Fundamentals of Private Equity and Venture Capital - PEI Media
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Fundamentals of Private Equity and Venture Capital - PEI Media
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THE FUNDAMENTALS OF<br />
PRIVATE EQUITY AND<br />
VENTURE CAPITAL<br />
Author <strong>and</strong> lead edited by Garry Sharp with<br />
Kelly DePonte <strong>and</strong> David Huckfield<br />
A PRIVATE EQUITY INTERNATIONAL PUBLICATION
Module 1:<br />
What is private equity<br />
<strong>and</strong> venture capital?<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY
Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
The evolution <strong>of</strong> venture capital <strong>and</strong> private equity 5<br />
Introduction 5<br />
Evolution <strong>of</strong> the US market 5<br />
Europe 6<br />
Asia 7<br />
The 1990s 8<br />
The dot com bubble 8<br />
<strong>Private</strong> equity today 8<br />
Types <strong>of</strong> private equity 9<br />
The private equity cycle – connecting institutional<br />
investors <strong>and</strong> entrepreneurs 10<br />
The limited partnership 11<br />
Fund manager remuneration 12<br />
Alternatives to pooled funds <strong>and</strong> limited partnerships 12<br />
Single investor funds 12<br />
Fund <strong>of</strong> funds 13<br />
Gatekeepers 13<br />
Secondary funds 13<br />
Why invest in private equity? 13<br />
The modern private equity firm – the shape <strong>of</strong> a GP 13<br />
Type 13<br />
Investment focus 14<br />
Investment style 14<br />
Case study 1: Get big or die; two very different venture capital tales 15<br />
Case Study 2: The management buyout 17<br />
Case study 3: Investor forces an exit 18<br />
Summary 19<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 1 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
introduces the core principles <strong>of</strong> private equity <strong>and</strong> venture capital, examines<br />
how they evolved <strong>and</strong> provides a broad introduction to today’s markets. It is<br />
designed to work both as a st<strong>and</strong> alone section <strong>and</strong> as part <strong>of</strong> the whole series.<br />
For the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has been<br />
incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in bold,<br />
to indicate that there is a glossary entry for them.<br />
<strong>Private</strong> equity – the provision <strong>of</strong> risk <strong>and</strong> reward sharing (equity) capital to a company<br />
whose shares are not freely traded on a recognised stock exchange (private).<br />
The evolution <strong>of</strong> venture capital<br />
<strong>and</strong> private equity<br />
Introduction<br />
In 1957, American Research <strong>and</strong> Development<br />
(ARD) – the world’s first ever investment<br />
fund to specialise in backing start-up companies –<br />
invested $70,000 for a 77 percent equity stake in a<br />
new company created by four students with no<br />
business experience. The company was called<br />
Digital Equipment Corporation, <strong>and</strong> 14 years later<br />
the investment’s value had grown to $355 million.<br />
Spectacular successes like this – similar stories<br />
include Apple, Intel, Sun Microsystems, Federal<br />
Express <strong>and</strong> even (in a smaller way) Trivial Pursuit<br />
– brought attention to the returns available from a<br />
new way <strong>of</strong> investing. This, for obvious reasons,<br />
acquired the tag “venture capital”.<br />
The concept <strong>of</strong> providing financial backing to<br />
entrepreneurs, sharing risks <strong>and</strong> rewards in a<br />
privately negotiated transaction, has been<br />
around since time immemorial (Queen Isobel’s<br />
backing <strong>of</strong> Christopher Columbus in the late<br />
15th Century is regularly cited as one <strong>of</strong> the first<br />
examples). More recently, the 1920s <strong>and</strong> 1930s<br />
saw companies such as Xerox <strong>and</strong> Eastern<br />
Airlines founded with private backing from<br />
wealthy family trusts. But it was the pioneer<br />
investors in the US during the 1950s, 1960s <strong>and</strong><br />
1970s who gave birth to today’s private equity<br />
industry, albeit an industry that after three<br />
decades <strong>of</strong> accelerated evolution bears little<br />
resemblance to its forebears.<br />
However the spectacular growth <strong>of</strong> private equity,<br />
from obscure specialism to economic prominence,<br />
has been far from smooth or painless. On<br />
the basis that those who fail to learn from history<br />
are condemned to repeat it – <strong>and</strong> there are parts<br />
<strong>of</strong> this story it would be better not to repeat – a<br />
brief summary <strong>of</strong> the high <strong>and</strong> low lights will<br />
bring perspective to all that follows.<br />
Evolution <strong>of</strong> the US market<br />
The early US venture capitalists were not investment<br />
managers in the conventional sense; rather<br />
they were for the most part successful entrepreneurs<br />
<strong>and</strong> corporate managers with extensive<br />
experience in building businesses. The funds<br />
they invested were to a large extent their own<br />
money. (ARD for example had, with great difficulty,<br />
raised only $1.8 million, out <strong>of</strong> a total <strong>of</strong> $5<br />
million in its first fund, from institutional<br />
investors in 1946; the balance came from the<br />
fund’s managers, individual investors <strong>and</strong> family<br />
trusts.) Their approach to investing was very<br />
proactive, becoming closely involved in the day<br />
to day running <strong>of</strong> the companies they backed, so<br />
that their expertise added at least as much value<br />
as their money.<br />
During the 1970s this began, slowly at first, to<br />
change as pension fund <strong>and</strong> insurance company<br />
fund managers noted the returns some <strong>of</strong> the<br />
venture capitalists were achieving. These institutional<br />
investors experimented cautiously with<br />
the new asset class; typically only $50 million or<br />
less was raised from these sources each year during<br />
the decade (less than 30 percent <strong>of</strong> the total,<br />
most <strong>of</strong> which came from individuals <strong>and</strong> family<br />
trusts). But suddenly <strong>and</strong> dramatically a tipping<br />
point was reached in 1980, when commitments<br />
to venture capital, during that year alone, shot up<br />
to around $1 billion, reaching nearly $2 billion in<br />
1982 <strong>and</strong> over $4 billion in 1983. 1<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
after deciding to become part <strong>of</strong> a start-up, <strong>and</strong> was introduced through mutual friends. But it<br />
soon became apparent that the company would need a heavyweight, experienced CEO with credibility<br />
on Wall Street.<br />
The first attempts to recruit a CEO highlighted a serious issue – eBay had no VC backing. The fact<br />
that with monthly pr<strong>of</strong>its <strong>of</strong> some $200,000 by early 1997 it did not need external funds was irrelevant;<br />
in Silicon Valley (eBay was based in San Jose, California) it was regarded as an essential<br />
seal <strong>of</strong> approval for a company to have raised venture capital, to have been vetted <strong>and</strong> appraised<br />
<strong>and</strong> to have passed the test. Without this, eBay couldn’t even get an executive search firm to work<br />
for them.<br />
The rule <strong>of</strong> thumb for a venture capital firm appraising an early stage investment was that there<br />
had to be a clear route to making 10 times the original investment within three years. Benchmark<br />
Partners, a venture capital manager itself only two years old, saw this potential in eBay <strong>and</strong> in July<br />
1997 invested $6.7 million for a 25 percent equity stake on terms which valued the company at<br />
$20 million before its investment (the pre-money valuation – see Module 4). eBay never spent<br />
these funds – the money was left untouched in the bank – but capitalised on the contacts, credibility<br />
<strong>and</strong> experience <strong>of</strong> Benchmark’s partners. It was Benchmark who recommended a search<br />
firm to find a CEO, who instructed that firm to pursue a c<strong>and</strong>idate who had declined their first<br />
approach, <strong>and</strong> ultimately played a key role in persuading that c<strong>and</strong>idate – Meg Whitman – that<br />
she should leave her high pr<strong>of</strong>ile, secure role at a major corporation, move her family to California<br />
<strong>and</strong> join a tiny internet start-up.<br />
In September 1998 eBay went public, achieving a listing at a market valuation <strong>of</strong> $2 billion; this<br />
had grown to $21 billion by the spring <strong>of</strong> 1999, producing a return for Benchmark on its $6.7 million<br />
investment <strong>of</strong> 100,000 percent in less than two years (albeit based on highly distorted valuations,<br />
but nevertheless a spectacular return).<br />
Whilst eBay was preparing for its stock market float in 1998, the boo.com team was trying, with<br />
increasing desperation, to find some backers amongst the US venture capital community. A frustrating<br />
round <strong>of</strong> visits to Wall Street, Boston <strong>and</strong> California produced a series <strong>of</strong> rejections <strong>and</strong> a<br />
decision to increase their first round fundraising target from $2 million to $15 million, <strong>and</strong> to<br />
appoint an investment bank. Here was a crucial difference with eBay, who had quickly built a close<br />
relationship with Benchmark, their single investor; from the beginning boo.com was going to raise<br />
funds from a syndicate <strong>of</strong> investors, <strong>and</strong> an investment bank would play a large role both in the<br />
fundraising <strong>and</strong> the subsequent investor relations. This was to have enormous consequences.<br />
The boo.com team’s approach to JP Morgan coincided with a decision by the London <strong>of</strong>fice <strong>of</strong> that<br />
venerable, “old money” institution to explore the internet world, <strong>and</strong> after furious internal debate<br />
they agreed to lead the fundraising. A strength <strong>of</strong> JP Morgan was the ability to introduce, in addition<br />
to mainstream venture capital firms, corporate investors who may be able to add strategic<br />
value. The first round, which closed at $8.8 million in January 1999, included an investment from<br />
Bernard Arnault, the chairman <strong>of</strong> Louis Vuitton Moet Hennessy (LVMH), who assumed the role <strong>of</strong><br />
lead investor.<br />
1999 was characterised by an endless series <strong>of</strong> fundraising – a total <strong>of</strong> $135 million was ultimately<br />
invested – <strong>and</strong> equally endless delays <strong>and</strong> slippages in the launch date for boo.com’s websites.<br />
The team had, in addition to setting itself the phenomenally ambitious task <strong>of</strong> a simultaneous,<br />
multi-country launch, made serious errors in the design <strong>and</strong> development <strong>of</strong> its technology. An<br />
effective single, dominant venture capital investor would have insisted on a simpler strategy,<br />
imposed discipline on the high spending management team (whose excesses in salaries, expenses<br />
<strong>and</strong> over elaborate infrastructure quickly became notorious in London, where they were based)<br />
16 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Module 2:<br />
<strong>Private</strong> equity as an<br />
asset class<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY
Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
Introduction 5<br />
Terminology 5<br />
Returns – <strong>and</strong> risk 5<br />
Analysing risk in quoted markets 6<br />
Risk in private equity 7<br />
Assymetric risk <strong>and</strong> return 7<br />
Using statistics in measuring private equity performance 7<br />
Managing risk 8<br />
<strong>Private</strong> equity performance 10<br />
Measuring returns 10<br />
Comparing private <strong>and</strong> quoted equity returns 11<br />
Reasons for allocating funds to private equity 14<br />
Issues with private equity 16<br />
Resource requirements 16<br />
Illiquidity <strong>and</strong> timescale 16<br />
Unpredictability 16<br />
Lack <strong>of</strong> control 16<br />
Difficulty <strong>of</strong> access 16<br />
Routes to private equity 17<br />
Direct/co-investment 17<br />
<strong>Private</strong> equity funds 17<br />
Fund <strong>of</strong> funds 17<br />
Secondaries 17<br />
Securitised/collateralised products 17<br />
Publicly-traded private equity 17<br />
<strong>Private</strong> equity market drivers 18<br />
Availability <strong>of</strong> investment opportunities 18<br />
Dem<strong>and</strong> for private equity 18<br />
Economic infrastructure for private equity 19<br />
Exit opportunities 19<br />
Summary 19<br />
Appendix 1: Enter the Pantheon 20<br />
Appendix 2: <strong>PEI</strong> 50 – <strong>Private</strong> <strong>Equity</strong> International’s ranking <strong>of</strong> the<br />
world’s largest private equity firms 29<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 2 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on private equity as an asset class. It is designed to work both as a st<strong>and</strong><br />
alone section <strong>and</strong> as part <strong>of</strong> the whole series. It necessarily draws upon topics<br />
reviewed in Module 1, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content. However, for<br />
the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has been incorporated,<br />
which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in bold, to<br />
indicate that there is a glossary entry for them.<br />
Introduction<br />
This module focuses on the private equity industry from the viewpoint <strong>of</strong> the<br />
institutional investors – pension funds, endowment funds, insurance companies<br />
<strong>and</strong> banks – who provide its raw material – capital.<br />
The emphasis here, unlike other modules in this series, is on performance issues<br />
not at the individual investment level but across funds, portfolios <strong>of</strong> funds <strong>and</strong><br />
the private equity industry as a whole. We are concerned with:<br />
• How does private equity behave as an asset class – what are its characteristics<br />
<strong>and</strong> how do they differ from quoted equities?<br />
• Why do institutional investors allocate capital to private equity?<br />
• What are the factors that drive the development <strong>of</strong> private equity markets?<br />
Terminology<br />
It is difficult to avoid confusion in the use <strong>of</strong> generic terms such as management,<br />
investor <strong>and</strong> investment when discussing private equity at the fund level. The private<br />
equity fund is the core part <strong>of</strong> the process. It raises money from investors<br />
(who in turn are themselves managers <strong>of</strong> investment funds), <strong>and</strong> is managed by<br />
a private equity firm, <strong>of</strong>ten referred to as a general partner, but also as a manager<br />
or a management team. It then makes investments (hence becoming an<br />
investor) in private companies which in turn have their own management teams.<br />
We therefore need to be careful in our choice <strong>of</strong> terms for the various participants.<br />
By institutional investors, investors or limited partners, we mean the<br />
pension funds, insurance companies <strong>and</strong> the like who allocate capital to private<br />
equity funds. By private equity firm, fund manager or general partner, we<br />
mean the specialist teams who raise private equity funds <strong>and</strong> are responsible for<br />
making <strong>and</strong> managing investments in individual companies.<br />
Returns – <strong>and</strong> risk<br />
The private equity industry consistently claims to<br />
produce returns to its investors which exceed<br />
those available from investing in conventional,<br />
quoted equities. Before examining these (much<br />
debated) claims in some detail, however, we<br />
must appreciate that simply comparing annual<br />
