Private Equity Overview
IntroductionBackground – Josh Ciampa
• •BU SMG and CAS 2005• •General Electric ( 5 years)
o •Financial Management Program (2), Leveraged Finance (3)• •First Atlantic Capital – Associate
o •NY based middle market private equity firm (Packaging, Consumer, Business Services focus)o •Total funds under management in excess of $700M
Background – Boris Bystrov• BU SMG and CAS 2006• Merrill Lynch / Bank of America
o Risk / Underwriting (3), Corporate Banking (1), Investment Banking (1)• LS Power Equity Advisors – Associate
o NY based private equity fund focused on the energy and power industryo Part of a larger power companyo Total funds under management in excess of $4Bn
Private Equity OverviewWhat is Private Equity?
• •Management of assets for investors seeking alpha via participating in the purchase of stock or assets in private or public companies through a leveraged buyout o •Control investing (own > 50% of equity and control BOD)o •Minority or Co-investing alongside a Control investor or
injecting equity into a business directly o •Secondaries / Fund of Funds investing (buying another
investor’s equity interest at a discount)• •Investment fund is raised with Limited Partners committing
capital to the fundo •Money is not sent to the fund until “called” when an equity
check is ready to be written for an investment• •10 year fund lifecycle – 5 years to invest, 5 years to harvest
o •Illiquid investments with long time horizon• •Fund charges 2% management fee on assets under
management (AUM) and keeps a carried interest “carry” of 20% of the returns above a certain thresholdo •Must hit a fund hurdle rate or subject to a “claw back”
provision where investors are reimbursed
Flow of Funds
PE Funds
LPs (Limited Partners)* Endowments, Pension Funds, Fund of
Funds
PE Firms / GPs (General Partners)*Manage Multiple Funds
Portfolio Companies
Exits (IPO or M&A)
Types of Private Equity Firms“Mega funds”: Multi-billion dollar funds that invest across all industries
• •Invests in mature companies with strong cash flows via leveraged buyouts• •Examples: Blackstone, KKR, Carlyle, TPG, etc.
Middle-market: $500mm to $5bn funds that invest within specific sector or across all industries• •Typically invests in small to mid-cap companies via equity commitments ranging from $25mm to
$100mm• •Examples: Advent International, Golden Gate, Avista Capital, HIG Capital, etc.
Growth equity: funds that invest in earlier-stage companies• •Typically invests in smaller targets via platform or “build-and-buy” investing• •Examples: General Atlantic, TA Associates, Summit Partners, etc.
Sector-specific: funds that invest in one or two industries• •Typically middle-market / growth equity or distressed• •Examples: Silver Lake (tech), Lone Star (financials / real estate), Cressey & Co. (Healthcare), Energy
Capital Partners (Power)Financial Institutions: private equity subsidiaries that invest across all industries
• •Typically invest in mid-stage to mature companies with commitments ranging from $25mm to $1bn with more of a net income focus than other shops
• •Examples: GE Capital, Goldman Sachs, Barclays, etc.
Private Equity Landscape
Stage of Company / Strategy
“Equity
check” size
Mature / LBOEarly-stage / Growth
“Mega-funds”
Middle-market
Growth equity
Financial institution-backed
Private Equity Market Overview
• •2007 was peak of PE related activity• •1st half of 2011 activity impacted by volatile credit markets• •Lots of activity expected in 2nd half of 2011 and 2012
• Private Equity is the asset class that purchases an equity stake in a company that is not publicly traded on a stock exchange
• The PE landscape can be broken down by the varying strategies based on the ownership/control, mix of debt & equity, stage of company, risk/reward, etc.
Stages of Investment
VentureCapital Mid-MarketPrivate Equity LeveragedBuyoutAngelInvesting GrowthCapital Distressed
Stage of Company / ControlStartup Mature
Lines are blurring as VCs are investing in earlier and later-stage companies
Venture Capital is Early and Exciting
Venture Capital Investment
$ Billions
*Source: National Venture Capital Association Yearbook 2010. Includes statistics from the PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report based on data from Thomson Reuters.
