Private Equity Overview

October 20, 2015

2

Background

Justin Shuman

Drexel Class of 2007

E-mail: Justin.Shuman@gmail.com

Education

• $20 B pension fund

• $5 B private equity allocation

• Invested in $750 MM+ of LBO, VC, RE funds, as well as co-investments and secondary interests

• Boutique M&A investment bank

• Predominantly sell-side advisory

• Executed 5 live transactions; 3 sell-side and 2 buy-side, worth $1 B +

• Fund-less private equity sponsor

• Focused on transitional investing in micro-cap companies

• Sourced 3 investments; worth $75 MM +

• Healthcare IT company

• Focused on reducing laboratory costs for insurance companies

• Responsible for managing sales pipeline from introduction to contract

Professional Experience

Drexel University Cornell University

Invested in private equity funds

Sold companies for private equity funds

Sourced investment opportunities and

invested

Build a company for a private equity fund

DuPont Capital Management

Analyst

Harris Williams & Co.

Associate

Woodlawn Partners

Senior Associate

Avalon Healthcare Solutions

Director

2002 – 2007B.S., Business Administration

Concentration: Finance

2009 – 2011M.B.A.

Concentration: Investment Banking

2007 2011 2013 2014

3

Execute Summary

Private Equity & Market Overview

Fund Structure and Economics

Investment Process

Recommended Reading

4

Private Equity

Venture Capital

Leverage Buyout

Mezzanine

Distressed Debt

Real Estate

• Investors acquire an entire company or other asset using significant amounts of debt and equity

• Investors use substantial leverage make acquisitions to optimize the amount of equity capital necessary, thereby increasing potential returns and also increasing overall investment risk

• Investors provide capital to a start-up in exchange for equity, convertible debt, or some other security to fund company development and growth

• Investors with a tolerance for high-risk participate in this asset class because start-ups generally do not have access to capital markets

• Investors acquire a hybrid of debt and equity securities, with little or no collateral provided by the borrower to secure the investment

• Investments are aggressively priced to provide 20 – 30% IRR returns to the investor

• Investors purchase debt securities that are trading at a distressed level, in anticipation that those securities will have a higher market valuation and generate profit at a future selling point

• Investors often time purchase debt securities in an attempt to take control, through bankruptcy proceedings

• Investors purchase both debt and equity investments in property

• Investments typically involve an active management strategy ranging from moderate repositioning or releasing properties to be extensively developed or redeveloped

5

Market Overview

North America$290 B

Source: Prequin Global Private Equity and Venture Capital Report

Portfolio Unrealized Value and Dry Powder, 2004 – 2014

Capital Raised by Private Equity Funds in 2014

273 VC Funds LBOs

Raised $177 B

11% CAGR

Top Challenges Facing LP Investors in 2015

Significant capital raised Substantial economic representation

Fees are investors’ big concernGrowing portfolios and dry-powder

39%

24%

21%

21%

18%

16%

0% 10% 20% 30% 40% 50%

Fees

Economic Environment

Regulation

Performance

Transparency

Investment Opportunities

554 675 898 1,2651,204

1,4131,7832,0292,332

2,5462,644

404559

796

999 1,0661,057

9541,002

9401,0741,144

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

17% CAGR

($ Millions)

• U.S. Private Equity (“PE”) Firms: 3,883

• PE Owned Companies: 12,992

• Employees of PE Owned Companies: 11.3 million

Market Statistics

6

Execute Summary

Private Equity & Market Overview

Fund Structure and Economics

Investment Process

Recommended Reading

7

Investments

Private Equity Structure

General Partner(“GP”)

Investor #2Limited Partner

(“LP”)

Investor #1Limited Partner

(“LP”)

Private Equity Fund

• Pension Funds

• Endowments

• Foundations

• Bank Holding Companies

• High-Net-Worth Individuals

• Insurance Companies

• Family Offices

• Corporations

Venture Capital

Leverage Buyout

MezzanineDistressed

DebtReal

Estate

Company Start-upSenior Debt

Mezzanine Debt

Real Estate

Capital Commitment $

Investment $

Carried Interest $

Portfolio Fees $

1

2

3

4

Source: Private Equity Fund Formation; Scott W. Naidech, Chadbourne & Parke LLP

8

Fund Terms & Economics

Term Definition Market

Fund Life Private equity funds have long lives. The term of a fund begins following the first fund closing.

10 – 12 years

Investment Period Capital contributions are funded on an as-needed basis to make investments. New investments are sourced for the fund during an investment period and investments are made on a deal-by-deal basis.