rates <strong>of</strong> return from the two different asset classes<br />
is <strong>of</strong> limited value. This is because institutional<br />
fund managers do not primarily focus on<br />
absolute levels <strong>of</strong> return; they take into account<br />
the risks associated with making a particular<br />
investment. Risk, in this context, means the probability<br />
<strong>of</strong> failing to achieve a targeted or desired<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
Exhibit 3: Distribution when one fund is chosen at r<strong>and</strong>om 100,000 times<br />
30<br />
25<br />
Probability (%)<br />
20<br />
15<br />
10<br />
5<br />
0<br />
0 0.5 1.0 1.5 2.0 2.5 3.0<br />
Fund <strong>of</strong> funds multiple<br />
Source: <strong>Capital</strong> Dynamics simulation <strong>of</strong> 1,755 US funds as at 31 December 2004.<br />
3.5<br />
4.0<br />
4.5<br />
5.0<br />
Exhibit 4: Distribution when one, three, 10 <strong>and</strong> 30 funds are chosen at r<strong>and</strong>om 100,000 times<br />
Probability (%)<br />
70<br />
60<br />
50<br />
40<br />
30<br />
20<br />
30 funds<br />
10 funds<br />
3 funds<br />
One fund<br />
10<br />
0<br />
0 0.5 1.0 1.5 2.0 2.5 3.0<br />
Fund <strong>of</strong> funds multiple<br />
Source: <strong>Capital</strong> Dynamics simulation <strong>of</strong> 1,755 US funds as at 31 December 2004.<br />
3.5<br />
4.0<br />
4.5<br />
5.0<br />
revert to the classic definition <strong>of</strong> risk as the probability<br />
<strong>of</strong> achieving a less than targeted return.<br />
Stochastic techniques, <strong>of</strong> which the Monte Carlo<br />
simulation is the best known, use repeated, r<strong>and</strong>om<br />
selection <strong>of</strong> variables to produce probability<br />
distributions. Exhibit 3 shows the distribution<br />
when one fund is chosen at r<strong>and</strong>om 100,000<br />
times, <strong>and</strong> as you would expect this is very close to<br />
the distribution in Exhibit 2, with an unacceptable<br />
probability <strong>of</strong> selecting a fund that loses money.<br />
Exhibit 4 demonstrates what happens when three<br />
funds, 10 funds <strong>and</strong> finally 30 funds are selected<br />
at r<strong>and</strong>om. Not only do the mean, median <strong>and</strong><br />
average multiple returns increase, but the probability<br />
<strong>of</strong> losing money across the portfolio decreases<br />
markedly. This may seem counter-intuitive –<br />
the more funds you choose at r<strong>and</strong>om, the greater<br />
the possibility <strong>of</strong> choosing losers. However it<br />
works because <strong>of</strong> the asymmetric risk we identified<br />
earlier – successful funds earn multiples<br />
many times higher than the single multiple which<br />
is the maximum a fund can lose. A larger portfolio<br />
will capture more <strong>of</strong> these successes, which more<br />
than compensate for the losers <strong>and</strong> help bring the<br />
median return closer to the average.<br />
Hence diversification not only reduces risk, it<br />
enhances overall returns.<br />
Avoiding the worst<br />
Returns can be further enhanced, not by the<br />
daunting task <strong>of</strong> selecting the very best fund<br />
managers, but by meeting the far simpler challenge<br />
<strong>of</strong> avoiding the worst. Exhibit 5 shows the<br />
effects <strong>of</strong> removing increasing percentages <strong>of</strong><br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 9
mean that they are highly restricted in terms <strong>of</strong> the<br />
information they can share with their investors.<br />
The problem with governance in this environment<br />
is that it is required to protect a huge array<br />
<strong>of</strong> interests – from shareholders, through<br />
employees to much more broadly defined interests<br />
such as the environment <strong>and</strong> the broader<br />
community – <strong>and</strong> to do so with a universally<br />
applied set <strong>of</strong> rules <strong>and</strong> procedures.<br />
By contrast a private equity backed management<br />
team has a tightly defined shareholder group <strong>and</strong><br />
a governance structure tailored to a specific <strong>and</strong><br />
explicitly agreed set <strong>of</strong> objectives (explored further<br />
in Module 8). The team can share detailed<br />
information with its investors, discuss <strong>and</strong> obtain<br />
specific consent for its strategies <strong>and</strong> plans, <strong>and</strong><br />
essentially operates in an unregulated environment<br />
where shareholders are assumed to be<br />
sophisticated, able to look after their own interests<br />
<strong>and</strong> in need <strong>of</strong> no further protection than that<br />
afforded by the tenets <strong>of</strong> corporate law.<br />
Beyond the regulatory <strong>and</strong> governance issues,<br />
there are broader commercial attractions to the<br />
private equity environment. Foremost among<br />
these is that the pressure to post earnings growth<br />
every quarter is alleviated – replaced, <strong>of</strong> course<br />
by performance pressures <strong>of</strong> a different kind (see<br />
Modules 4 <strong>and</strong> 5) Beyond this, the intense, <strong>of</strong>ten<br />
misinformed public scrutiny which <strong>of</strong>ten follows<br />
every action, announcement <strong>and</strong> report from a<br />
major quoted company is removed (although as<br />
private equity backed companies become ever<br />
larger <strong>and</strong> more economically <strong>and</strong> politically significant,<br />
the press <strong>and</strong> public are showing much<br />
greater interest in their activities). The freedom<br />
to make decisions in private, in direct consultation<br />
with shareholders <strong>and</strong> lenders, with a focus<br />
on medium- to long-term value creation without<br />
worrying about day to day share price performance<br />
has many attractions.<br />
The lure <strong>of</strong> private equity for corporate managers<br />
is further accentuated by the status issue, which<br />
although a very personal <strong>and</strong> human driver is<br />
highly relevant. Growing public cynicism about<br />
corporate behaviour – which comes not just from<br />
a series <strong>of</strong> accounting sc<strong>and</strong>als but from increased<br />
questioning about ethics <strong>and</strong> social responsibility<br />
– means that being a director <strong>of</strong> a major quoted<br />
company no longer has the cachet, the status, that<br />
it awarded in earlier decades.<br />
Finally, <strong>of</strong> course, private equity not only <strong>of</strong>fers<br />
managers the prospect <strong>of</strong> significant financial<br />
gain, but actively incorporates the generation <strong>of</strong><br />
wealth in its fundamental principles. This<br />
approach centres on shared motivation between<br />
shareholder <strong>and</strong> manager <strong>and</strong> represents a clear<br />
solution to the perennial corporate management<br />
challenge – the agency issue.<br />
The agency issue<br />
Managers act as agents for their shareholders,<br />
<strong>and</strong> are required to make decisions in the best<br />
interests <strong>of</strong> those shareholders. But in the quoted<br />
company environment management may <strong>of</strong>ten<br />
have vastly differing motivations from those<br />
shareholders <strong>and</strong>, more importantly, different<br />
means <strong>of</strong> achieving rewards.<br />
Options to purchase shares, short-term performance<br />
related bonuses, golden parachutes, h<strong>and</strong>cuffs<br />
<strong>and</strong> hellos, large salaries, plus access to<br />
corporate jets, properties, entertainment <strong>and</strong><br />
various other perks are all designed to attract<br />
<strong>and</strong> motivate the highest performers to run<br />
major companies. However no matter how carefully<br />
these are designed <strong>and</strong> how extensively<br />
they are debated, there is the constant risk <strong>of</strong> a<br />
structural disconnect between these types <strong>of</strong><br />
remuneration <strong>and</strong> shareholders’ long-term interests,<br />
especially now that the tenures <strong>of</strong> CEOs are<br />
becoming shorter <strong>and</strong> shorter.<br />
A well structured private equity transaction, by<br />
contrast, ensures that management will gain in<br />
t<strong>and</strong>em with its investors. Furthermore, because<br />
cash is ultimately the only measure used to gauge<br />
success, it becomes the focus <strong>and</strong> short-term<br />
methods to manage pr<strong>of</strong>it performance or to<br />
influence a share price, so common in quoted<br />
markets, become irrelevant.<br />
Access to emerging markets<br />
The development <strong>of</strong> stock exchanges, the evolution<br />
<strong>of</strong> governance <strong>and</strong> reporting st<strong>and</strong>ards, <strong>and</strong><br />
the ability to invest in quoted companies tends to<br />
lag behind economic growth in developing<br />
economies. This makes it difficult for investors to<br />
gain exposure to these economies <strong>and</strong> private<br />
equity, with the ability to bypass public<br />
exchanges <strong>of</strong>fers an alternative route.<br />
Informed decision making <strong>and</strong> access to<br />
insider information<br />
By definition, investors in quoted stocks are<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 15
Module 3:<br />
Structuring <strong>and</strong> raising<br />
a fund<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-45-7 978-1-904696-45-2<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
Terminology 5<br />
Fundraising – making the case 5<br />
The GP 6<br />
Investment strategy <strong>and</strong> fund categories 6<br />
Refining the proposal 7<br />
Size <strong>and</strong> type <strong>of</strong> investment 7<br />
Geography 7<br />
Sector focus 7<br />
The management team 7<br />
Investment track record 8<br />
Dealflow generation strategy 8<br />
Use <strong>of</strong> debt/financial structuring 8<br />
Syndication 8<br />
Due diligence processes 9<br />
Added value/aftercare 9<br />
Achieving exits 9<br />
The “perfect” fund proposition 9<br />
The fundraising process 9<br />
Identifying potential investors 9<br />
Pre-marketing 10<br />
Consistency 10<br />
The <strong>of</strong>fering memor<strong>and</strong>um (or private placement memor<strong>and</strong>um) 10<br />
Preparation <strong>of</strong> the investment pitch 11<br />
Preparation <strong>of</strong> supporting information 11<br />
Placement agents 11<br />
Due diligence 12<br />
Track record 12<br />
The management team 13<br />
Terms <strong>and</strong> conditions 14<br />
Key commercial issues 14<br />
<strong>Private</strong> equity fund structuring 17<br />
by Nick Benson, <strong>Private</strong> Funds Group, Clifford Chance, February 2007<br />
Introduction 17<br />
Basic structuring considerations 17<br />
Specific investor requirements 18<br />
Multiple vehicle structures 19<br />
Types <strong>of</strong> fund vehicle 19<br />
Limited partnerships 20<br />
Conclusion 21<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 3 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on structuring <strong>and</strong> raising a fund. It is designed to work both as a st<strong>and</strong><br />
alone section <strong>and</strong> as part <strong>of</strong> the whole series. It necessarily draws upon topics<br />
reviewed in earlier modules, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content.<br />
However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has<br />
been incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in<br />
bold, to indicate that there is a glossary entry for them.<br />
Terminology<br />
It is difficult to avoid confusion in the use <strong>of</strong> generic terms such as management,<br />
investor <strong>and</strong> investment when discussing private equity at the fundraising level.<br />
The private equity fund is the core part <strong>of</strong> the process. It raises money from<br />
investors (who in turn are themselves managers <strong>of</strong> investment funds), <strong>and</strong> is managed<br />
by a private equity firm, <strong>of</strong>ten referred to as a general partner, but also as a<br />
manager or a management team. It then makes investments (hence becoming an<br />
investor) in private companies which in turn have their own management teams.<br />
We therefore need to be careful in our choice <strong>of</strong> terms for the various participants.<br />
By institutional investors, investors or limited partners, we mean the<br />
pension funds, insurance companies <strong>and</strong> the like who allocate capital to private<br />
equity funds. By private equity firm, fund manager or general partner, we<br />
mean the specialist teams who raise private equity funds <strong>and</strong> are responsible for<br />
making <strong>and</strong> managing investments in individual companies.<br />
Raising a new fund is an event <strong>of</strong> singular strategic<br />
importance for a private equity firm. The<br />
firm’s future is, in effect, placed into the h<strong>and</strong>s <strong>of</strong><br />
the institutional investors; the pension funds,<br />
insurance companies <strong>and</strong> endowment trusts<br />
whose capital allocation decisions, as we saw in<br />
Module 2, are a key influence in shaping the private<br />
equity industry. These investors will, by<br />
choosing whether or not to participate in the<br />
fund, either provide a m<strong>and</strong>ate for continued<br />
growth or cast a collective vote <strong>of</strong> no confidence<br />
from which very few managers will recover.<br />
The complexity <strong>of</strong> the fundraising process matches<br />
its strategic significance, as every aspect <strong>of</strong> the<br />
firm’s investment focus, track record, competence,<br />
people <strong>and</strong> processes is laid open to<br />
intense scrutiny <strong>and</strong> questioning. In many<br />
respects this represents a mirror image <strong>of</strong> the<br />
approach the private equity firm will itself use in<br />
appraising investment opportunities, although<br />
they differ considerably in detail.<br />
The combination <strong>of</strong> these two factors – the strategic<br />
importance <strong>and</strong> the extensive dem<strong>and</strong>s <strong>of</strong> the<br />
process – requires that the fundraising exercise is<br />
planned, launched <strong>and</strong> executed on the basis <strong>of</strong><br />
extensive research, a compelling business case<br />
<strong>and</strong> close attention to detail. This module<br />
reviews the process by starting with the strategic,<br />
commercial <strong>and</strong> marketing aspects before moving<br />
on to consider the various ways in which<br />
funds are structured <strong>and</strong> the terms under which<br />
they are managed.<br />
Fundraising – making the case<br />
Every year, more than 400 new funds are<br />
launched, 1 <strong>of</strong> which typically less than half reach<br />
a first close (i.e. raise the minimum amount<br />
required). Superficially this would indicate that<br />
the sheer volume <strong>of</strong> funds seeking capital will<br />
make it difficult for any single one to draw attention,<br />
<strong>and</strong> that there is a medium risk <strong>of</strong> failure.<br />
However, all funds – <strong>and</strong> geographies – are far<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
not facilitate a tranched drawdown <strong>of</strong> committed<br />
capital. The Luxembourg SICAF is a similar<br />
vehicle to the SICAV but with fixed rather<br />
than variable capital; SICAFs may issue partly<br />
paid-in shares (provided a minimum <strong>of</strong> 25<br />
percent <strong>of</strong> their par value is paid-up at the<br />
date <strong>of</strong> issue) but a capital increase or<br />
decrease requires a change <strong>of</strong> the articles <strong>of</strong><br />
incorporation by decision <strong>of</strong> an extraordinary<br />
general meeting <strong>of</strong> shareholders.<br />
The limited partnership is commonly viewed as<br />
the vehicle <strong>of</strong> choice for private equity fund managers<br />
