Growth Equity & Buyout Funds.pdf

1. Growth Equity & Buyout Funds
Venture Capital & Private Equity

2. Basic Value Creation Formula: Fundamental Idea
1) Re-focuses acquired businesses resulting in lower costs
and improved efficiency.
2) Value is created through basic finance that says debt can
increase firm value if you can afford it!
• Exploits corporate aversion to debt (Henry McVey,
Morgan Stanley).
3) Regulatory Arbitrage – Sarbanes-Oxley

3. The Basic Value Creation Formula
Debt can increase Value
Dupont Equation
Equity
Assets
Total
X
Assets
Total
Sales
X
Sales
NI
Equity
NI
ROE 

Leverage – Debt as % of Assets
 Equity  Multiplier  ROE

4. The Basic Value Creation Formula
Debt can increase Value – Unleveraged
Firm (all Equity Financed) vs Leverage
Firm
ROE
Equity
Assets
Total
X
Assets
Total
Sales
X
Sales
NI

%
16
100
16
100
100
100
160
160
16


X
X
Consider a company that takes on debt at a cost of $3 in Net Income, but
changes NOTHING ELSE.
Could drop NI to 4.8 and still match the previous ROE!!
%
40
30
12
30
100
100
160
160
12


X
X

5. Analysis of Value Creation
Unleveraged Firm/All Equity Financing:
• NPM is $ 16 M; Sales=$ 160 M; Total Assets = $ 100 M
Leveraged Firm:
NPM is $ 12 M; Sales=$ 160 M; Total Assets = $ 100 M; Interest Cost= $ 4
M
Note: Difference in NPM in both firms is $ 4 M that represents Interest Cost
Leverage Ratios:
Equity Multiplier = $ 100 M / $ 30 M = 3.33 times
Debt to Equity = [$ 100 - $ 30]/ $ 30 M = 2.33 times
ROE is way to higher for leveraged firm as opposed to all equity financed
firm: 40% versus 16%!

6. Growth Equity
• Growth equity (also known as growth capital or
expansion capital) is a type of investment
opportunity in relatively mature companies that
are going through some transformational event in
their lifecycle with potential for some
dramatic growth.

7. Growth Equity
• Growth equity funds invest in fast-growing
businesses (which have moved beyond the start-
up stage) in exchange for a minority equity stake.
• Given the lack of control, a strong working
relationship and trust-based partnership between
the investors, existing owners, and management
are required to achieve the desired outcome:
advancing the company to a new stage of
development.

8. Defining Characteristics of Growth Equity

9. Value Creation in Growth Equity

10. Buyout Funds
• In private equity, Buyout Funds and investors
seek out underperforming or undervalued
companies that they can take private and turn
around.

11. Defining Characteristics of Buyout Funds

12. Leveraged Buyout (LBO)
Case 1 (5 years) – No Profit Increase Case 2 (5 years) – Profit Increase
The Basic Value Creation Formula – An Example
of Carlyle Group

13. Analysis of Buyout Transaction
Key Financial Prior to Buyout:
Annual Profit of Target/Investee Co. : $ 10 Million
Entry Multiple: Price Paid for Buyout
10 Times multiple of Annual Profit:
10 x $ 10 Million = $ 100 Million
Debt Level: $ 70 Million
Equity: $ 30 Million

14. Analysis of Buyout Transaction
Exit Scenario – I [With Partial Debt Repayment]:
Debt Repayment: $ 30 Million
Remaining Debt: $ 40 Million
Exit Multiple: @ 10 Times => 10 X $ 10 Million = $ 100 Million
Net Proceeds: Sale Price – Remaining Debt
 $ 100 Million - $ 40 Million = $ 60 Million
Return on Investment (ROI): Net Proceeds / Equity Investment
= $ 60 M /$30 M = 100%
Annualized ROI: 14.9% approx. 15% (5 years)

15. Analysis of Buyout Transaction
Exit Scenario – II [No Debt Repayment]:
Debt Repayment: $ -0-
Remaining Debt: $ 70 Million
Exit Multiple: @ 15 Times => 15 X $ 10 Million = $ 150 Million
Net Proceeds: Sale Price – Remaining Debt
 $ 150 Million - $ 70 Million = $ 80 Million
Return on Investment (ROI): Net Proceeds / Equity Investment
= $ 80 M /$30 M = 100%
Annualized ROI: 21.7% approx. 22% (5 years)

16. Thank you