Lecture 9: Clients: Private equity Flashcards
What two transactions does private equity primary involve?
1) Investing directly into private companies
2) Engaging in buyouts of public companies, resulting in the emergence of a private company
What are the four different types of investement in private equity?
1) LBO: Leveraged buyout: target typically mature companies with good cash flows, investors are a small group of equity investors in combination with a large amount of debt
2) Capital growth: Minority equity investments in mature companies that need capital (NO CONTROL OF COMPANY)
3) Mezzanine capital: Target smaller companies that want to borrow capital - invested in subordinated debt or preferred stock
4) Venture capital: Equity investment in less mature non-public companies (start ups, early development or expansion of business)
Who is the ‘financial sponsor’?
Provider of the equity component in LBO, as well as the orchestrator of all aspects of the LBO transaction, including negotiating purchase price and securing debt financing to complete the purchase
Who are the five key participants and what are their roles
1) Private Equity (PE) firm: general partner
- Select appropriate LBO firm
- Determine the acquisition price, secure debt and close transaction
- Responsible for all strategic and financial decisions
- Determine how and when to exist the investment
2) Investment banks:
- Introduce potential targets
- Help to negotiate acquisition price
- Provide loans or arrange bond finance
- Arrange exist transaction (IPO, private acquisition ect.)
3) Investors: limited partners
- Institutional and high net worth
- Sign contracts to keep investment in then fund for as long as 10-12 years
- Receive payment upon completion of exist strategy (which may be IPOs, sale of company)
4) Management: co-invest with the PE firm: and may also have motivation in form of stock options
5) Lawyers, accountants, tax experts and other professionals
Who are the 5 participants in PE transactions l?
1) PE FIRM: general partner- select LBO target, negotiate acquisition price, secure debt and close transaction, make all major strategic and financial decisions, determine how and when to exit investment
2) IBANK: Produce potential targets to PE firms, help negotiate acquisition price, provide loanst or arrange financing, arrange exit transaction
3) investors: limited partners- high net worth, and investment will be locked up, receive payment on completion
4) management: co- invest with PE firm- both will do very well if successful exit
5) lawyers and accountants
What kinds of buyers are LBO private equity firms? How can they sometimes outbid strategic buyers? What is the term called for their strategy?
Financial buyers: therefore don’t bring syngergies
Financial engineering can outbid strategic buyer when they have aggressive assumptions regarding cash flow (based on different capital structure and more effective management decisions)
How are private equity transactions typically funded (in terms of capital structure)
30-40% equity, and 60-70% debt financing
What are the two types of debt used?
Senior debt: provided by banks and secured by assets of omapny
Subordinated debt: Non secured and comes from high yield capital markets
What are the six characteristics of potential target companies for private equity?
1) Motivated and competent management: be able to operate a highly leveraged company, with little margin for error
2) Robust and stable cash flow: to pay interest due on large amounts of debt, and ideally, to also pay down debt over time > greater cash flow > greater debt > smaller equity investment > greater the return potential
3) Leverage able balance sheet: should have efficient debt structure and assets
4) Low capital expenditure: ideal balance for making improvements and saving to pay interest and repayment principles
5) Asset sales and cost cutting: can sell any assets that aren’t used to generate cash flow > create cash to pay down acquisition debt.
6) Quality assets > service based companies are less idea, assets are mostly intangibles which can’t be used to secure debt
Where do private equity firms receive compensation
1) Management fees: paid by limited partners (1-3% of AUM)
2) Carry or carried interests: A portion of the profits generated by the fund - around 20% of the profits - strong for the private equity firm to created value
What are transaction fees?
Fees for IB and consulting services: paid by the company the PE fund invests in
What do partnership agreements do?
Define the expected payments from limited partners to general partners
How do PE fees compare to hedge fund fees?
- About the same as hedge funds
- Difference:
- Hedge funds receive performance fees annually whereas
- Private equity fund GPs only ‘carry interest’ compensation when their investment is monetized (after the 3-7 year holding period)
What are the five principle sources in an LBO transaction?
Debt:
- Senior bank debt: which includes revolving credit facility and term debt
- Junior debt: High yield bonds primarily
Equity
- Preferred stock
- Common stock
What are the typical characteristics of a private equity transaction?
1) third party secured debt and institutional funding
2) high leverage
3) tiered debt structure: subordinated and high yield
4) frequently ‘go private’ takeover of public companies
5) 3-7 year hold with a range of exists (IPO, sale to trade buyer or another PE firm)
6) high rates or return: typically 20% plus IRR