<strong>and</strong> is the vehicle most <strong>of</strong>ten used for private<br />
equity funds with an international investor<br />
base. The other vehicles described above tend to<br />
be used where a more limited range <strong>of</strong> investors<br />
is targeted <strong>and</strong>/or where the manager's activity is<br />
concentrated in particular jurisdictions, where a<br />
non-partnership vehicle may be more appropriate.<br />
The features <strong>of</strong> limited partnerships are considered<br />
in more detail below.<br />
Limited partnerships<br />
A limited partnership comprises a general partner,<br />
who is responsible for the operation <strong>and</strong> management<br />
<strong>of</strong> the partnership <strong>and</strong> has unlimited liability<br />
for the partnership's liabilities that cannot be<br />
satisfied out <strong>of</strong> its assets, <strong>and</strong> one or more limited<br />
partners, who cannot be involved in operation or<br />
management <strong>and</strong> whose liability is limited to the<br />
amount <strong>of</strong> capital contributed by them to the partnership.<br />
In the private equity fund context, the<br />
fund manager acts as general partner (though<br />
<strong>of</strong>ten the general partner is a subsidiary <strong>of</strong> the<br />
manager rather than the manager itself) <strong>and</strong> the<br />
investors are the limited partners. The general<br />
partner <strong>and</strong>/or manager <strong>of</strong> a limited partnership<br />
will usually need to be regulated in the place<br />
where it is based, which may be different from the<br />
jurisdiction <strong>of</strong> the fund. For example, the UK manager<br />
<strong>of</strong> an English limited partnership will need to<br />
be regulated by the UK Financial Services<br />
Authority (FSA), whereas an <strong>of</strong>f-shore manager<br />
operating an English limited partnership fully outside<br />
the UK would not need to be regulated by the<br />
FSA in relation to that activity but would need to<br />
be regulated in the relevant <strong>of</strong>f-shore jurisdiction.<br />
The main advantages <strong>of</strong> a limited partnership<br />
structure include:<br />
• limited liability for investors (assuming they<br />
do not participate in “management”);<br />
• tax transparency;<br />
• contractual flexibility;<br />
• manager's autonomy (the limited liability <strong>of</strong><br />
each limited partner generally depends on it<br />
not becoming involved in management);<br />
• no/minimal regulatory requirements in<br />
respect <strong>of</strong> the vehicle itself;<br />
• potential for tax efficient management <strong>and</strong><br />
performance fee structuring; <strong>and</strong><br />
• no requirement for public disclosure <strong>of</strong> the<br />
partnership agreement or the partnership's<br />
accounts.<br />
Meanwhile, the potential drawbacks <strong>of</strong> limited<br />
partnerships may include the following:<br />
• certain countries do not regard limited partnership<br />
vehicles as tax transparent, which<br />
may necessitate establishing a separate parallel<br />
vehicle for investors in such jurisdictions;<br />
• it will not be possible for a limited partnership<br />
to take advantage <strong>of</strong> the EU Parent/Subsidiary<br />
directive (exempting dividends paid by subsidiaries<br />
to their parents from tax), although<br />
subsidiary companies owned by the limited<br />
partnership <strong>and</strong> individual investors in the<br />
limited partnership may be able to do so; <strong>and</strong><br />
• it will only be possible to rely on double tax<br />
treaty protection to the extent that the underlying<br />
investor is able to do so (although subfund<br />
structuring using, for example, Dutch or<br />
Luxembourg corporate holding entities is usually<br />
employed to minimise withholding <strong>and</strong><br />
achieve other tax objectives).<br />
Although it is possible to generalise about the<br />
features <strong>of</strong> limited partnerships as a type <strong>of</strong> fund<br />
vehicle, there are significant differences<br />
between the different types <strong>of</strong> partnership established<br />
in different jurisdictions, <strong>and</strong> it is important<br />
to underst<strong>and</strong> these differences when<br />
designing a structure. The most common jurisdictions<br />
for private equity limited partnerships<br />
are Cayman, Delaware, Engl<strong>and</strong>, Jersey <strong>and</strong><br />
Scotl<strong>and</strong>. Most <strong>of</strong> the core characteristics are<br />
common to all <strong>of</strong> these jurisdictions; however<br />
one important distinction is whether the partnership<br />
is deemed to have separate legal personality<br />
(Scottish LP) or is a body corporate<br />
(Delaware LP; Jersey LP by election). Partnerships<br />
with the latter characteristics may not be<br />
recognised as tax transparent by the local tax<br />
authorities in certain jurisdictions where they<br />
invest, which would remove one <strong>of</strong> the key rea-<br />
20 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Module 4:<br />
<strong>Venture</strong> <strong>and</strong><br />
development capital<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-46-5 978-1-904696-46-9<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
Introduction 5<br />
Identifying the opportunities – venture fund strategy 7<br />
A dose <strong>of</strong> reality 9<br />
Making investments 9<br />
Generating dealflow 9<br />
Early appraisal 9<br />
Structuring investments 11<br />
The principles <strong>of</strong> investment structuring 12<br />
Assumptions <strong>and</strong> targets 12<br />
Preference 13<br />
Preferred shares in practice 13<br />
Xytrak proposed terms 15<br />
The term sheet 15<br />
Preconditions to investment 16<br />
Representations <strong>and</strong> warranties 16<br />
Board structure <strong>and</strong> membership 16<br />
Provision <strong>of</strong> information 16<br />
Consent matters 17<br />
Share rights 17<br />
Service agreements 17<br />
Confidentiality 17<br />
Payment <strong>of</strong> costs 18<br />
Exclusivity agreement 18<br />
Summary 18<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL
GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 4 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on venture <strong>and</strong> early stage investing. It is designed to work both as a<br />
st<strong>and</strong> alone section <strong>and</strong> as part <strong>of</strong> the whole series. It necessarily draws upon topics<br />
reviewed in earlier modules, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content.<br />
However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has<br />
been incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in<br />
bold, to indicate that there is a glossary entry for them.<br />
Introduction<br />
We define early stage investing as the provision<br />
<strong>of</strong> equity capital to companies that have not<br />
yet achieved stable, pr<strong>of</strong>itable trading. Exhibit 1<br />
quickly recaps (from Module 1) the definitions <strong>of</strong><br />
specific types <strong>of</strong> investment within this<br />
broad category.<br />
The factor which unites all investments <strong>of</strong> this<br />
type is the significantly higher level <strong>of</strong> risk<br />
attached to unproven companies, markets, products,<br />
technologies <strong>and</strong> management teams.<br />
Uncertainty about future outcomes is endemic in<br />
all forms <strong>of</strong> investment, but applies to nascent or<br />
very young companies not only in every possible<br />
Exhibit 1: Classifications <strong>of</strong> investment types<br />
Investment<br />
type<br />
Purpose <strong>of</strong><br />
funding<br />
Investee company<br />
Characteristics<br />
Key<br />
objectives<br />
Typical exit<br />
horizon<br />
Seed corn<br />
To develop, refine <strong>and</strong><br />
market test intellectual<br />
property, prototypes<br />
or concepts<br />
Non trading, usually no firm<br />
business plan or commitment<br />
to a specific route to<br />
commercial exploitation at<br />
this stage<br />
To test <strong>and</strong> verify the<br />
practical <strong>and</strong> commercial<br />
viability <strong>of</strong> the product<br />
or concept<br />
To establish routes to<br />
market <strong>and</strong> a viable<br />
business model<br />
To build a commercial<br />
management team<br />
5 years<br />
or more<br />
Spin-out<br />
To establish a business<br />
based on the transfer <strong>of</strong><br />
intellectual property<br />
from a corporate or<br />
academic research<br />
environment<br />
Similar to seed corn,<br />
although conceptual or<br />
intellectual property<br />
development may be<br />
more advanced<br />
As with seed corn.<br />
Replacing academic or<br />
scientific priorities with<br />
commercially driven<br />
management objectives is<br />
<strong>of</strong>ten the major objective<br />
with spin-outs<br />
5 years<br />
or more<br />
start-up<br />
To establish a viable<br />
trading concern with<br />
customers, revenues<br />
<strong>and</strong> a clear route<br />
to pr<strong>of</strong>it<br />
A commercially focused,<br />
backable <strong>and</strong> (mostly)<br />
complete management team<br />
will be in place<br />
To establish a sustainable<br />
market presence<br />
To make clear progress<br />
towards pr<strong>of</strong>itability<br />
To prove the<br />
management team<br />
Up to<br />
5 years<br />
Early stage<br />
To accelerate the<br />
progress <strong>of</strong> a<br />
young company<br />
Typically will not yet be<br />
pr<strong>of</strong>itable, but will be able<br />
to demonstrate the viability<br />
<strong>of</strong> its product or service<br />
<strong>and</strong> markets<br />
Management team will<br />
have, to some extent,<br />
demonstrated their<br />
competence <strong>and</strong><br />
effectiveness<br />
To achieve pr<strong>of</strong>itable<br />
trading <strong>and</strong> a solid<br />
platform for growth<br />
3–5 years<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY 5
exercise, without the danger <strong>of</strong> the company<br />
agreeing a deal with a different investor.<br />
In addition to the financial aspects we have<br />
already discussed, the major commercial points<br />
addressed in a term sheet are:<br />
• preconditions to investment;<br />
• representations <strong>and</strong> warranties;<br />
• board structure <strong>and</strong> membership;<br />
• provision <strong>of</strong> information;<br />
• consent matters;<br />
• share rights;<br />
• service agreements;<br />
• confidentiality;<br />
• payment <strong>of</strong> costs;<br />
• arrangement <strong>and</strong> monitoring fees; <strong>and</strong><br />
• exclusivity.<br />
Preconditions to investment<br />
Completion <strong>of</strong> the investment will always be<br />
subject to the satisfactory completion <strong>of</strong> due<br />
diligence, agreement <strong>of</strong> legal documents <strong>and</strong><br />
final approval from the investor’s investment<br />
committee. In addition to these generic conditions,<br />
the term sheet will also spell out specific<br />
conditions, including:<br />
• a detailed outline <strong>of</strong> the due diligence requirements<br />
(see Module 8);<br />
• where appropriate, contemporaneous completion<br />
<strong>of</strong> investments from co-investors;<br />
• restructuring, or creation, <strong>of</strong> a share option<br />
pool for employees;<br />
• regulatory <strong>and</strong> tax clearances; <strong>and</strong><br />
• key man insurance on senior members <strong>of</strong> the<br />
management team.<br />
There may also be specific milestones to be<br />
achieved; for example the securing <strong>of</strong> a patent,<br />
the appointment <strong>of</strong> a new member <strong>of</strong> the management<br />
team or signing <strong>of</strong> a commercially significant<br />
contract.<br />
The use <strong>of</strong> milestones can be refined by breaking<br />
an agreed investment amount into tranches,<br />
individual slices which can only be drawn<br />
when the company achieves specific pre-agreed<br />
objectives.<br />
Representations <strong>and</strong> warranties<br />
The simple objective <strong>of</strong> warranties provided by the<br />
company <strong>and</strong> its management is to ensure that the<br />
information they have provided to investors is<br />
accurate, complete <strong>and</strong> not misleading. The principal<br />
areas covered by warranties are:<br />
• historic accounts;<br />
• current trading <strong>and</strong> management accounts;<br />
• financial projections <strong>and</strong> forecasts;<br />
• the business plan;<br />
• due diligence reports;<br />
• ownership <strong>of</strong> assets including IP; <strong>and</strong><br />
• no litigation or contractual breaches<br />
outst<strong>and</strong>ing.<br />
Board structure <strong>and</strong> membership<br />
One <strong>of</strong> the major changes that accompanies raising<br />
venture capital for the first time is the introduction<br />
<strong>of</strong> a formalised reporting <strong>and</strong> decision<br />
making process, which will be centred around<br />
the board <strong>of</strong> directors. The board acts as both the<br />
primary decision making body <strong>and</strong> the main<br />
interface between management <strong>and</strong> investor. It is<br />
essential that board meetings are a forum for<br />
open debate <strong>and</strong> discussion, <strong>and</strong> that the management<br />
team does not attempt this to circumvent<br />
this by making decisions in private <strong>and</strong><br />
presenting the board with fait accompli.<br />
The investor will invariably require, at the very<br />
minimum, the right to appoint an investor director.<br />
An important consideration here is that company<br />
law requires directors to act in the best<br />
interest <strong>of</strong> all shareholders, <strong>and</strong> not a particular<br />
group. To avoid conflicts <strong>of</strong> interest, the investor<br />
may appoint an observer to the board, or use a<br />
different executive from the investor director<br />
when decisions are needed.<br />
Appointment <strong>of</strong> a chairman or additional nonexecutive<br />
directors will be made in agreement<br />
with the management team, although the<br />
investor may reserve the ultimate right to decide<br />
should agreement not be reached.<br />
Other areas relating to the board are:<br />
• frequency <strong>and</strong> timing <strong>of</strong> board meetings; <strong>and</strong><br />
• the composition <strong>of</strong> audit <strong>and</strong> remuneration<br />
committees or their equivalent.<br />
Module 8 looks at the composition <strong>and</strong> management<br />
<strong>of</strong> boards, as part <strong>of</strong> the aftercare process,<br />
in greater detail.<br />
Provision <strong>of</strong> information<br />
The reporting cycle will be closely linked to the<br />
16 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Module 5:<br />
Management <strong>and</strong><br />
leveraged buyouts<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-47-3 978-1-904696-47-6<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL
Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
The buyout principle – three different routes to value creation 5<br />
Creating value in buyouts 5<br />
The consequences <strong>of</strong> leverage 7<br />
The future for value creation 7<br />
Evolution <strong>of</strong> the buyout markets 8<br />
Management buyouts 9<br />
Failures 9<br />
Investment criteria – characteristics <strong>of</strong> a buyout company 11<br />
Strategy <strong>and</strong> market positioning 11<br />
The company 11<br />
The management team 11<br />
The buyout process 12<br />
Auctions 12<br />
The management role in a buyout <strong>and</strong> conflicts <strong>of</strong> interest 12<br />
The application <strong>of</strong> leverage – types <strong>of</strong> debt <strong>and</strong> their uses 14<br />
Senior debt 14<br />
Working capital facility 14<br />
Subordinated or junior debt 14<br />
Second lien debt 14<br />
Mezzanine debt 14<br />
High yield bonds 15<br />
Securitisation 15<br />
Institutional debt 15<br />
Documentation 15<br />
The MBO model 21<br />