• Early-Stageo Seed: Deployment of a relatively small amount of capital for the entrepreneur / company to prove out a concept
before qualifying for Start-up financing Product Development, Market Research, Build Management Team, Develop a Business Plan
o Start-up: Complete development of product & initial marketing efforts. o Technology / product / market risk
• Growth-Stageo Capital for initial expansion – sales & marketing, continued technology development, hiring, and working capitalo Risk migrates from technology / product risk to execution / market risk
• Later-Stageo After companies have proven their ability to execute at a limited scale they will look to raise a larger round of
capital to scale the business while continuing to fund sales & marketingo Ultimately this stage of financing should enable the company to position themselves for an exit
Stages of Companies
Value CreationThe Big 4 Drivers
• •Organic EBITDA growth• •Acquisitions• •Multiple Expansion• •Cost Cutting / Deleveraging
Strategies• •Platform Investment
o •Acquiring a solid distributor of fire protection equipment and adding SKUs / moving into adjacent markets / products
• •Industry Roll-up or consolidation strategyo •Acquiring a security guard company for 6.0x EBITDA and acquiring
mom and pop security firms for 3.0-4.0x EBITDA, consolidating a fragmented industry
• •Regional to national expansiono •CompUSA: private company with 2 locations, PE investors took it
national with 100 locations and > $1BN revenue • •Capex harvesting
o •Satellite companies purchased post 5 yr capex investment cycle• •Capacity utilization expansion
o •Helicopter transportation company purchased for a low multiple when capacity utilization is at 40%
Managing the Inflection Points (step functional growth)• •Upgrade management, sales• •Manufacturing – single plant to multiple locations
o •Moving US manufacturing to China• •Rethink distribution, warehousing strategy• •Brand expansion, marketing• •Single product to diverse offering
Comments on Lifecycles• •Venture capital investing at Introduction phase• •Growth phase receives private equity investment
(growth equity) o •Revenue ramp, addition of customers, need
for professional management, logistics, distribution
o •Mezzanine facility• •Maturity phase supports leveraged buyout well –
o •Low capexo •High free cash flow / Stable
Private Equity ConceptsEBITDA
• •Earnings before interest, taxes, depreciation & amortization
• •Allows for comparability across industries (asset heavy vs. light)
• •Disregards financing decisions and tax benefits• •Excludes non-cash charges against income (D&A)
Enterprise Value or Firm Value (EV)• •Value of Debt + Equity less Cash on balance sheet• •Represents Takeover Value of Company• •EV of a public company – see chart at right• •EV of a private company = EBITDA x Exit Multiple
Valuation in Practice• •Enterprise Value / EBITDA multiple or EV/EBITDA• •Quote value of a company as a multiple of LTM or TTM
EBITDACapital Structure Comments
• •Equity is the residual claim on Assets • •Liabilities have security interest on assets • •Seniority of Capital Structure• •Cost of Capital relates to relative risk of tranche• •Investors demand more return for more risk
o •Cost of Capital for tranches o •Secured vs. Unsecured
Valuation
Visual Summary
Private Equity LBO Example
Considerations• Equity Value increased 2.4x
while TEV increased 1.5x (beauty of leverage)
• EBITDA increased 50% but our return was > 100%
• Free Cash flow paid down debt to accelerate increase in equity value: TEV increased $120M while Equity Value increased $145M
• Returns would have been higher if exit multiple was higher than entry
Private Equity Time Allocation
30%
15%
25%
10%
15%
Research / Prospecting / Sourcing
Pre Term Sheet Diligence
Post Term Sheet Diligence
Portfolio Company Support
Internal Projects / Reporting
• Researching industry trends & opportunities; building domain expertise• Prospecting: Identifying companies of interest to proactively contact• Sourcing
