhancing strategies- there are no side agendas.
  3. Buy-out players have explicit competences in their fouc area of change management, sector expertise, financial engineering, etc.
36
Q

Management buy-out - Management buy-in - Buy in management buy out

A

MBOs, MBI’s and BIMBOs share most characteristics with LBOs with the difference in the roll of management.

37
Q

MBO

A

Buyers are the managers of the target company and in consecuence, there is little due diligence because they all ready have important knowledege about the company.

Seller unlikely to give any but the most basic warranties.

Managers may have more information

38
Q

MBI

A

A manager or a management team FROM OUTSIDE THE COMPANY raises the necessary finance, buys it, and becomes the company’s new management.

There is competition with other purchasers in the search for a suitable business.

Requires significant manager experience.

39
Q

BIMBO

A

It is a combination of MBO and MBI where the team that buys out is a combination of existing managers and individual from outside the company who will the join the management team following the buyout.

40
Q

What is venture capital?

A

Investments made in less mature companies for the launch, early development or expansion of a business.

VC is most suitable for businesses with large up-front capital requirement which cannot be financed by cheaper alternatives such as debt.

41
Q

What are the key elements of the investment agreement suscribed in start-up transactions for the PE firm? (5)

A
  1. Guaranteed return
  2. Preferential conditions for its investment in case of successive rounds of financing
  3. Exit clauses
  4. Protection of key assets
  5. Formation of solid management team
42
Q

What are the key elements of the investment agreement suscribed in start-up transactions for the founders/managers? (3)

A
  1. Institutional support
  2. Margin for the management of the business
  3. Anti-dilution clauses
43
Q

What is growth capital?

A

It is a strategy that tipically involves minority investments in relatively mature companies that need to expand, restructure operations, enter in new markets or finace a major acquisituion without a change of control of the business.

It is usually used to finance transformation in their life cycle.

It could also be used to restructure a company’s balance sheet in order to reduce the amount of leverage.

44
Q

What are the key elements suscribed in growth capital transaction for the PE firm? (4)

A
  1. Protection of minority shareholders
  2. Representations and warranties
  3. Dividends policy
  4. Continuance and non-competence of the management team
45
Q

What are the key elements suscribed in the growth capital transaction for the partners/managers? (3)

A
  1. Partial realization of capital gains
  2. Margin for the management of the business
  3. Institutional and financial support
46
Q

What are distressed and situations PE?

A

It refers to a big category of investments in equity or debt securities of financially stressed companies.

47
Q

What are distressed-to control or loan-to-own strategies?

A

Strategies where the investors acquire debt securities in the hopes of emerging from a corporate resctructuring in control of the company’s equity

48
Q

What are special situations or turnaround strategies?

A

Strategies where an investor will provide debt debt and equity investments (often recue financings to companies undergoing operational or financial challenges).

49
Q

What is mezzanine capital?

A

It refers to subordinated debt or preferred equity securities that often represent the most junior portion of a company’s captial structure that is senior to the company’s common equity.

50
Q

What are secondary investments?

A

Refers to investments made in existing private equity assets including private equity fund interests or portfolios of direct investments in privately held companies through the purchase of these investments from existing institutional investors.

51
Q

What are other strategies that can be considered PE or a close adjacent market?

A
  1. Infrastructure: investment in various public works that are mady typically as part of a privatization initiative on the part of a government entity.
  2. Energy and power
  3. Merchant banking: negotiated private equity investment by financial institutions in the unregistered securities of either privately or publicly held companies.
52
Q

What is the PE secondary market?

A

Buying and selling of preexisting commitments to PE and other alternative investment funds.

PE asset class is illiquid (intended to be a long-term investment) but there is a robust and maturing secondary market available for sellers of PE assets.

Intended to diversify PE risk exposure.

53
Q

What is publicly traded private equity?

A

Refers to an investment firm or investment vehicle, which makes investments conforming to one of the various private equity strategies, and is listed on a public stock exchange.

Legal Aspects of International Finance (5 decks)

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