Summary 23<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 5 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on management <strong>and</strong> leveraged buyouts. It is designed to work both as a<br />
st<strong>and</strong> alone section <strong>and</strong> as part <strong>of</strong> the whole series. It necessarily draws upon topics<br />
reviewed in earlier modules, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content.<br />
However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has<br />
been incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in<br />
bold, to indicate that there is a glossary entry for them.<br />
The explosive growth in buyouts over the last<br />
three decades is a direct result <strong>of</strong> the natural,<br />
inherent strengths <strong>of</strong> the buyout model. The<br />
essential elements <strong>of</strong> this model are:<br />
• a close partnership between the management<br />
team <strong>of</strong> a buyout company <strong>and</strong> the investors<br />
<strong>and</strong> lenders who finance its acquisition;<br />
• precise <strong>and</strong> careful tailoring <strong>of</strong> the buyout’s<br />
financial structure to the cash <strong>and</strong> pr<strong>of</strong>it generation<br />
characteristics <strong>of</strong> the company;<br />
• clear objectives, shared between management<br />
<strong>and</strong> investors, which enable a high degree <strong>of</strong><br />
focus in setting the company’s strategic <strong>and</strong><br />
operational priorities; <strong>and</strong><br />
• ownership structures which reinforce the<br />
management team’s motivation to achieve<br />
these objectives by sharing the rewards.<br />
The buyout principle – three<br />
different routes to value creation<br />
The underlying principle behind a buyout is the<br />
use <strong>of</strong> a target company’s assets <strong>and</strong> – more<br />
importantly – future cashflow as the basis on<br />
which to fund its acquisition.<br />
Creating value in buyouts<br />
There are three routes to creating equity value in<br />
a buyout company, <strong>and</strong> whilst most investments<br />
demonstrate a blend <strong>of</strong> all three, modern market<br />
conditions have pr<strong>of</strong>oundly altered the mix; we<br />
shall return to this topic after reviewing the basic<br />
principles.<br />
These principles can be demonstrated through a<br />
simple example. DemCo is the subject <strong>of</strong> a buyout<br />
at a total cost (acquisition price plus pr<strong>of</strong>essional<br />
<strong>and</strong> arrangement fees) <strong>of</strong> €100 million, which is a<br />
multiple <strong>of</strong> 10 on its annual earnings before interest<br />
<strong>and</strong> tax (EBIT) <strong>of</strong> €10 million. Adding back non<br />
cash expenses – depreciation <strong>and</strong> amortisation – <strong>of</strong><br />
€4 million per year gives us an EBITDA, which is a<br />
rough proxy for the company’s surplus operating<br />
cashflow, <strong>of</strong> €14 million. This clearly provides the<br />
capacity to service debt, <strong>and</strong> for this example we<br />
assume that equity investors provide €30 million<br />
<strong>of</strong> the acquisition cost, with the balance, €70 million,<br />
coming as a combination <strong>of</strong> loans with an<br />
overall interest cost <strong>of</strong> seven percent.<br />
By running the company with a tight focus on<br />
cash generation, not only is the interest cost covered<br />
but debt principal repayments can be made<br />
– for this simple example we have assumed a €5<br />
million repayment at the end <strong>of</strong> year 1, increasing<br />
by €1 million per year thereafter as the reducing<br />
interest burden helps free up more cash for<br />
debt repayment.<br />
As Exhibit 1 overleaf demonstrates, each debt<br />
repayment enhances the equity value even if the<br />
company itself does not grow in value. After four<br />
years, if the company, still generating €10 million<br />
EBIT a year is sold for the same €100 million<br />
price at which it was bought, so that the EBIT<br />
multiple is unchanged, equity investors have<br />
nearly doubled the value <strong>of</strong> their investment,<br />
which produces an internal rate <strong>of</strong> return (IRR)<br />
<strong>of</strong> 22 percent per annum (before allowing for the<br />
fact that some <strong>of</strong> this upside will have been<br />
shared with the management team).<br />
This approach to generating equity returns by<br />
using the cash generation capacity to repay debt<br />
is referred to as the financial engineering<br />
approach to value creation.<br />
However, any management team unable to produce<br />
some degree <strong>of</strong> pr<strong>of</strong>it growth is unlikely to<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
Exhibit 4: Trends <strong>of</strong> buyouts/buy-ins, 1981–2006<br />
Number<br />
800<br />
700<br />
600<br />
500<br />
400<br />
300<br />
200<br />
100<br />
Number<br />
Value<br />
12,000<br />
10,000<br />
8,000<br />
6,000<br />
4,000<br />
2,000<br />
Value (€ millions)<br />
0 0<br />
1981<br />
1982<br />
1983<br />
1984<br />
1985<br />
1986<br />
1987<br />
1988<br />
1989<br />
1990<br />
1991<br />
1992<br />
1993<br />
1994<br />
1995<br />
1996<br />
1997<br />
1998<br />
1999<br />
2000<br />
2001<br />
2002<br />
2003<br />
2004<br />
2005<br />
2006<br />
Sources: CMBOR, Barclays <strong>Private</strong> <strong>Equity</strong>, Deloitte.<br />
Exhibit 5: Growing sponsor involvement in global M&A volume, 1999–2006<br />
25<br />
20<br />
Volume ($ billions)<br />
% <strong>of</strong> global M&A<br />
519<br />
% <strong>of</strong> global volume<br />
15<br />
10<br />
5<br />
157 162<br />
104<br />
146<br />
173<br />
285<br />
356<br />
0<br />
1999 2000 2001 2002 2003 2004 2005<br />
Year<br />
Sources: SDC Platinum <strong>and</strong> Citigroup.<br />
Q1–Q2<br />
2006<br />
Exhibit 6: Surging average deal size for private equity-related transactions, 1999–2006<br />
Average deal size ($ millions)<br />
800<br />
600<br />
400<br />
200<br />
US<br />
Europe<br />
0<br />
1999 2000 2001 2002 2003 2004 2005<br />
Year<br />
Sources: SDC Platinum <strong>and</strong> Citigroup.<br />
Q1–Q2<br />
2006<br />
10 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Module 6:<br />
<strong>Private</strong> equity real estate<br />
<strong>and</strong> infrastructure<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-48-1 978-1-904696-48-3<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL
Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
Growth <strong>of</strong> the private equity real estate market 5<br />
Real estate investment categories 6<br />
Value added activities 7<br />
Opportunistic 7<br />
Real estate asset types 7<br />
Infrastructure investments 8<br />
Privatisations <strong>and</strong> buyouts 9<br />
Public private partnerships, concessions <strong>and</strong> new projects 10<br />
Types <strong>of</strong> PPP 11<br />
<strong>Private</strong> equity <strong>and</strong> infrastructure 14<br />
Appendix 1: 20 l<strong>and</strong>mark transactions in private equity real estate history 15<br />
Appendix 2: The structure <strong>of</strong> things 27<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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preceded the private equity hotel craze by a<br />
good seven years.<br />
In a transaction valued at more than $980 million,<br />
the private equity groups acquired the<br />
hotel portfolio from a 100-year-old publicly<br />
held company that was controlled by a family<br />
trust. Once the dust settled, Blackstone <strong>and</strong><br />
Colony had a clutch <strong>of</strong> luxury UK lodging<br />
assets: The Savoy, Claridge’s, The Berkeley <strong>and</strong><br />
The Connaught. In addition to owning four <strong>of</strong><br />
the seven “superluxury” hotels in London, the<br />
investor group walked away with The Lygon<br />
Arms, a country-house hotel in the Cotswolds<br />
region, <strong>and</strong> the quintessentially English restaurant<br />
Simpson’s-in-the-Str<strong>and</strong>.<br />
In the buyer’s minds, the benefits <strong>of</strong> the transaction<br />
were threefold. The firms held a majority<br />
<strong>of</strong> London’s 1,250 luxury hotel rooms. In<br />
addition, the hotels had recently seen a number<br />
<strong>of</strong> capital improvements that, according to<br />
Blackstone, had affected annual numbers<br />
without being seen in operating performance.<br />
Finally, the investors saw a number <strong>of</strong> opportunities<br />
to create value in the assets: During<br />
their ownership, Colony <strong>and</strong> Blackstone added<br />
additional rooms, contemporary lounges <strong>and</strong><br />
high-class restaurants; divested themselves <strong>of</strong><br />
non-core assets like staff lodging <strong>and</strong> the<br />
Savoy Group laundry business; <strong>and</strong> sold <strong>of</strong>f<br />
the Lygon Arms property in June 2003 to pay<br />
down debt.<br />
The investor group rode out the storm that hit<br />
the hotel market at the beginning <strong>of</strong> the<br />
decade: the foot-<strong>and</strong>-mouth crisis in the UK; a<br />
business downturn in the US; the terrorist<br />
attacks <strong>of</strong> September 11, 2001; SARS; <strong>and</strong><br />
armed conflict in the Middle East. While it no<br />
doubt affected the bottom line, the investors<br />
held onto the properties long enough to experience<br />
some upside from the revitalisation <strong>of</strong> the<br />
market. In May 2004, the Savoy Group was<br />
sold to an investor group led by Dublin-based<br />
Quinlan <strong>Private</strong> for £750 million, approximately<br />
a 1.8x return on investment.<br />
Colony <strong>and</strong> Blackstone have continued to make<br />
hotels an important part <strong>of</strong> their investment<br />
strategies – <strong>and</strong> made European property takeprivates<br />
an important part <strong>of</strong> everyone else’s.<br />
A gamble on Harvey’s<br />
1999<br />
When Colony <strong>Capital</strong> spent $1.2 billion to buy<br />
an additional four gambling parlours from<br />
Harrah’s <strong>and</strong> Caesar’s last April, the firm<br />
became the proud owner <strong>of</strong> the largest privately<br />
held casino company. Although those investments<br />
have had a shaky first year, there is no<br />
denying Colony’s strength in the gaming sector.<br />
All <strong>of</strong> this was set in motion by one purchase:<br />
the firm’s 1999 acquisition <strong>of</strong> Harvey’s Casino<br />
Resorts in Lake Tahoe for $405 million. The<br />
firm later sold the company, which also owns<br />
hotels <strong>and</strong> casinos in Iowa, to Harrah’s for $625<br />
million two years later.<br />
“When Colony bought Harvey’s, we saw an<br />
industry with only big, strategic players <strong>and</strong> no<br />
one to sell to except each other,” Colony chief<br />
executive <strong>of</strong>ficer Tom Barrack told sister publication<br />
<strong>Private</strong> <strong>Equity</strong> International last year.<br />
“We thought we could act as a liaison to all<br />
these larger companies. Now, the consolidation<br />
in the industry has been great fuel for our<br />
acquisition program.”<br />
Today Colony is one <strong>of</strong> the few private equity<br />
firms licensed in US gaming – Barrack has<br />
referred to the licensing process as a Bataan<br />
death march – <strong>and</strong> its acquisitions have included<br />
the Las Vegas Hilton <strong>and</strong> the Resorts company.<br />
Earlier this year, the firm joined a consortium <strong>of</strong><br />
investors including Goldman Sachs <strong>and</strong><br />
Providence <strong>Equity</strong> Partners in acquiring Kerzner<br />
International, the owner <strong>of</strong> the Mohegan Sun<br />
Casino in Connecticut <strong>and</strong> the Atlantis Resort in<br />
the Bahamas, for $3.6 billion. With deregulation<br />
occurring across the country <strong>and</strong> more <strong>and</strong><br />
more US states legalizing some form <strong>of</strong> gambling,<br />
the gaming sector is big business these<br />
days <strong>and</strong> Colony is one <strong>of</strong> its biggest players. The<br />
firm is even looking overseas: In conjunction<br />
with the Las Vegas S<strong>and</strong>s, Colony portfolio company<br />
Fairmont Hotels is planning to develop a<br />
new resort in Far East gaming mecca Macau.<br />
The monolithic Time Warner Center<br />
2000<br />
Colony’s first casino acquisition launches<br />
an empire<br />
Apollo <strong>and</strong> The Related Companies fix up a<br />
blighted Columbus Circle<br />
When construction started on the Time Warner<br />
22 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL
Exhibit A2.3: <strong>Private</strong> equity restructures – breakdown <strong>of</strong> global infrastructure deal volumes<br />
by acquirer, 1998–2006 YTD<br />
150<br />
125<br />
<strong>Private</strong> equity<br />
Non-private equity<br />
$ (billions)<br />
100<br />
75<br />
50<br />
25<br />
0<br />
1998 1999 2000 2001 2002 2003 2004 2005<br />
Year<br />
Source: Thomson Financial.<br />
2006<br />
YTD<br />
Or, as Chuck Leitner, the global head <strong>of</strong><br />
RREEF, the real estate <strong>and</strong> infrastructure arm<br />
<strong>of</strong> Deutsche Bank, puts it: “Just about everybody<br />
that talks about infrastructure has<br />
Australian accents.”<br />
Contrasted with the mature infrastructure<br />
market in Australia, the developing countries<br />
<strong>of</strong> Asia, particularly China <strong>and</strong> India, are also<br />
witnessing a boom in infrastructure as their<br />
surging economies necessitate vast new networks<br />
<strong>of</strong> roads, tunnels, ports et cetera.<br />
According to a report last year in the Wall<br />
Street Journal, China is planning to spend up to<br />
$400 billion on infrastructure through 2010,<br />
while consulting firm McKinsey has estimated<br />
that India needs over $250 billion in infrastructure<br />
investment.<br />
“The single most important bottleneck is infrastructure,”<br />
Aashish Kalra, managing director <strong>of</strong><br />
Trikona <strong>Capital</strong>, which is partnering with<br />
IL&FS for a $100 million infrastructure joint<br />
venture, told <strong>PEI</strong>’s sister publication <strong>Private</strong><br />
<strong>Equity</strong> Real Estate in 2006.<br />
US: A new market<br />
Despite the size <strong>of</strong> the infrastructure market in<br />
the US – the Bureau <strong>of</strong> Economic Analysis has<br />
estimated it at $5.6 trillion – the sector is relatively<br />
immature in terms <strong>of</strong> private investment.<br />
This is primarily due to the municipal<br />
bond markets, which have provided governments<br />
with robust financing for public infrastructure<br />
projects. In recent years, however, as<br />
the country’s infrastructure has aged <strong>and</strong> the<br />
ability to raise capital via taxes has diminished,<br />
more <strong>and</strong> more public entities are looking<br />
to the private sector.<br />
“Estimates suggest that the US needs<br />
$1.6 trillion over the next five years just to<br />
repair <strong>and</strong> build highways, bridges, dams, airports,<br />
railroads <strong>and</strong> other infrastructure,”<br />
Dale Anne Reiss, the head <strong>of</strong> Ernst & Young’s<br />
global real estate practice, said in an<br />
early 2007 statement. “The annual tab to<br />
maintain the nation’s 50-year old highway<br />
system is $176 billion alone. With real estate<br />
capital flows at their highest levels ever,<br />
I would not be surprised to see more pension<br />
funds <strong>and</strong> other long term investors move<br />
into private funding <strong>of</strong> key infrastructure<br />
developments.”<br />
In recent years, the most prominent examples<br />
<strong>of</strong> US infrastructure investments have been<br />
toll roads. From the greenfield development <strong>of</strong><br />
the San Joaquin Toll Road in California in the<br />
1990s to the recent privatisation <strong>of</strong> the<br />
Chicago Skyway, widely regarded as a l<strong>and</strong>mark<br />
transaction in the sector, local governments<br />
