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Introduction to Private Equity
- 1. Introduction to Private Equity Gustavo Velez
- 2. Appendix • Introduction to PE • Debt Financing • Company Screening • Leveraged Buyout Disclaimer: This guide aims to provide a high level overview of what is private equity. PPT should merely serve as a guide.
- 3. Introduction to PE What is PE? • Investment Management Company • Practice of acquiring firms, through debt financing (LBO), improving its operations, and exiting at a profit Venture Capital (VC): early stage seed funding for startups Middle Market PE: PE focused on small/mid-sized companies with revenues < $500 million Public to Private: practice of taking public companies private Deal Size Types of Investment Growth Capital: minority investment intended to restructure operations, enter new markets, or finance significant acquisition without change of control in the business Bolt on Acquisition: company purchased for add-on to existing firm in Fund’s portfolio Principal Co. Investment: Traditional investment methodology PE Fund Subsidiary A Subsidiary B Subsidiary C PE Portfolio = Subsidiaries
- 4. Introduction to PE PE Process Step 1: Deal Sourcing Step 2: Due Diligence Step 3: Close Deal Step 4: Grow & Improve Company Performance Step 5: Sell (3 – 6 years) Different PE funds will have different investment methodologies and procedures. It is important to note that some firms specialize in specific industries, products, etc. Varies by Firm Conceptually Private equity firms purchase businesses with minimum equity investments (high leverage). The firm then strives to cut costs, grow business, and improve performance/revenue over the holding period. Excess cash that is generated from the business is used, in several cases, to pay off debt. Lower debt means a higher percentage of equity in the business and a higher bottom line payout for investors
- 5. Company Screening Criteria Stable and recurring Cash Flows Low Cyclicality / Seasonality Growing Industry Sustainable Competitive Advantage Low Capital Expenditures (CAPEX) Strong Management Team Private Equity firms look for companies that have high and stable cash flows, which can hold a high debt load. Ability to cover your interest expense is essential to staying in business and avoiding bankruptcy issues. Size of businesses, industry preference, and other business characteristics vary by PE fund. *While traditional PE firms invest in companies with these criteria, there are funds that deviate from this investment strategy.
- 6. Leveraged Buyouts What is An LBO Acquisition of Company primarily through debt financing Leveraging an Asset can provide higher returns through minimal equity investments Common Terminology Exit Multiples Equity IRR Leverage Ratio Interest Coverage Ratio EV/EBITDA Net Debt/EBITDA LTM EBITDA The Purchase House: $100k Down Payment (Equity): $35 Mortgage (Debt): $65 Over a period of 5 years: $20 of debt are repaid Demand for Houses along with improvements drive the price of the House up 30% The Sale House: $130k Equity: $85 Mortgage (Debt): $45 LBO – (Like taking Mortgage)
- 7. Debt Financing Term Loans or Revolvers Senior Claim to Business Collateral – Asset Based Requires Interest + Principal Payments Lowest Interest Payment (lowest risk) Referred to as 1st Lien / 2nd Lien Biggest chunk of financing BBB Credit Rating or Lower Below senior debt / Usually Unsecured No Collateral – Cash Based High Interest Rates – No Principal Payment Covenant Requirements Both Debt and Equity Like Qualities Convertible Option Attached Warrants Preferred Stock with Warrants Unsecured with very few covenants Mezzanine Finance High Yield Bonds Bank Debt (Revolver/Term Loans) Institutional Investors & Banks Institutional Investors Hedge Funds & Mezz Funds
- 8. End GVA | Finance Academy