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PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS
       Session 2. Private Equity deal origination,
         execution and portfolio management




                                                                         March 2013

                                                                    Alexey Milevskiy
                                                                     Gleb Fomichev


                    The presentation is prepared solely for the purposes of master classes
                                                        at the Higher School of Economics
Session 1
 wrap-up


            2
Speakers


    Alexey Milevskiy
    Alexey Milevskiy is an Investment Manager at UFG Private Equity,
    leading Private Equity firm managing over $500 million across several
    funds in Russia and CIS. He participated in all stages of investment
    process: origination, due diligence, structuring and execution.
    Prior to UFG PE Alexey worked at European Private Equity division of
    GIMV in Belgium, KPMG Business Valuation group and ING Bank.
    Alexey holds masters degree from Vlerick Business School, Belgium and
    bachelors from Higher School of Economics. He is also the winner of
    several McKinsey&Co business case competitions.



    Gleb Fomichev
    Gleb Fomichev is an Analyst at JSFC Sistema, major Russian
    investment company. Gleb is one out of 7 investment professionals
    running Sistema’s $2 billion portfolio of high technology assets. He is
    engaged in strategy development and portfolio companies management
    as well as in new deals origination.
    Prior to Sistema Gleb worked at A&NN Group, one of the top performing
    Russian family office, where he managed fund’s assets in retail,
    telecommunications, logistics, publishing and financial services sectors.
    Gleb’s other experience includes E&Y business valuation team. Gleb
    holds masters and bachelors degree from Higher School of Economics.




                                                                                3
Session 1. Private Equity landscape


  1st part
  • Private Equity definition;
  • Company funding lifecycle: FFF, business angels, venture capital, private equity, IPO;
  • Organizational structure of a PE fund: LP-GP agreements;
  • Typical activities performed by PE fund: fund raising, deal sourcing and originating, due diligence,
    management of portfolio companies, exits;
  • Key success factors for PE deals;


  2nd part
  • Russian PE/VC landscape: PE funds, captive funds and family offices, government-backed funds,
    venture capital funds;
  • Russian vs Foreign PE industry;
  • Entry strategies: full buyout, growth capital, LBO, minority recapitalization, mezzanine, distressed
    situations.
  • Exit strategies: IPO, trade sale to strategic/financial investor, MBO, sale to other shareholder;
  • PE careers.




                                                                                                           4
Private Equity definition




          Private equity is a:
           • medium to long-term financing
           • provided in return for an equity stake
           • in potentially high growth
           • unquoted companies




                                                      5
Private Equity value creation formula




                                                      Multiple
            EBITDA growth                 Leverage
                                                     Expansion

       Topline           Efficiency
       growth          improvement




                            Superior returns



                                                                 6
What value Private Equity fund brings


 PE Entry                 Value creation within 3-5 years                                     Exit
             Financial support
             - Raising new equity rounds and debt financing
             - Financial planning and cost control, IFRS implementation
             - Introducing transparent reporting system
             M&A support
             - Developing M&A strategy
             - Search and valuation of attractive acquisition targets
             - Legal support and deal structuring
             - Integration assistance
             Operational support
             - Help in bringing top experienced people to the team to bridge personnel gaps
             - Attracting independent board members and industry experts
             - Motivation schemes implementation
             - Development of tax and legal structure, IT-systems
             - Access to a new partner and client network, help in expanding abroad
             - Optimization business processes and internal decision-making

             Help in forming/ adapting company strategy
             - Business model adaptation to changing market realities
             - Implementing company development plan and setting KPI’s
             Preparing company for an IPO or trade sale
             - Improvement of corporate governance
             - Substituting investment banks at exit
             - Legal support and deal structuring

                                                                                                     7
Private Equity target returns




                                IRR 30%
       Cash-on-cash 3x over 5 years




                                          8
Investment approach and key success factors




    1     Market leaders are typically winning

    2     Strong and motivated management team

    3     Fair entry price

    4     Proper deal structuring

    5     Proactive monitoring

    6     Clear exit strategy

    7     Industry growth and deep market expertise


                                                      9
Private Equity fund structure



        Limited Partners            Distribution
     Institutional investors        of proceeds
      • Pension funds
      • Sovereign wealth funds
      • Financial institutions
     HNWI

                Disbursement
                of commitments                          Carry
                                      Fund
                                                                  General Partners
                                                                PE or VC firm


                           Equity            Exit
                       Investment            proceeds


                             Investee company


                                                                                     10
Typical PE/VC fund remuneration structure



                               Management fee 2%


                     LP                                    GP

                                   Carry 20%

    Management fee of 2% is charged on the total amount of committed/invested
    capital.
    Carry is received upon exit from portfolio investments.
    • First, LPs get total commitments at cost plus hurdle rate (8-10% annual).
    • Second, remaining exit proceeds split while 80% goes to LPs and 20% to
      GPs.