across the country have followed suit.<br />
And given the current state <strong>of</strong> the nation’s<br />
infrastructure, as highlighted by Reiss, many<br />
experts predict that privatisation <strong>of</strong> existing<br />
toll roads will accelerate.<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 29
Module 7:<br />
Due diligence<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-49-X 978-1-904696-49-0<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
What is due diligence? 5<br />
Types <strong>of</strong> due diligence 5<br />
Commercial due diligence 5<br />
Financial due diligence 5<br />
Management due diligence 6<br />
Legal <strong>and</strong> regulatory due diligence 6<br />
IT due diligence 6<br />
Technology or product due diligence 6<br />
Environmental due diligence 6<br />
Forensic due diligence 6<br />
Other specialist due diligence 7<br />
Vendor due diligence 7<br />
The due diligence process 7<br />
Pr<strong>of</strong>essionalism 7<br />
Clear focus 7<br />
Careful planning 7<br />
Allocation <strong>of</strong> resources 8<br />
Transparent decision making 8<br />
Careful selection <strong>of</strong> advisers 8<br />
The sale process <strong>and</strong> early due diligence 8<br />
The sales process 8<br />
Detailed due diligence 8<br />
The data room 8<br />
Financial due diligence 10<br />
The brief 10<br />
Historic financial performance 10<br />
Working capital movements <strong>and</strong> cashflows 10<br />
Historic performance against budget 11<br />
The financial projections 11<br />
Financial reporting <strong>and</strong> control systems 11<br />
The post-transaction funding structure 12<br />
Commercial due diligence 12<br />
Objectives 13<br />
Selection <strong>of</strong> advisers 13<br />
The management viewpoint 14<br />
Gathering information for CDD 14<br />
Management due diligence 17<br />
Looking to the future 17<br />
Methodology 18<br />
Due diligence issues <strong>and</strong> problems 18<br />
Obtaining information 18<br />
Integration <strong>of</strong> disciplines 19<br />
Presentation <strong>and</strong> correlation <strong>of</strong> results 19<br />
Summary 19<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 7 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on the due diligence process. It is designed to work both as a st<strong>and</strong> alone<br />
section <strong>and</strong> as part <strong>of</strong> the whole series. The module necessarily draws upon topics<br />
reviewed in earlier modules, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content.<br />
However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has<br />
been incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in<br />
bold, to indicate that there is a glossary entry for them.<br />
What is due diligence?<br />
In its simplest terms, we can define due diligence<br />
as the process <strong>of</strong> assuring that all the assumptions<br />
on which an investment or acquisition decision<br />
are based do, in fact, hold true; an exercise in validation<br />
or verification. In modern practice, however,<br />
it goes further than this, as the results <strong>of</strong> a<br />
thorough, detailed <strong>and</strong> focused series <strong>of</strong> reviews<br />
into a company’s markets, processes, finances,<br />
management, technologies, assets, intellectual<br />
property <strong>and</strong> customers will in many cases identify<br />
areas where improvements can be made, risks<br />
reduced <strong>and</strong> additional gains realised.<br />
The levels <strong>of</strong> competition in modern private equity<br />
markets dem<strong>and</strong> that investors must consistently<br />
add value in order to outperform. As we saw in<br />
Modules 4, 5 <strong>and</strong> 6 this added value is increasingly<br />
generated by identifying, instigating <strong>and</strong> driving<br />
performance enhancements, in t<strong>and</strong>em with the<br />
investee company’s management teams. To do this<br />
requires ever deeper underst<strong>and</strong>ing <strong>of</strong> markets,<br />
companies <strong>and</strong> strategic opportunities. The due<br />
diligence exercise can contribute to this underst<strong>and</strong>ing<br />
by providing essential raw material to<br />
inform the entire investment, growth <strong>and</strong> realisation<br />
process, rather than being seen as a tedious<br />
<strong>and</strong> non-productive hurdle between commercial<br />
decision making <strong>and</strong> completion.<br />
As with every aspect <strong>of</strong> private equity, the most<br />
valuable due diligence exercises are those where<br />
investors, their advisers <strong>and</strong> the management<br />
team are fully engaged, with shared objectives<br />
<strong>and</strong> complete openness.<br />
Types <strong>of</strong> due diligence<br />
Due diligence has evolved in depth, complexity<br />
<strong>and</strong> sophistication, <strong>and</strong> in modern practice is<br />
broken down into a series <strong>of</strong> different disciplines.<br />
Commercial due diligence<br />
Commercial due diligence (CDD), also referred to<br />
as market, or strategic due diligence, is focused on:<br />
• establishing the credibility <strong>of</strong> the revenue projections<br />
in the investee company’s business plan;<br />
• providing an objective, impartial assessment<br />
<strong>of</strong> the company’s markets <strong>and</strong> its position in<br />
them; <strong>and</strong><br />
• testing <strong>and</strong> evaluating the key strategic drivers<br />
in the company’s business plan.<br />
With the growing importance <strong>of</strong> earnings, or performance,<br />
enhancement as the route to value<br />
creation in the buyout market, a subset <strong>of</strong> CDD –<br />
operational due diligence – is becoming an<br />
increasingly prominent part <strong>of</strong> the process.<br />
As the Clinovia case study in Module 5 demonstrates,<br />
market due diligence need not be limited<br />
to specific investment proposals but can also be<br />
used as a tool for identifying attractive sectors or<br />
investment opportunities.<br />
Financial due diligence<br />
Whilst the focus <strong>of</strong> CDD is primarily external,<br />
financial due diligence (FDD) looks in detail at<br />
the company itself, providing a review <strong>of</strong>:<br />
• the company’s historic financial performance;<br />
• working capital movements <strong>and</strong> cashflows;<br />
• comparison <strong>of</strong> actual performance with forecasts<br />
<strong>and</strong> budgets;<br />
• the financial projections;<br />
• financial reporting <strong>and</strong> control systems;<br />
• tax compliance; <strong>and</strong><br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
Manufacturing due diligence expertise is supported by our dedicated manufacturing team whose<br />
expertise has developed working on high pr<strong>of</strong>ile strategy <strong>and</strong> operational engagements for major<br />
international blue-chip manufacturers.<br />
We also back our own market insights via the PA <strong>Venture</strong>s programme, as evidenced by the successful<br />
spin-<strong>of</strong>f <strong>of</strong> Ubinetics, the innovative 3G equipment supplier.<br />
Recent examples <strong>of</strong> where PA has applied this specialised knowledge in strategic due diligence<br />
assignments include:<br />
A major European private equity deal where PA Consulting Group worked with an equity sponsor<br />
on the due diligence <strong>of</strong> a specialist manufacturer <strong>of</strong> chemicals. By mapping the underlying manufacturing<br />
technology to the changes in dem<strong>and</strong>s for various polymer <strong>and</strong> substitute products, PA<br />
were able to greatly enhance the financial sponsors’ view <strong>of</strong> the key capital investment priorities.<br />
For a 2006 deal, involving a major European PE house, PA Consulting Group were able to apply a<br />
strategic due diligence team <strong>of</strong> manufacturing specialists to evaluate the real competitive advantage<br />
<strong>of</strong> the core technologies, identifying potential market applications, <strong>and</strong> uncovering specific<br />
high risk areas such as product warranty, all issues that materially impacted on the deal value.<br />
A best practice approach to strategic due diligence<br />
These cases illustrate how strategic due diligence, based on an ability to add value well beyond a<br />
cursory market examination, has yielded significant deal value to our clients.<br />
As the private equity mid-market becomes more competitive expect to see more financial sponsors<br />
investing in true strategic due diligence.<br />
Management due diligence<br />
Appraisal <strong>of</strong> the management team is a core<br />
part <strong>of</strong> the private equity firm’s responsibilities<br />
<strong>and</strong>, naturally, starts from the very first meeting.<br />
It also continues through the life <strong>of</strong> the<br />
investment, as considered in Module 8, as the<br />
investor constantly updates <strong>and</strong> refreshes her<br />
view <strong>of</strong> the team.<br />
Despite this, management due diligence will also<br />
be undertaken as a separate, formal exercise<br />
designed to reinforce – or question – the<br />
investor’s views. The process will examine three<br />
principal areas:<br />
• the track record, performance, competence<br />
<strong>and</strong> integrity <strong>of</strong> each senior executive on an<br />
individual basis;<br />
• the structure, efficiency, compatibility <strong>and</strong><br />
effectiveness <strong>of</strong> the senior management team<br />
as a unit; <strong>and</strong><br />
• the extent to which each individual’s motivation<br />
<strong>and</strong> personal objectives are aligned with<br />
the focus on value growth <strong>and</strong> realisation<br />
inherent in any private equity financing.<br />
Looking to the future<br />
Although there is, by necessity, a heavy degree <strong>of</strong><br />
reliance on past performance in appraising the<br />
management team, it is also essential to project<br />
this appraisal into an assessment <strong>of</strong> suitability for<br />
the dem<strong>and</strong>s <strong>of</strong> running an independent, private<br />
equity backed company. This requires a clear<br />
underst<strong>and</strong>ing <strong>of</strong> roles, responsibilities <strong>and</strong> success<br />
criteria post-investment.<br />
Two examples <strong>of</strong> failures in this area will help<br />
reinforce the message. The first concerned the<br />
buy-in/buyout <strong>of</strong> a company making injection<br />
moulded plastic components for a highly specialist<br />
sub sector. The company was purchased from<br />
its founder who had also been the CEO <strong>and</strong><br />
retired from business after the sale. A new incoming<br />
chief executive, who <strong>of</strong>fered particularly<br />
strong sales <strong>and</strong> marketing credentials, combined<br />
with the incumbent production director to form<br />
the nucleus <strong>of</strong> the new management team.<br />
Unfortunately the due diligence process failed to<br />
identify that the highly complex, custom developed<br />
application <strong>of</strong> injection moulding machinery,<br />
which gave the company its competitive edge,<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 17
Module 8:<br />
Aftercare <strong>and</strong> exits<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-50-3 978-1-904696-50-6<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL
Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
Introduction 5<br />
Aftercare 5<br />
Protecting value 5<br />
Reporting structure 6<br />
Modern trends in reporting 6<br />
Informal reporting 6<br />
Board structure <strong>and</strong> composition 7<br />
Executive directors 7<br />
Non-executive directors 7<br />
Representing the investor 7<br />
Monitoring progress <strong>and</strong> performance 7<br />
Contributing to growth <strong>and</strong> development 8<br />
Characteristics <strong>of</strong> the effective non-executive 8<br />
Board committees 8<br />
The chairman <strong>and</strong> board meetings 8<br />
Operating partners 9<br />
Aftercare – who does it 9<br />
Underperformance 10<br />
Causes <strong>of</strong> underperformance 10<br />
Addressing underperformance 10<br />
Anticipation 10<br />
Analysis 10<br />
Action 11<br />
Follow-on investments 11<br />
Fund reporting 11<br />
Annual report 11<br />
Valuation 12<br />
The valuation process 12<br />
Calculating the enterprise value 12<br />
The multiple 13<br />
The earnings figure 13<br />
EBITDA multiples 13<br />
Early stage companies 13<br />
Calculating the value <strong>of</strong> the fund’s investment 13<br />
Structuring issues 14<br />
Exits 14<br />
Types <strong>of</strong> exit 15<br />
Stock market flotation (IPO) 16<br />
The secondary buyout 17<br />
Re-leveraging 17<br />
Summary 18<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Garry Sharp – independent practitioner, consultant, writer <strong>and</strong> trainer<br />
Garry Sharp has 22 years’ experience as a practitioner, consultant, writer <strong>and</strong> trainer in the private<br />
equity <strong>and</strong> venture capital markets. He joined independent venture capital company Baronsmead in<br />
1985, becoming a director <strong>and</strong> shareholder following Baronsmead’s own management buyout in<br />
1989. During the early 1990s the company grew to become one <strong>of</strong> the UK’s largest independent private<br />
equity firms <strong>and</strong> was acquired by fund manager Ivory & Sime in 1996. Shortly thereafter Garry<br />
left to co-found Independent Direction, a specialist consultancy to the private equity industry. He sold<br />
Independent Direction in 2005 to concentrate on training <strong>and</strong> writing, <strong>and</strong> continues to work in an<br />
advisory capacity in private equity.<br />
Garry has trained newcomers to private equity since 1990, <strong>and</strong> delivers courses in Western <strong>and</strong><br />
Eastern Europe, the Middle East <strong>and</strong> a wide range <strong>of</strong> African countries. His first book, The Insider’s<br />
Guide to <strong>Venture</strong> <strong>Capital</strong>, was published in 1990, followed by five more on private equity, M&A <strong>and</strong><br />
corporate finance.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 8 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on the aftercare <strong>and</strong> exit aspects <strong>of</strong> the private equity cycle. It is<br />
designed to work both as a st<strong>and</strong> alone section <strong>and</strong> as part <strong>of</strong> the whole series.<br />
The module necessarily draws upon topics reviewed in earlier modules, <strong>and</strong><br />
seeks to avoid repetition <strong>of</strong> their content. However, for the benefit <strong>of</strong> the st<strong>and</strong><br />
alone reader, a comprehensive glossary has been incorporated, which explains<br />
the background <strong>and</strong> use <strong>of</strong> private equity terminology. All terms which may<br />
require explanation or expansion are printed in bold, to indicate that there is a<br />
glossary entry for them.<br />
Introduction<br />
The culmination <strong>of</strong> the investment process –<br />
dealflow generation, appraisal, negotiation, due<br />
diligence, legal documentation <strong>and</strong>, finally,<br />
completion <strong>of</strong> the investment – marks the beginning,<br />
<strong>and</strong> not the end, <strong>of</strong> the investment cycle.<br />
Whilst selection <strong>and</strong> structuring are critical to<br />
private equity success, it is once the investment<br />
has been made that the creation <strong>and</strong> realisation<br />
<strong>of</strong> value begins. The investor’s contribution to<br />
value creation lies in the approach to, <strong>and</strong> implementation<br />
<strong>of</strong>, aftercare, <strong>and</strong> he will play a key<br />
role in the realisation <strong>of</strong> this value through driving<br />
the exit process.<br />
Aftercare<br />
The aftercare function is driven by two key<br />
objectives:<br />
• protecting the value <strong>of</strong> the investment; <strong>and</strong><br />
• adding <strong>and</strong> realising value.<br />