o Reaching out to companies proactively or tapping the network to make first contact with CEOs/Companies
o Networking with other investors, bankers, CEOs
• Process to determine if the firm should bid (and at what price) on a company/deal: o Relationship building, diligence, deal structuring & returns analysis, firm buy-in, term
sheet construction, negotiations• Summary Diligence: Management, Market, Company / Product, Technology, Barriers to Entry,
Financials
• The company has selected our firm and we enter into a period of exclusivity where the firm spends a significant amount of time conducting diligence on every aspect of the business before completing the transactiono Full model; transaction memo; legal documents; continued negotiations
• Attend board meetings• Support companies with strategy, hiring, future financing, and exits• Ad hoc projects
• Fundraising• Reporting on company, deal, and fund performance• Ad hoc projects
Private Equity Deal Process and ResponsibilitiesNew Deal Evaluation
• •Originationo •Investment Bank auctionso •Proprietary relationships with PE Funds, Companies
• •1st Round Deal Evaluationo •Receive CIM (Confidential Info Memo) from a banko •Evaluate investment opportunity o •LBO Model o •Bid
• •Management Meetingso •Evaluate quality of management o •Plant / facility tourso •Data room accesso •2nd Round Bids
Portfolio Management• •Strategy sessions
o •Organic Growtho •Acquisitions
• •Help management build budgeto •Market sizing analysiso •Market growth analysiso •Customer analysis
• •Attend Board of Director meetingso •Set short term and long term goals for companyo •Discuss long term exit strategy for company
• •2nd Round / Formal Diligence o •Data Room accesso •Investment thesiso •Access to management for questionso •Refine investment case – build full operating modelo •Quality of Earnings, Environmental, Legal, Insurance
review, Third party industry studyo •Review of major contracts, financials, audits, othero •Financing Sourceso •Negotiate purchase agreemento •Negotiate lender credit agreements
• •Weekly sales reviews with CFO or CEO• •Monthly analysis of financials• •Assist with C-level hiring
o •Interview candidates• •Acquisitions
o •Meet with CEO and management of potential targetso •Research targets and make offerso •Engage bankers for strategic alternativeso •Build M&A models for tuck acquisitions
Career in private equity
What do private equity firms look for?• •Most firms typically require background experience in investment banking and less
frequently consulting for pre-MBAs• •Strong analytical / modeling skills (excel modeling test)• •Excellent communication skills
PE associate program overview• •Typically two-year commitment for pre-MBAs• •Some firms (mostly middle market) offer ability to stay without MBA or return post-MBA• •Ability to co-invest available at certain firms
Life after private equity• •Top-tier business school• •Lateral to other PE shops, hedge funds, etc.
• Supply of money on sidelines driving purchase multiples
• Financing markets remain conservative• Very difficult to be a value investor in this market• Shrinking number of funds, consolidation• Operational value vs financial engineering
Market
• AC346, AC347 (Intermediate Accounting)• AC414 Financial Statement Analysis• Finance, economics• Have a tangible skill set• Differentiate yourself • Take upper level 300 and 500 liberal arts classes• Directed Study• Excel modeling
Recommended Classes at BU
• PE values transaction and business experienceo 2-5 yrs experience is the sweet spot for entryo Larger funds - MBA, smaller funds more flexibleo Highest recruits from banking; Also consulting,
corporate training programs, and industry• Life after PE
o BD, Consulting, Start-upo Move funds (large cap, middle market, VC,
value, public equities, fixed income, high yield, mezz)
Career in PE
• FT, WSJ, Barron’s, Economist, IBD, Seeking Alpha, Wired
• One up on Wall Street, Beating the Street (Peter Lynch)
• The Shareholder Letters of Marty Whitman, Warren Buffet
• Barbarians at the Gate, Against the Gods
Suggested Reading
Closing Thoughts