4 – 6 years

Management Fee Investment Period % of committed capital 2%

Harvest Period % of invested capital 1%

Carried Interest % of profits, normally after a preferred return

20%

Preferred Return1 Guaranteed return to LPs, before carried interest

8%

(1) Venture capital funds typically do not guarantee investors a preferred return

Source: Private Equity Fund Formation; Scott W. Naidech, Chadbourne & Parke LLP

9

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

Committed Capital 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$

Invested Capital (20,000)$ (20,000)$ (20,000)$ (20,000)$ (20,000)$

Realized Capital (Cost Basis) 20,000$ 20,000$ 20,000$ 20,000$ 20,000$

Cumulative Invested Capital (20,000)$ (40,000)$ (60,000)$ (80,000)$ (100,000)$ (80,000)$ (60,000)$ (40,000)$ (20,000)$ -$

Management Fee 2,000$ 2,000$ 2,000$ 2,000$ 2,000$ 800$ 600$ 400$ 200$ -$

Year 1 Realization 60,000$

Year 1 Pref Return (21,600)$ (23,328)$ (25,194)$ (27,210)$ (29,387)$

Year 1 Net Profit (Less Pref Return) 30,613$

Year 1 Carried Interest 6,123$

Year 1 Invested Capital (20,000)$

Year 1 Total Return 60,000$

Year 1 Total Profit 40,000$

LP Preferred Return 9,387$

LP Profit Share 24,491$

GP Profit Share 6,123$

Fund Economics ExampleAssumptions

• 20% carried interest• $20MM invested each year• 5 year hold, before realization• 3.0x return on invested capital

Investment compounding at 8% annually

20% of profits, after preferred return

2% of committed capital 1% of cumulative invested capital

• $100MM committed to private equity fund• 2% management fee during investment period• 1% management fee in harvest period• 8% preferred return

Carried interest dilutes LP ROIC from 3.0x to 2.7x or

IRR from 25% to 22%

10

Execute Summary

Private Equity & Market Overview

Fund Structure and Economics

Investment Process

Recommended Reading

11

Investment Process

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

1 – 2 Weeks 4 – 6 Weeks 4 – 6 Weeks 4 – 6 Weeks 4 – 6 Weeks

• Personal network

• Lawyers

• Accountants

• Industry Associations

• Conferences

• Brokers

• Investment Banks

• Create financial projections and returns model

• Propose valuation and transaction structure to seller

• Execute binding Letter of Intent (“LOI”)

• Evaluate competitive landscape

• Valid financial statements

• Confirm growth plan

• Assess management

• Seek to uncover all business and legal risks

• Negotiate purchase price and related terms, including roll-over equity, earn-out, and seller note, if applicable

• Employment contracts for key management

• Create Private Placement Memorandum (“PPM”)

• Approach debt and equity investors to fund transaction

An investment can take 4 months to 6 months to identify and close

12

Required Skills by Phase

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Broad business skill-set required to execute investment from beginning to end

Interpersonal

Writing / Contracting

Financial Statement Analysis

Valuation

Business Acumen

Marketing

Strategy

13

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

• Business Owners

• Personal network

• Industry Associations

• Conferences

More Proprietary

LessProprietary

• Lawyers

• Accountants

• Investment Banks

Prospecting Methods

• Brokers

Networking ReferralsCold CallingE-mail Campaigns

Prospecting Sources

• Brokers list• Databases (e.g. LexusNexus,

Dun & Bradstreet, etc.)

• LinkedIn• Industry Association Lists

• LinkedIn• Industry Association Lists

Finding quality investments requires resourcefulness and hustle

14

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Indication of Interest (“IOI”)

No Exclusivity

Negotiations

Letter of Intent (“LOI”)

Exclusivity

• Valuation

• Management roll-over equity

• Transaction Structure

• Valuation

• Management roll-over equity

• Transaction Structure

PrincipalAgreement

BindingAgreement

Valuation and transaction structure are key to gaining exclusivity

15

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

(1) Total debt less cash(2) Discount applied to equity value to adjust for size difference between transaction set and target(3) Premium that investors are willing to pay for the equity of a public company, in order to have a controlling interest

Public Comparable Valuation Analysis

Equity Market Valuation Multiple

Company Value Enterprise Value Sales EBITDA EBITDA $10,000

Company Z $15,000.0 $15,310.0 0.9x 5.9x Multiple 6.0x

Company Y $12,300.0 $12,500.0 1.9x 3.4x

Company X $14,500.0 $16,200.0 2.3x 7.3x Implied Enterprise Value $60,000

Company W $21,000.0 $18,400.0 1.7x 6.0x

Company V $32,000.0 $35,900.0 4.7x 9.3x Less: Net Debt1 $20,000

Low of Entire Group $12,500.0 0.9x 3.4x Equity Value $40,000

Median of Entire Group $16,200.0 1.9x 6.0x Size Discount210%

Control Premium320%

High of Entire Group $35,900.0 4.7x 9.3x Adjusted Enterprise Value $63,200

• Identify public companies as similar to the target as possible, with respect to service or product offering, customer base, geography, and other factors

• Identify closed transactions, as recent as possible; typically 18-24 months is reasonable

• Companies that are as similar to the target as possible, with respect to service or product offering, customer base, geography and other characteristics