Exhibit 1 summarises the key aspects <strong>of</strong> the<br />
investor’s role during the life <strong>of</strong> the investment.<br />
Protecting value<br />
Validating<br />
The period immediately following completion <strong>of</strong><br />
an investment can represent, for the investor, the<br />
Exhibit 1: Aftercare priorities <strong>and</strong> the investor’s role<br />
Reporting<br />
regime<br />
Progress<br />
reporting<br />
Board<br />
structure<br />
Validating<br />
Financial<br />
reporting<br />
Management<br />
appraisal<br />
Protecting<br />
Testing<br />
Monitoring<br />
EXIT<br />
VALUE<br />
Adding<br />
Creating<br />
Realising<br />
Strategy<br />
development<br />
Operational<br />
enhancements<br />
Acquisitions<br />
Management<br />
development<br />
Financing<br />
growth<br />
Exit routes<br />
Exit strategy<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
Operating partners<br />
Earlier modules – Module 5 in particular – identified<br />
the growing requirements for private<br />
equity firms to add operational value to their<br />
investee companies. This has led in many cases<br />
to a significant change in the make up <strong>of</strong> many<br />
firm’s executive teams, which have broadened<br />
to include individuals with significant, senior<br />
level operational experience <strong>and</strong> a deep underst<strong>and</strong>ing<br />
<strong>of</strong> a particular sector or market.<br />
Although investors have always used external<br />
consultants <strong>and</strong> expertise to help them appraise<br />
<strong>and</strong> develop companies, the incorporation <strong>of</strong><br />
operating partners into the team brings this<br />
expertise into the equity ownership <strong>and</strong> carried<br />
interest return pool, making them an integral<br />
part <strong>of</strong> the team with a reward structure better<br />
aligned to the creation <strong>of</strong> value. Specific models<br />
<strong>of</strong> operating partner involvement vary<br />
between firms.<br />
At one extreme, major industry names are hired;<br />
for example Louis Gerstner (former IBM chairman,<br />
currently chairman <strong>of</strong> Carlyle), Jack Welch<br />
(former CEO <strong>of</strong> General Electric, at Clayton,<br />
Dubilier <strong>and</strong> Rice) <strong>and</strong> Paul O’Neill (former US<br />
Treasury Secretary, special adviser to the<br />
Blackstone Group).<br />
Expertise is also, in many firms, tightly integrated<br />
into the process by building deal teams<br />
around industry sectors, which helps not only in<br />
sourcing <strong>and</strong> appraising investments but identifying<br />
opportunities to add value quickly post<br />
investment. An alternative to sector specialisation<br />
is a focus on more generic business capabilities<br />
that can be applied across a range <strong>of</strong><br />
investee companies. This can incorporate areas<br />
such as supply chain management, sales force<br />
management, management development or<br />
even highly specialist areas such as the provision<br />
<strong>of</strong> health <strong>and</strong> medical benefits (a significant<br />
<strong>and</strong> growing expense for many companies).<br />
Related to this latter approach is the provision<br />
by some private equity firms <strong>of</strong> shared purchasing<br />
<strong>of</strong> goods <strong>and</strong> services, designed both to<br />
reduce cost <strong>and</strong> increase the efficiency <strong>of</strong> the<br />
procurement process.<br />
Whilst this greater involvement in operational<br />
issues is becoming widespread across the private<br />
equity industry, the approach is not universal.<br />
Some firms identify fundamental difficulties<br />
with its adoption, primarily centred on the<br />
potential for disruption <strong>and</strong> discord it can bring.<br />
The risks it can entail include:<br />
• friction caused by imposing a senior industry<br />
figure on top <strong>of</strong> an existing management team;<br />
• a lack <strong>of</strong> underst<strong>and</strong>ing <strong>of</strong> the private equity<br />
approach by operating partners who come<br />
from a major corporate background; <strong>and</strong><br />
• the added degree <strong>of</strong> risk entailed in backing a<br />
company with an incomplete team, <strong>and</strong> relying<br />
on an operating partner’s input.<br />
Aftercare – who does it<br />
The question <strong>of</strong> where, <strong>and</strong> to whom, a private<br />
equity firm should allocate responsibility for<br />
aftercare is a source <strong>of</strong> perennial debate within<br />
the industry. Broadly speaking, there are three<br />
approaches:<br />
• the original deal team retains responsibility<br />
for the investment;<br />
• responsibility is immediately passed to a dedicated,<br />
specialist aftercare team; <strong>and</strong><br />
• there is a phased transition, with the original<br />
deal team retaining the relationship for a period<br />
<strong>of</strong> time – one or two years – before the<br />
aftercare team takes over.<br />
The arguments in favour <strong>of</strong> the deal team retaining<br />
responsibility are:<br />
• they will have the deepest underst<strong>and</strong>ing<br />
<strong>of</strong> the company at the time the investment<br />
completes;<br />
• they will have built a relationship with the<br />
management team, <strong>and</strong> a first h<strong>and</strong> underst<strong>and</strong>ing<br />
<strong>of</strong> their strengths, personalities,<br />
areas <strong>of</strong> potential weakness <strong>and</strong> development<br />
requirements; <strong>and</strong><br />
• they will have clear ownership <strong>of</strong> the value<br />
creation <strong>and</strong> realisation strategy, having been<br />
primarily responsible for developing it with<br />
the company’s management.<br />
The potential drawbacks to this approach, however,<br />
<strong>and</strong> arguments for a dedicated team include:<br />
• the personalities required <strong>of</strong> investment executives,<br />
to find <strong>and</strong> drive investments through<br />
to completion, do not always suit the different<br />
dem<strong>and</strong>s associated with aftercare;<br />
• the investment team may not have the specialist<br />
sector or operational skills required to add<br />
value; <strong>and</strong><br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 9
Module 9:<br />
Secondaries <strong>and</strong><br />
their alternatives<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-51-1 978-1-904696-51-3<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
What drives the need for liquidity? 5<br />
History – overview <strong>of</strong> the primary private equity market 6<br />
The structural issue <strong>and</strong> transparency 7<br />
The rise <strong>of</strong> specialised secondary funds 8<br />
Secondary sales <strong>and</strong> purchases: practical issues 10<br />
Difficulties in execution 10<br />
Motivations <strong>of</strong> institutional investors: portfolio management 10<br />
Recent variations: primary secondaries 11<br />
More recent variations: direct secondaries 11<br />
The fund managers’ perspective: investor relationships <strong>and</strong> stapled secondaries 12<br />
The role <strong>of</strong> intermediaries 12<br />
Alternatives to secondary sales 13<br />
Trading exchanges/bulletin boards 13<br />
Securitised vehicles 14<br />
Total return swaps 16<br />
The future: The evolution continues 18<br />
Summary 21<br />
Appendix 1: A brief private equity liquidity timeline 22<br />
Appendix 2: Specialised secondary funds 23<br />
Appendix 3: Secondaries – the pricing dynamic 25<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
Kelly DePonte – Probitas Partners<br />
Kelly DePonte is a partner <strong>and</strong> head <strong>of</strong> research <strong>and</strong> due diligence for Probitas Partners’ alternative<br />
fund placement activities. Prior to joining Probitas Partners, Kelly was Managing Director at Pacific<br />
Corporate Group, a leading provider <strong>of</strong> alternative investment advisory, managing <strong>and</strong> consulting<br />
services to institutional clients, where he oversaw the partnership investment program. Before joining<br />
PCG, Kelly held various positions at First Interstate Bancorp in private equity, asset liability management<br />
<strong>and</strong> derivatives. He earned an MBA from the Anderson Graduate School <strong>of</strong> Management at<br />
UCLA, <strong>and</strong> a BA in communications from Stanford University.<br />
iv<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 9 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on private equity secondaries <strong>and</strong> their alternatives. It is designed to<br />
work both as a st<strong>and</strong> alone section <strong>and</strong> as part <strong>of</strong> the whole series. The module<br />
necessarily draws upon topics reviewed in earlier modules, <strong>and</strong> seeks to avoid<br />
repetition <strong>of</strong> their content. However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader,<br />
a comprehensive glossary has been incorporated, which explains the background<br />
<strong>and</strong> use <strong>of</strong> private equity terminology. All terms which may require<br />
explanation or expansion are printed in bold, to indicate that there is a glossary<br />
entry for them.<br />
In any market, secondary activity is driven by<br />
three major factors: volume in the primary market,<br />
investment structure, <strong>and</strong> transparency.<br />
Issues with all <strong>of</strong> these factors mitigated against<br />
the development <strong>of</strong> a strong secondary market<br />
in private equity until the last decade, when the<br />
growth <strong>of</strong> straight secondary sales <strong>and</strong> the creation<br />
<strong>of</strong> liquidity alternatives exploded. Even<br />
though institutional private equity vehicles<br />
have existed since the 1940s, the volume <strong>of</strong><br />
activity in the primary market did not warrant<br />
an institutional approach to secondary activity<br />
until the mid-1980s, <strong>and</strong> only in the late 1990s<br />
did the primary market really begin to dramatically<br />
exp<strong>and</strong>.<br />
What drives the need for liquidity?<br />
Before delving more deeply into history, however,<br />
it is useful to address participant motivations.<br />
Exhibit 1 summarises briefly buyer <strong>and</strong><br />
seller motivations. While some circles may still<br />
stigmatise fund managers whose fund has been<br />
sold, most transactions are driven by the strategic<br />
needs <strong>of</strong> the seller. In fact, in dollar terms,<br />
most transactions have been driven by large<br />
financial institutions – such as banks <strong>and</strong> insurance<br />
companies – who have decided that private<br />
equity is not a core business <strong>and</strong> who use<br />
the secondary market to exit private equity<br />
entirely, with the goal <strong>of</strong> redeploying capital<br />
into core business lines. Recently, more activity<br />
has been driven by institutional investors seeking<br />
to rebalance their portfolios.<br />
It is also important to note the buyer’s motivation.<br />
Increasingly, investors with a long-term<br />
commitment to private equity seek to purchase<br />
positions in specific funds in order either to<br />
develop a relationship with a fund manager<br />
to gain access to future funds being raised,<br />
or to strengthen a relationship with a the man-<br />
Exhibit 1: Summary <strong>of</strong> buyer <strong>and</strong> seller motivations<br />
Why do institutions sell existing<br />
private equity positions?<br />
Most <strong>of</strong>ten, sales <strong>of</strong> private equity funds are driven by<br />
the internal motivations <strong>of</strong> the seller <strong>and</strong> not<br />
performance issues. Reasons for selling include:<br />
• Inability to fund future commitments<br />
• Need for current cash<br />
• Shift in institutional strategy away from private<br />
equity or long-term assets in general<br />
• Need to rebalance portfolio allocations between<br />
private equity sub-sectors<br />
• “House cleaning” <strong>of</strong> stub positions or problem<br />
funds that will not be supported in the future in<br />
order to decrease administrative burdens<br />
Why do institutions buy secondary<br />
private equity positions?<br />
Institutions purchase secondary positions for a variety<br />
<strong>of</strong> reasons given their strategic goals:<br />
• To generate returns based upon the cash flow<br />
potential <strong>of</strong> the portfolio<br />
• To gain access to future funds to be raised by the<br />
general partner <strong>of</strong> the fund being purchased<br />
• To minimise the J-curve impacts on an<br />
overall portfolio<br />
• To rebalance portfolio allocations between private<br />
equity sub-sectors<br />
• To add vintage year or sector diversification to<br />
a portfolio<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
difficult to track, as the exact sub-allocations to<br />
secondaries within fund-<strong>of</strong>-funds, or allocations<br />
within institutional investors’ alternative programs<br />
are not widely advertised <strong>and</strong> can also be<br />
flexibly adjusted. In total, however, the amount<br />
<strong>of</strong> money focused on secondary market investing<br />
is in the range <strong>of</strong> two to three times the amount<br />
raised for specialised secondary funds.<br />
Secondary sales <strong>and</strong> purchases:<br />
practical issues<br />
Difficulties in execution<br />
Though secondary sales have been around for a<br />
long time, there are a number <strong>of</strong> issues that make<br />
the execution <strong>of</strong> secondary transactions difficult.<br />
Problems with the traditional sales process<br />
include the following:<br />
• The potential for deep discounts. Secondary<br />
purchases are usually executed at a discount<br />
to the fund manager’s carrying value though<br />
the level <strong>of</strong> discount fluctuates with market<br />
forces. (A more detailed primer on secondary<br />
pricing dynamics is included in Appendix 3 on<br />
pages 25–26.) Throughout the 1990s, the<br />
increasing number <strong>of</strong> funds focused on secondary<br />
investing resulted in pressure on these<br />
discounts, resulting in transactions being executed<br />
at prices in the range <strong>of</strong> 75 percent to 85<br />
percent <strong>of</strong> reported NAV. With the bursting <strong>of</strong><br />
the internet bubble these discounts increased,<br />
resulting in transaction values <strong>of</strong> zero percent<br />
to 50 percent <strong>of</strong> reported NAV for venture capital<br />
funds, <strong>and</strong> to 40 percent to 70 percent <strong>of</strong><br />
NAV for buyout funds. Over the last three<br />
years the market has rebounded significantly,<br />
to the point that high quality buyout funds<br />
<strong>of</strong>ten trade at a premium to NAV.<br />
• Long time required to execute. The process <strong>of</strong><br />
selling a partnership position takes a long<br />
time. The due diligence process by a potential<br />
buyer to establish a final price – especially<br />
when a portfolio <strong>of</strong> a number <strong>of</strong> partnerships<br />
is involved – can take weeks to accomplish.<br />
Once the due diligence process is completed,<br />
the final sale, or legal transfer <strong>of</strong> rights <strong>and</strong><br />
obligations from one party to another, must be<br />
approved by the fund manager in a process<br />
that can also take weeks or months as the fund<br />
manager <strong>of</strong>ten has little motivation to help the<br />
process <strong>and</strong> respond quickly.<br />
• Right <strong>of</strong> first refusal. A significant number <strong>of</strong><br />
funds contain “right <strong>of</strong> first refusal” clauses<br />
which m<strong>and</strong>ate that, before a position can be<br />
transferred to another investor, current LPs in<br />
the fund have the right to match the price.<br />
This clause can add to the complexity <strong>of</strong> the<br />
sales process <strong>and</strong> affect details <strong>of</strong> the bidding<br />
