Session 3-4 Flashcards
What is the goal of a VC fund
Invest in early and development-stage firms
What is the goal of a growth equity fund?
Invest in later-stage, pre-IPO firms, or in private investment in public equity (PIPE) transactions with public firms
What is the goal of a buyout fund
Acquire controlling interests in firms with an eye toward later selling them or taking them public, with a range of strategies
What are the challenges a VC faces when investing in a start-up?
The start-up needs capital to expand operations, they have to reach next development stage with low/negative cashflows, high cash burn rates
What can the VC bring the startup?
They’re a minority investor: keep founders invested, allow for future funding rounds
They specialize in the sector and the early development stages
What is a VC’s investment policy?
High risk/high returns, they usually take on more investments than other PE to diversify and have better firms in their portfolio
What is the IRR of the deal target in a VC?
40 to 80%
What are the 2 advantages of staged financing?
It’s option-like for investors: they can exit in between rounds and only keep good positions
Entrepreneurs can benefit from increasingly higher valuation while giving away less equity
What are the 2 possible outcomes for convertible preferred equity?
Failure/limited success: downside protection for the payoff
Success: convert into ordinary shares
What are the unique elements of VC compared to other PE?
For deal-sourcing: rep is super important, good VCs have plenty of contacts, regular stream of calls, pitch books, etc; gut feeling is critical
Due diligence + valuation: subjective
Hands-on support: VC’s experience in the startup’s industry is critical
Syndicated (club) deals
What are the challenges of Growth Equity?
unlock latent potential, improve profitability, accelerate growth of late-stage targets
What are new investments used for in growth equity?
Funding specific projects
Providing owners with liquidity (ability to exit the firm)
Where can you unlock growth in growth equity?
In expanding economies/sectors, or industries ripe for disruption
What are 2 characteristics of Growth Equity?
Minority investment: control stays with the firm, common shares
Strong working relationship & partnership: define common goals
What are the target firms of Growth Equity?
They have high CAPEX and working capital requirements
Late-SMEs
Late VCs
Corporate spinoff
How do growth equity funds create value?
New initiatives to drive change
professionalizing businesses and governing processes
Rarely employ leverage
Presence of a new committed shareholder sends a message about the value of the target
How do GthEq conduct due diligence & deal sourcing?
Deal sourcing: can take years, strong network (owners don’t necessarily seek to grow
Due diligence & valuation: easier than in buyouts (no leverage, few parties) but still hard: lack of info from monitoring (SME) + lots of competition (VC)
Why do you negotiate a term sheet?
To monitor target firm, preempt conflicts of interest and unfair treatment
What is included in the term sheet?
Operating control
Company culture
Exit Timing
How do GE exit?
They either go for a strategic buyer or an IPO (disagreements between owners & PE firm can complicate things)
What is an LBO?
PE firms acquire controlling stakes in targets, typically with leverage
What does the PE do during an LBO?
Restructuring: professionalize, change capital structure of the firm (higher debt), improve ops
Equity control: take a controlling interest to control the board and do exit planning
Realignment of managerial interests (executive pay)
How do PE’s manage leverage during an LBO?
Target post buyout has 50-75% of debt
Leverage magnifies ROE since they invest less equity to buy target firm
Leverage creates a disciplinary effect on management (reduce FCF problems and distortions)
What are the different types of buyouts other than LBO?
MBO: managers wanna sell the firm
MBI: external managers wanna buy the firm and replace internal
IBO: PE negotiates directly with seller
What are the different types of transactions in buyouts?
P2P (Public to Private)
Exchange firm becomes private (less reporting costs and focus on st performance)
Carve-out: non-critical subdivision becomes a standalone firm after PE buys it
Secondary Buyout
Buy from another PE firm
What are some attractive targets of buyouts?
Family business
Government-owned (privatization)
What are the 2 different types of deal sourcing?
proprietary/in-house: done by the PE itself
intermediated deal flow: thru advisories, investment banks, M&A boutiques
What is the downside of deal sourcing?
Time-consuming & inefficient
What are the 3 different stages of deal sourcing:
preliminary
formal
confirmatory
What does a PE need to do during preliminary dd?
Sign an NDA to get confidential info from the target firm
Read the CIM: first document provided by firm containing historical & projected financials, strategy, key personnel
Attend the management presentation: extra info to CIM
Submit the Preliminary investment memorandum (PIM) to the Investment Committee (IC)
What is included in formal dd?
Deal team drives investment process
dd questionnaire submitted to target to get key info
data room to get and review all statements, docs, contracts
Site visit of target
submit Final Investment Memorandum (FIM) to IC
What are the 4 different types of due diligence?
Comercial
Legal
HR
Financial
Pro and Con of early exit
Pro: lock-in firm’s IRR & raise follow-on funds
Con: negatively affect CCM (measure of PE success) if cash is still left
Pro and Con of late exit
Pro: Maximize money multiples
Con: comes at the expense of LPs (see zombie PEs)
When do you start exit shaping?
As early as possible: seek control of exit shaping as minority investors (registration, drag along, tag along, redemption rights)
Keep closely monitoring performance & exit environment (liquidity, IPO, CAPEX cycles)
What are the different types of exit routes?
Sale to a third party: strategic buyer vs financial buyer
IPO
Benefits and drawbacks of strategic buyers
Benefits
*perceived synergies may lead to higher valuation
*familiarity with industry may reduce DD required, saving time and resources
Drawbacks
*may be complex for sale of minority PE investments
may require regulatory approval and compliance (cartel, anti-trust)possible leakage of sensitive corporate info
*management may not support due to risk of post-deal redundancies
Benefits and drawbacks of financial buyers
Benefits
*lower risk, higher speed of execution
*minimal strategic and governance alignment required with the buyer
*helps bridge unfavorable market conditions for a strategic buyer or IPO
Drawbacks
*lower valuation, hard negotiations
*extensive due diligence required
Benefits and Drawbacks of IPO
Benefits
*highest returns historically, allows further appreciation on retained equity
*management support due to dispersed ownership, independence
*high-profile deals help PE firm reputation, follow-on fundraising
*IPO announcement can prompt bids from strategic and financial buyers
Drawbacks
failure at any stage has serious reputational consequencesIPO underpricing , fixed costs 5-15% of capital raised, listing time and effort
*IPO market is notoriously cyclical, subject to market and macro shocks
*selecting the right exchange / geography can be complex