Comparable Transaction Valuation Analysis

Valuation Multiple

Target Acquirer Enterprise Value Sales EBITDA EBITDA $10,000

Company A Company 1 $640.0 1.7x 11.7x Multiple 9.8x

Company B Company 2 $1,190.0 1.4x 9.8x

Company C Company 3 $315.0 1.7x 8.9x Implied Enterprise Value $98,000

Company D Company 4 $155.0 0.4x 4.3x

Company E Company 5 $3,010.0 0.8x 17.2x Less: Net Debt1 $20,000

Low of Entire Group $155.0 0.4x 4.3x Equity Value $78,000

Median of Entire Group $640.0 1.4x 9.8x Size Discount210%

High of Entire Group $3,010.0 1.7x 17.2x Adjusted Enterprise Value $90,200

16

Discounted Cash Flow Analysis

Net Present Value Calculation Enterprise Value Sensitivity

($ in 000s) ($ in 000s)

Dec-15 hoh5

NPV of Free Cash Flow $49,999 EBITDA Exit Multiples in Year 5

NPV of Terminal Value 154,612 7.0x 7.5x 8.0x 8.5x 9.0x

NPV of Tax Shields 0 14.0% $192,604 $202,698 $212,793 $222,887 $232,982

Enterprise Value $204,611 14.5% 188,898 198,774 208,650 218,526 228,402

15.0% 185,284 194,947 204,611 214,274 223,937

Plus: Cash & Equivalents 12,162 15.5% 181,759 191,215 200,671 210,127 219,583

Less: Total Debt (32,162) 16.0% 178,321 187,575 196,829 206,083 215,337

Equity Value $184,611

Assumptions:

EBITDA Multiple 8.0x

Base Discount Rate 15.0%

Tax Rate 40.0%

WA

CC

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Leveraged Buyout Analysis

Enterprise Value: Returns Sensitivity Enterprise Value: Leverage Sensitivity

($ in 000s) ($ in 000s)

EBITDA Exit Multiple EBITDA Exit Multiple

7.0x 7.5x 8.0x 8.5x 9.0x 7.0x 7.5x 8.0x 8.5x 9.0x

21.0% $190,138 $197,631 $205,125 $212,618 $220,112 4.00x $177,941 $184,319 $190,697 $197,076 $203,454

22.0% 187,281 194,472 201,663 208,855 216,046 4.25x 181,776 188,154 194,533 200,911 207,290

23.0% 184,561 191,464 198,368 205,272 212,176 4.50x 185,611 191,990 198,368 204,747 211,125

24.0% 181,970 188,600 195,230 201,859 208,489 4.75x 189,447 195,825 202,203 208,582 214,960

25.0% 179,502 185,871 192,239 198,608 204,977 5.00x 193,282 199,660 206,039 212,417 218,796Tota

l Le

vera

ge

Equ

ity

IRR

• Ensure reasonableness of sales growth, profit margin, capex investment, tax, and exit multiple assumptions

• Terminal value can significantly impact and potentially skew valuation

• Determine key leverage levels and capital structure (senior and subordinated debt, mezzanine financing, etc.) that result in realistic financial coverage and credit statistics.

• Solve for the price that can be paid to achieve an investor’s required IRR target

17

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Enterprise Value

$166 $173 $180 $187 $194 $201 $208 $215 $222 $229 $235 $242 $249

Comparable Public Companies

Comparable Transactions

Discounted Cash Flow Analysis

Leveraged Buyout Analysis

6.00x 6.25x 6.50x 6.75x 7.00x 7.25x 7.50x 7.75x 8.00x 8.25x 8.50x 8.75x 9.00x

Enterprise Value as a Multiple of 2013P Adjusted EBITDA

$211-$239

$190-$218

$218-$245

$203-$231

Overlap of analyses creates a reasonable valuation range for negotiation

18

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Accounting

• Accounting controls

• Validate historical financials

Market

• Evaluate market size and projected growth

• Assess competition

Business

• Review product/service offering

• Understand customers, profitability, and overall business drivers

Legal

• Search to identify legal liabilities, which could impact transaction

Due diligence is conducted to discover risks, prior to investment

19

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Purchase agreement codifies valuation, structure, and risk mitigation controls

Valuation

• Purchase Price

• Working Capital Estimate

Structure

• Debt

• Equity

• Earn-out

• Seller-financing

Risk Mitigation

• Tax Liability Contingencies

• Environmental Liability Contingencies

• Escrow

Other

• Management Employment Agreement

• Non-Compete Agreement

20

Source LeadUnderwrite

and Gain Exclusivity

Due DiligenceNegotiate Purchase

Agreement

Raise Capital and Fund

Investor CreateConfidential Information

Memorandum (“CIM”)

DistributeCIM to

potential investors

RequestTerm Sheets

Negotiate Final Terms

Execute Subscription Agreements

Fund Capital

• PE Fund

• Fund-less Sponsor

• Bank• Mezzanine

Fund

Equ

ity

Deb

t

Dedicated PE Fund Does Not Require This Process

21

Execute Summary

Private Equity & Market Overview

Fund Structure and Economics

Investment Process

Recommended Reading

22

Recommended Reading

• Books

o “Applied Mergers & Acquisitions” – Robert F. Bruner

o “Investment Banking: Valuation, Leverage Buyouts, and Mergers & Acquisitions” – Joshua Rosenbaum and Joshua Pearl

• Websites

o www.prequin.com

o www.pehub.com

o www.pitchbook.com

o www.thedeal.com

o www.dealbook.com

o www.altassets.com

o www.bloggingbuyouts.com