process.<br />
• Due diligence can be intensive <strong>and</strong> disruptive.<br />
The due diligence process that a buyer necessarily<br />
performs in order to develop a firm bid,<br />
especially in situations where the buyer is not<br />
intimately familiar with the partnerships<br />
being sold, is usually intensive <strong>and</strong> can be disruptive<br />
for both parties. This can result in<br />
damaged relationships with the fund manager<br />
– an important consideration for a buyer<br />
whose interest in purchasing a position may<br />
be driven by a desire to gain access to future<br />
funds to be raised by that same GP.<br />
• May impact the relationship with a fund manager<br />
<strong>and</strong> access to future funds. Selling a partnership,<br />
especially if it is part <strong>of</strong> a targeted<br />
portfolio rebalancing effort as opposed to a<br />
wholesale portfolio sale, may communicate<br />
the message to a fund manager that its efforts<br />
<strong>and</strong> the relationship are not valued. Just as the<br />
purchaser <strong>of</strong> a partnership interest seeks to<br />
establish a relationship, selling a position<br />
communicates the opposite. A seller seeking<br />
to maintain a relationship <strong>and</strong> future access to<br />
a fund being sold needs to proceed carefully.<br />
Motivations <strong>of</strong> institutional investors:<br />
portfolio management<br />
Over the last few years, more institutional<br />
investors (as opposed to specialised secondary<br />
fund managers or fund-<strong>of</strong>-funds managers) have<br />
begun to consider both purchasing <strong>and</strong> selling<br />
positions in the secondary market for portfolio<br />
management purposes. The motivations for<br />
these investors include the following:<br />
• To provide flexibility in rebalancing a portfolio.<br />
A portfolio manager may decide to rebalance a<br />
portfolio in order to reduce overall exposure<br />
<strong>and</strong> maintain it within allocations, or to<br />
decrease or increase exposure to specific market<br />
or industry sectors. The sale <strong>of</strong> positions in<br />
the portfolio or the purchase <strong>of</strong> positions on<br />
the open market can be effective tools to reach<br />
those goals.<br />
• To change portfolio cash flow dynamic. In situations<br />
where a portfolio manager needs to generate<br />
cash, the sale <strong>of</strong> private equity positions<br />
can both generate immediate cash <strong>and</strong> at the<br />
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Exhibit 7: Secondary private equity ABS structure<br />
Portfolio being securitised<br />
Undrawn<br />
commitments<br />
Investments<br />
outst<strong>and</strong>ing<br />
Financing structure<br />
Liquidity facility<br />
“AA” tranche<br />
“A” tranche<br />
“BBB” tranche<br />
“BB” tranche<br />
“B” tranche<br />
<strong>Equity</strong> tranche<br />
Bank or insurance<br />
company<br />
Structured<br />
bond buyers<br />
Purchasers <strong>of</strong><br />
residual risk<br />
Note: The difference in size between the facilities is driven by the discount <strong>and</strong> the need to over collateralise the<br />
top rated tranches.<br />
Securitised vehicles<br />
To date, most <strong>of</strong> the effort in producing structured<br />
vehicles has been in the primary market as<br />
structured fund-<strong>of</strong>-funds, but the technology<br />
developed in this area is now being applied in the<br />
secondary market. The primary goal <strong>of</strong> these<br />
structures as applied to private equity portfolios<br />
is to decrease the discount to NAV on secondary<br />
positions <strong>and</strong> to make the portfolio more marketable<br />
through the use <strong>of</strong> financial structuring.<br />
There is no common nomenclature yet for these<br />
structures, though “collateralised fund obligations”<br />
<strong>and</strong> “private fund obligations” have been used frequently.<br />
They are based on st<strong>and</strong>ard asset backed<br />
security (ABS) financial technologies that have<br />
been used for years to create securities backed by<br />
mortgages, credit card receivables, auto loans,<br />
commercial bank loans <strong>and</strong> corporate bonds.<br />
The goal <strong>of</strong> most ABS structures is to create a more<br />
efficient financing vehicle for assets by taking a<br />
large portfolio <strong>and</strong> stripping the cash flow generated<br />
by the underlying securities into different<br />
obligations. Each “strip” or tranche has different<br />
cash flow characteristics <strong>and</strong> has a credit rating<br />
that declines with each descending strip depending<br />
upon the collateral or cash flow priority held in<br />
support <strong>of</strong> that particular security. The last strip in<br />
the structure is the unrated “equity” strip, which<br />
retains all <strong>of</strong> the residual return <strong>and</strong> risk. Each<br />
strip is then sold to different types <strong>of</strong> investors on<br />
the basis <strong>of</strong> their respective risk/return appetite. A<br />
sample structure is shown in Exhibit 7.<br />
The structure outlined in Exhibit 7 differs from a<br />
typical ABS structure by the inclusion <strong>of</strong> a liquidity<br />
facility. <strong>Private</strong> equity portfolios are different<br />
from most ABS situations in that, even with a seasoned<br />
portfolio, new funding is required as commitments<br />
are drawn down. Though the early<br />
return <strong>of</strong> capital on certain investments provides<br />
a means <strong>of</strong> funding future draw-downs, it is prudent<br />
to arrange a liquidity facility or line <strong>of</strong> credit<br />
with a bank to ensure that future commitments<br />
will be met in a timely manner regardless <strong>of</strong> the<br />
realisation experience <strong>of</strong> the portfolio.<br />
Another way <strong>of</strong> looking at the structure is as a<br />
leveraged investment in private equity for those<br />
willing to invest in the equity tranche. The various<br />
tranches senior to the equity tranche effectively<br />
provide debt financing to purchase the portfolio,<br />
while the residual risks – <strong>and</strong> residual benefits –<br />
accrue to the holder <strong>of</strong> the equity tranche.<br />
To date, relatively few private equity transactions<br />
– either in the primary fund-<strong>of</strong>-funds market or in<br />
the secondary market – have been rated by the<br />
credit rating agencies. However, St<strong>and</strong>ard <strong>and</strong><br />
Poor’s, Moody’s, <strong>and</strong> Fitch’s have all established<br />
rating policies for securities collateralised by portfolios<br />
<strong>of</strong> private equity partnerships. At a summary<br />
level, the policies <strong>of</strong> all three require similar<br />
elements in order to achieve specified rating levels.<br />
These elements include, for example, pr<strong>of</strong>essional<br />
portfolio oversight, specified levels <strong>of</strong><br />
portfolio diversification, differing levels <strong>of</strong> overcollateralisation<br />
or cash flow preference, <strong>and</strong> equity<br />
protection provided by the unrated tranche.<br />
Issues with the ABS structure<br />
Fundamental issues with the ABS structure<br />
have kept it from being widely used as a means<br />
14 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Module 10:<br />
Running a private<br />
equity firm<br />
COPYING WITHOUT PERMISSION IS UNLAWFUL<br />
THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-52-X 978-1-904696-52-0<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This module is part <strong>of</strong> a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private equity.<br />
The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Contents<br />
About the author<br />
iv<br />
Getting the most out <strong>of</strong> this module 5<br />
The institutionalisation <strong>of</strong> private equity <strong>and</strong> its meaning for a general partner 5<br />
Building the right structure: roles <strong>and</strong> responsibilities 6<br />
Human capital: attracting <strong>and</strong> retaining talent 7<br />
Human capital 7<br />
Attracting talent 8<br />
Retaining talent 8<br />
Carried interest: meaning, uses <strong>and</strong> calculation 9<br />
Meaning 9<br />
Uses 9<br />
Calculation 10<br />
Effect <strong>of</strong> GP’s retirement on carried interest 11<br />
Reporting: managing the GP/LP dialogue 11<br />
Objectives 11<br />
Reporting obligations 11<br />
Delivery methods 12<br />
A GP’s technology requirements 12<br />
What does a private equity-specific s<strong>of</strong>tware package have to do? 12<br />
Operational infrastructure 13<br />
Overview <strong>of</strong> the process 13<br />
Different steps necessary 14<br />
Timeframe 15<br />
Costs 15<br />
Fund administration requirements 16<br />
Bookkeeping <strong>and</strong> accounts 16<br />
Investment portfolio activity <strong>and</strong> custody 16<br />
Secretarial <strong>and</strong> compliance 17<br />
Outsourcing fund administration – pros <strong>and</strong> cons 17<br />
Pros 18<br />
Cons 18<br />
Summary 19<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY iii
About the author<br />
David Huckfield – Baring <strong>Private</strong> <strong>Equity</strong> International<br />
David Huckfield has 20 years’ experience in the international private equity industry as a partner <strong>of</strong><br />
Baring <strong>Private</strong> <strong>Equity</strong>. In 2004 he played a leading role in coordinating <strong>and</strong> structuring the 8-way management<br />
buyout <strong>of</strong> the Group from ING Bank. Previously he was Group Chief Operations Officer,<br />
based in London, responsible for operations <strong>and</strong> compliance worldwide. During his tenure funds<br />
under management grew from $100 million to $2 billion as the Group exp<strong>and</strong>ed from a pan-European<br />
partnership with four <strong>of</strong>fices to an inter-continental institution with a network <strong>of</strong> 18 <strong>of</strong>fices in 13<br />
countries managing more than 20 funds. He held more than 60 directorships across the Group <strong>and</strong> is<br />
now a non-executive director <strong>of</strong> Baring <strong>Private</strong> <strong>Equity</strong> International with a focus on corporate governance<br />
st<strong>and</strong>ards. In this capacity he continues to chair the General Partner Boards <strong>of</strong> most <strong>of</strong> the<br />
Group’s $3.4 billion <strong>of</strong> private equity funds operating in Russia, Asia, India, Europe <strong>and</strong> Latin America.<br />
iv<br />
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GETTING THE MOST OUT OF THIS MODULE<br />
Welcome to Module 10 in the <strong>Fundamentals</strong> <strong>of</strong> private equity series. This module<br />
focuses on running a private equity firm. It is designed to work both as a st<strong>and</strong><br />
alone section <strong>and</strong> as part <strong>of</strong> the whole series. The module necessarily draws upon<br />
topics reviewed in earlier modules, <strong>and</strong> seeks to avoid repetition <strong>of</strong> their content.<br />
However, for the benefit <strong>of</strong> the st<strong>and</strong> alone reader, a comprehensive glossary has<br />
been incorporated, which explains the background <strong>and</strong> use <strong>of</strong> private equity terminology.<br />
All terms which may require explanation or expansion are printed in<br />
bold, to indicate that there is a glossary entry for them.<br />
The institutionalisation <strong>of</strong> private<br />
equity <strong>and</strong> its meaning for a<br />
general partner<br />
<strong>Private</strong> equity has long since ceased to be the nascent<br />
industry it was when the first venture capital<br />
pioneers made it a recognisable business<br />
more than quarter <strong>of</strong> a century ago.<br />
Institutionalisation has been defined as “to make<br />
part <strong>of</strong> a structured <strong>and</strong> usually well-established<br />
system” <strong>and</strong> throughout this module there is an<br />
undercurrent <strong>of</strong> what are, in reality, institutional<br />
imperatives that are fashioning the way general<br />
partners (GPs) go about their business. Limited<br />
partners (LPs) <strong>and</strong> GPs alike are becoming more<br />
sophisticated in their approach to the structuring<br />
<strong>of</strong> the product <strong>and</strong> the business process required<br />
to maximise returns on capital.<br />
Investors, especially the largest who are institutions<br />
in their own right, have turned the formation<br />
<strong>of</strong> a fund into a highly complex operation<br />
requiring greater assistance (<strong>and</strong> consequently<br />
expense) <strong>of</strong> specialist legal <strong>and</strong> tax pr<strong>of</strong>essionals<br />
to develop a structure <strong>and</strong> a set <strong>of</strong> fund documents<br />
to help manage the high risks attached to<br />
private equity investments. This is typified by the<br />
range <strong>and</strong> number <strong>of</strong> vehicles that now comprise<br />
a fund <strong>and</strong> the complexity <strong>of</strong> clausing in the fund<br />
partnership agreement; dealing with such matters<br />
as tapering management fees, carried interest<br />
hurdles <strong>and</strong> clawbacks, environmental<br />
policies, corporate governance <strong>and</strong> conflict <strong>of</strong><br />
interest resolution, among others.<br />
Fuelling this trend is the drive by financial services<br />
regulators around the world, especially<br />
those in certain jurisdictions formerly known as<br />
“tax havens” anxious to improve their reputations,<br />
to impose more <strong>and</strong> more regulation on<br />
the private equity industry. Many <strong>of</strong> these regulators<br />
now require practising pr<strong>of</strong>essionals to<br />
pass specialist tests <strong>and</strong> exams leading to GPs to<br />
incur the expense <strong>of</strong> more formal training programmes<br />
before being licensed to operate.<br />
Training programmes have also had to be<br />
extended to include anti-money laundering procedures<br />
which can look like maddening bureaucracy<br />
to a GP dealing with world-renowned<br />
institutional investors.<br />
Freedom <strong>of</strong> Information legislation is in a similar<br />
way feeding a media frenzy for disclosure <strong>of</strong><br />
fund performance data, previously subject to<br />
restricted access by GPs, especially from<br />
investors in the public sectors as their investment<br />
<strong>of</strong> pensioners funds come under closer<br />
scrutiny. Major investors, private equity associations<br />
<strong>and</strong> other trendsetters are at the same<br />
time seeking greater transparency in fund<br />
reporting. All this is presenting GPs with a<br />
greater challenge to their obligations under<br />
confidentiality undertakings to portfolio companies<br />
<strong>and</strong> competing legislation such as insider-trading<br />
laws which is taking up more<br />
management time in designing systems that<br />
provide a happy medium.<br />
These disclosure dem<strong>and</strong>s have also led to the<br />
creation <strong>of</strong> industry guidelines such as the International<br />
<strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong> Guidelines<br />
<strong>and</strong> the Corporate Governance <strong>and</strong><br />
Pr<strong>of</strong>essional St<strong>and</strong>ards <strong>and</strong> Reporting Guidelines<br />
endorsed by the European <strong>Venture</strong> <strong>Capital</strong><br />
Association, among others. Market <strong>and</strong> peer<br />
pressure on GPs to adopt such guidelines means<br />
greater investment in systems <strong>and</strong> procedures<br />
<strong>and</strong> an increase in the dem<strong>and</strong> for private equity<br />
specific s<strong>of</strong>tware to facilitate reporting.<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 5
<strong>of</strong> members including representatives <strong>of</strong> certain<br />
larger (for example: exceeding $X million or Y<br />
percent), Investors in the fund <strong>and</strong> sometimes<br />
individuals with no affiliation to the fund. The<br />
advisory council will meet at least twice a year to<br />
receive a report from the GP on matters falling<br />
within the jurisdiction <strong>of</strong> the advisory council<br />
which may include:<br />
• consenting to, reviewing or waiving any matter<br />
requiring their consent under the partnership<br />
agreement such as departures from the<br />
main investment strategy, investments that<br />
exceed specified limits;<br />
• approving the budget for partnership expenses;<br />
• approving changes in named key men who<br />
have left the employment <strong>of</strong> the GP;<br />
• reviewing <strong>and</strong>/or approving portfolio valuations;<br />
<strong>and</strong><br />
• reviewing <strong>and</strong>/or resolving conflicts <strong>of</strong> interest.<br />
Delivery methods<br />
The annual financial statements <strong>and</strong> associated<br />
reports due under the partnership agreement<br />
will normally by distributed by post but may also<br />
be sent by email where agreed. In addition GPs,<br />
or their fund administrators where outsourcing is<br />
used, may make such information available to<br />
authorised users via secure websites.<br />
The partnership agreement will also usually<br />
require the GP to hold an annual meeting <strong>of</strong> LPs.<br />
The agenda <strong>of</strong> such meetings typically include<br />
detailed reporting on the progress <strong>of</strong> the fund<br />
<strong>and</strong> its investment portfolio including presentations<br />
from portfolio company CEOs.<br />
It is also <strong>of</strong>ten the practice <strong>of</strong> GPs to send LPs<br />
newsletters from time to time reporting material<br />
events such as new investments, realisations<br />
<strong>and</strong> milestone achievements.<br />
A GP’s technology requirements<br />
What does a private equity-specific<br />
s<strong>of</strong>tware package have to do?<br />
GPs need s<strong>of</strong>tware packages that fulfil many functions<br />
including storing records, calculating statistics,<br />
maintaining accounts <strong>and</strong> generating reports.<br />
They may choose a number <strong>of</strong> discrete separate<br />
s<strong>of</strong>tware applications or a “one-stop-shop” solution<br />
from one <strong>of</strong> the growing number <strong>of</strong> providers<br />
that have developed custom packages based on a<br />
range <strong>of</strong> platforms specially to meet the needs <strong>of</strong><br />
the private equity industry. Alternatively they may<br />
be content to develop “home-made solutions”<br />
using st<strong>and</strong>ard <strong>of</strong>f-the-shelf spreadsheet, database<br />
<strong>and</strong> presentation s<strong>of</strong>tware.<br />
The main factors that influence their preferred<br />
choice <strong>of</strong> solution are the scale <strong>of</strong> their business,<br />
the financial cost <strong>of</strong> replacing legacy systems <strong>and</strong><br />
the human resources required to achieve the<br />
transition. Least inclined to embark on significant<br />
investment in custom applications are the<br />
small firms operating entirely from a single site<br />
without any outsourcing <strong>of</strong> fund administration.<br />
They are likely to have developed their own inhouse<br />
systems using proprietary s<strong>of</strong>tware tools.<br />
Larger firms with a more complex business<br />
model, for example, operating internationally<br />
<strong>and</strong> using third-party administrators are most<br />
likely to be attracted by the prospects <strong>of</strong><br />
installing an “all singing-all dancing” custombuilt<br />
solution.<br />
The main tasks that private-equity specific s<strong>of</strong>tware<br />
has to do relate to the source <strong>and</strong> application<br />
<strong>of</strong> funds under management <strong>and</strong> include<br />
the following:<br />
• Marketing <strong>and</strong> contact relationship management.<br />
This will include an address book module<br />
for existing <strong>and</strong> potential contacts who may<br />
be investors, portfolio companies, intermediaries<br />
etc; it must be able to h<strong>and</strong>le the coordinates<br />
<strong>and</strong> <strong>of</strong> multiple contacts with individual<br />
organisations <strong>and</strong> link into other modules <strong>of</strong><br />
the s<strong>of</strong>tware. Records should include pr<strong>of</strong>ile<br />
information that will enable data sorting,<br />
analysis <strong>and</strong> reporting. In marketing it is used<br />
to identify potential investors for new funds<br />
<strong>and</strong> coordinate approaches to them.<br />
• <strong>Capital</strong> account transacting. Possibly included<br />
in the fund accounting module but <strong>of</strong>ten<br />
tracked in greater detail in a module <strong>of</strong> its<br />
own. This must be capable <strong>of</strong> h<strong>and</strong>ling various<br />
ratios for the allocation <strong>of</strong> the purchase <strong>and</strong><br />
sale <strong>of</strong> investments, operating revenue <strong>and</strong><br />
expenses, realised <strong>and</strong> unrealised pr<strong>of</strong>its <strong>and</strong><br />
losses, capital calls <strong>and</strong> distributions.<br />
• Dealflow tracking. For every investment that is<br />
made, a private equity firm may process many,<br />
many more to a greater or lesser extent. Some<br />
may be rejected as non-starters, some may<br />
proceed to one or more meetings with the<br />
entrepreneurs, others may be the subject <strong>of</strong><br />
work-in-progress for many months <strong>and</strong> be<br />
12 THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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Glossary<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY
Published in September 2007 by:<br />
<strong>PEI</strong> <strong>Media</strong><br />
Second Floor<br />
Sycamore House<br />
Sycamore Street<br />
London EC1Y 0SG<br />
United Kingdom<br />
Telephone: +44 20 7566 5444<br />
© 2007 <strong>PEI</strong> <strong>Media</strong> Ltd.<br />
ISBN 1-904696-53-8 978-1-904696-53-7<br />
This publication is not included in the CLA Licence so you must not copy any portion <strong>of</strong> it without the<br />
permission <strong>of</strong> the publisher.<br />
All rights reserved. No parts <strong>of</strong> this publication may be reproduced, stored in a retrieval system or<br />
transmitted, in any form or by any means, electronic, mechanical, photocopy, recording or otherwise,<br />
without the prior written permission <strong>of</strong> the publisher.<br />
The views <strong>and</strong> opinions expressed in the book are solely those <strong>of</strong> the authors <strong>and</strong> need not reflect<br />
those <strong>of</strong> their employing institutions.<br />
Although every reasonable effort has been made to ensure the accuracy <strong>of</strong> this publication, the publisher<br />
accepts no responsibility for any errors or omissions within this publication or for any expense<br />
or other loss alleged to have arisen in any way in connection with a reader's use <strong>of</strong> this publication.<br />
This glossary is associated with a series <strong>of</strong> 10 modules entitled The fundamentals <strong>of</strong> private<br />
equity. The modules in this series are:<br />
Module 1<br />
Module 2<br />
Module 3<br />
Module 4<br />
Module 5<br />
Module 6<br />
Module 7<br />
Module 8<br />
Module 9<br />
Module 10<br />
Glossary<br />
What is private equity <strong>and</strong> venture capital?<br />
<strong>Private</strong> equity as an asset class<br />
Structuring <strong>and</strong> raising a fund<br />
<strong>Venture</strong> <strong>and</strong> development capital<br />
Management <strong>and</strong> leveraged buyouts<br />
<strong>Private</strong> equity real estate <strong>and</strong> infrastructure<br />
Due diligence<br />
Aftercare <strong>and</strong> exits<br />
Secondaries <strong>and</strong> their alternatives<br />
Running a private equity firm<br />
A comprehensive list <strong>of</strong> private equity terms<br />
<strong>and</strong> definitions<br />
To order any <strong>of</strong> the modules in this series, please contact <strong>Private</strong> <strong>Equity</strong> International on:<br />
+44 20 7566 5444.<br />
ii<br />
THE FUNDAMENTALS OF PRIVATE EQUITY<br />
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LP<br />
Management buy-in (MBI)<br />
Management buyout (MBO)<br />
Management fee<br />
Management ratchet<br />
M<strong>and</strong>atory redemption<br />
Market flex<br />
Marketability discount<br />
MBO<br />
MBI<br />
Mezzanine financing/loan<br />
Mezzanine notes<br />
Middle market<br />
Multiple<br />
See Limited partner.<br />
Where an outside manager or team purchases an ownership stake<br />
in a company <strong>and</strong> replaces the existing management team.<br />
The acquisition <strong>of</strong> a company by its management team, usually in<br />
partnership with external lenders <strong>and</strong>/or private equity investors.<br />
The fee paid by a private equity fund to the fund’s manager, generally<br />
in the range <strong>of</strong> 1.5 percent to 2.5 percent <strong>of</strong> the fund’s committed<br />
capital per annum. The fee is intended to cover the manager’s<br />
overhead <strong>and</strong> salary costs in finding, making <strong>and</strong> monitoring<br />
investments. It will scale down in later years as the fund’s portfolio,<br />
<strong>and</strong> hence the associated workload, reduces.<br />
See Ratchet.<br />
The requirement for a company to purchase all <strong>of</strong> an investor’s<br />
shares, at a set price on a certain date.<br />
Changes made to the terms <strong>of</strong> a loan (principally the interest rate),<br />
within limits pre-agreed with the borrower, in order to match them<br />
to market conditions when selling parts <strong>of</strong> the loan onto other<br />
lenders in a syndicate<br />
A discount applied to the valuation <strong>of</strong> an unquoted company to<br />
reflect that fact that its shares are not publicly-quoted <strong>and</strong> cannot<br />
be sold in an open market. Generally varies from 0 to 30% according<br />
to the size <strong>of</strong> the company, <strong>and</strong> the certainty <strong>and</strong> likely timing<br />
<strong>of</strong> an exit.<br />
See Management buyout.<br />
See Management buy-in.<br />
A junior loan which carries the right to participate in the equity <strong>of</strong><br />
the borrower, usually by carrying options to purchase shares at a<br />
nominal value. Hence mezzanine lies somewhere between pure<br />
equity <strong>and</strong> pure debt finance. Mezzanine loans will usually carry a<br />
significantly higher interest rate than that which applies to senior<br />
debt, <strong>and</strong> will carry a long-term (eight or more years) bullet<br />
repayment.<br />
Publicly-traded bonds which have mezzanine terms.<br />
Medium-sized companies; definitions vary according to region, but<br />
in Europe companies valued in the €100 million to €500 million<br />
range would be regarded as mid-market.<br />
A means <strong>of</strong> valuing a company by multiplying a key financial indicator,<br />
such as EBIT. The higher the multiple, the higher the anticipated<br />
growth rate in pr<strong>of</strong>it or cash generation. The price earnings<br />
ratio commonly calculated for public companies, by dividing the<br />
share price by earning per share, is a multiple.<br />
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THE FUNDAMENTALS OF PRIVATE EQUITY 15
The <strong>Fundamentals</strong> <strong>of</strong> <strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong><br />
As the private equity <strong>and</strong> venture capital industry continues to<br />
exp<strong>and</strong> <strong>and</strong> evolve globally it is crucial that pr<strong>of</strong>essionals<br />
entering the industry underst<strong>and</strong> its many facets fully. The<br />
<strong>Fundamentals</strong> <strong>of</strong> <strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong> provides<br />
a comprehensive manual to all those wanting an accessible,<br />
informed <strong>and</strong> insightful guide to this dynamic asset class. This<br />
unique series pulls together the ten most important topics on<br />
private equity <strong>and</strong> venture capital <strong>and</strong>, as a set, delivers an allencompassing<br />
guide to the subject. Whether a new entrant to<br />
this market wanting to gain a clear underst<strong>and</strong>ing <strong>of</strong> the industry<br />
or a pr<strong>of</strong>essional needing to exp<strong>and</strong> their knowledge on a<br />
specific area, The <strong>Fundamentals</strong> <strong>of</strong> <strong>Private</strong> <strong>Equity</strong> <strong>and</strong><br />
<strong>Venture</strong> <strong>Capital</strong> is a vital resource to all those working in the<br />
private equity or venture capital industry wherever you are<br />
based in the world.<br />
Brought to you by the team that publishes <strong>Private</strong> <strong>Equity</strong> International<br />
<strong>and</strong> <strong>Private</strong><strong>Equity</strong>Online.com, The <strong>Fundamentals</strong> <strong>of</strong><br />
<strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong> is split into ten modules <strong>and</strong><br />
a detailed up-to-date glossary – essential for any pr<strong>of</strong>essional in<br />
need <strong>of</strong> an underst<strong>and</strong>ing <strong>of</strong> individual elements <strong>of</strong> the industry<br />
or <strong>of</strong> the asset class as a whole.<br />
These modules are:<br />
1.<br />
2.<br />
3.<br />
4.<br />
5.<br />
6.<br />
7.<br />
8.<br />
9.<br />
10.<br />
11.<br />
What is <strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong>?<br />
<strong>Private</strong> <strong>Equity</strong> as an Asset Class<br />
Structuring <strong>and</strong> Raising a Fund<br />
<strong>Venture</strong> <strong>and</strong> Development <strong>Capital</strong><br />
Management <strong>and</strong> Leveraged Buyouts<br />
<strong>Private</strong> <strong>Equity</strong> Real Estate <strong>and</strong> Infrastructure<br />
Due diligence for <strong>Private</strong> <strong>Equity</strong> <strong>and</strong> <strong>Venture</strong> <strong>Capital</strong> Firms<br />
Aftercare <strong>and</strong> Exits<br />
Secondaries <strong>and</strong> their Alternatives<br />
Running a <strong>Private</strong> <strong>Equity</strong> Firm<br />
Glossary<br />
<strong>Fundamentals</strong> is a must-have companion for any private<br />
equity firm, investment group, investment bank or advisory firm<br />
engaged with the industry. It has been expressly written <strong>and</strong><br />
designed to deliver concise guidance <strong>and</strong> analysis, drawing<br />
on the real-world expertise <strong>of</strong> its authors <strong>and</strong> editor.<br />
KEY FEATURES<br />
• <strong>Fundamentals</strong> has been written <strong>and</strong> edited by three<br />
established authors <strong>and</strong> pr<strong>of</strong>essionals in the field <strong>of</strong> private<br />
equity <strong>and</strong> venture capital: Garry Sharp, Kelly DePonte <strong>and</strong><br />
David Huckfield.<br />
• Modules include real world examples <strong>and</strong> case studies from<br />
leading firms involved with private equity <strong>and</strong> venture capital.<br />
• Key articles from <strong>Private</strong> <strong>Equity</strong> International supply<br />
relevant commentary <strong>and</strong> context.<br />
• The layout <strong>of</strong> every module has been designed to optimise<br />
ease <strong>of</strong> use <strong>and</strong> comprehension, including valuable data in<br />
charts <strong>and</strong> tables, boxed checklists <strong>and</strong> valuable section<br />
summaries.<br />
• The language is accessible <strong>and</strong> friendly <strong>and</strong> delivers<br />
important knowledge in a digestible way.<br />
• A list <strong>of</strong> recommended reading is included to enhance your<br />
knowledge further.<br />
• A comprehensive <strong>and</strong> up-to-date glossary <strong>of</strong> industry terms<br />
is included.