    Carry is the main part of total remuneration and its existence ensures that the
    interests of LPs and GP are aligned and GP focused on value maximization
    and successful exits.


                                                                                      11
Company funding lifecycle


  Revenue




                                                         IPO


                                        Private Equity


                             Venture Capital

                   Business
                    angels

            FFF                                                    Time

        Start-up            Early          Growth         Mature


                                                                          12
Typical activities performed by PE fund




     Pre-deal        Deal origination     Deal screening   Due Diligence




     Deal             Negotiation            Structuring
                             Deal sourcing



                       Company
     Post-deal       management,                Exit
                     value creation




                                                                           13
Deal screening example



                                      Number of
                                        deals

                   Deal received       500

                   Signing NDA         200

               Investment Committee     20

                   Due diligence         3

                 Docs drafting and       2
                     closing

                                                  14
Russian PE industry landscape


   Institutional funds   Captive funds                    Government-
                                         Family offices
                                                            backed




                                                                        15
Russian VC industry landscape


   International funds    Russian funds   Accelerators   Government-
                                                           backed




                                                                   16
Entry strategies


                     Target         Stake           Deal             Deal        Fund’s        Type of
                    company        acquired      structure         funding      strategy        fund
                      stage
                                                                                               Classical
                                                   Current                                     PE funds,
                      Growth/                                      Debt/Self     Buy and
 Buyouts              Mature
                                     >50%        shareholders
                                                                   financed       build
                                                   cash out                                    mezzanine
                                                                                                 funds
                                               New issued stock                 Financial
                                                                                                Venture
                      Growth/                  purchase/current       Self       investor
 Growth capital       Mature
                                     <20%
                                                 shareholders      financed     (funds for
                                                                                               funds, PE
                                                                                                 funds
                                                partial cash out                 growth)

                                                                                 Financial
                                                                                                Venture
 Development                                   New issued stock       Self       investor
                    Early/Growth     <20%                                                      funds, PE
 capital                                          purchase         financed     (funds for
                                                                                                 funds
                                                                                 growth)

                                                                                 Financial
                                                   Current
 Minority             Growth/                                         Self       investor      Classical
                                     <50%        shareholders
 recapitalization     Mature                                       financed     (funds for     PE funds
                                                   cash out
                                                                                  growth

                                                                               Reorganizati     Special
 Distressed           Mature/                  Debt obligations       Self
                                   >50%/100%                                      on and       situations
 situations           Decline                    assignment        financed
                                                                               restructuring      funds


                                                                                                        17
Exit strategies


                                           Acquisition of a target by it’s current management
    Company                                 team
  size/maturity   MBO                      Management’s stake before MBO - zero/
                                            insignificant
                                           Example: buyout of a non-core subsidiary

                                                 Disagreements on company’s development
                      Sale to other               strategy
                                                 Dead lock danger
                       shareholder
                                                 Spin offs, non cash-deals


                                                         Acquisition by a new vehicle created
                                                          by new PE investor/strategic
                           Secondary buyout               investor
                                                         The third, forth, etc buyout rounds
                                                          may also take place

                                                                 Most IPO proceeds – growth
                                                                  and development capital
                                IPO                              Only partial cash out of
                                                                  current shareholders is
             Likelihood
                                                                  possible
             of positive
              target’s
            performance


                                                                                             18
PE careers

  Entry strategy                                                     Exit opportunities
                                       Partner          Unlimited


  Work experience in                                                Top management
                                  Investment director   Unlimited
   Private equity                                                     positions in industry
  Successful completed                                              Top management
   deals track record                                                 position in fund’s
  Recruiters, networking                                             company/project
                                                                     Own business/project
                                        VP/ Associate      1-3
                                          director                    launch
                                                          years


  Work experience in Big4,                                          Middle level
   IB, Industry is required                Associate/      1-3        management positions
  Recruiters, networking                                 years       in industry
                                          Investment
                                            manager                  Upside position in a
                                                                      smaller fund
                                                                     Own project launch

                                                           1-3
                                           Analyst        years

  Last year students
                                          Internships
  Applications on career sites

                                                                                              19
Session 2. PE deal origination, execution and portfolio management


  1st part
  Industry analysis
  • Investment strategies: buy-and-build vs bet-and-win;
  • Industry KPIs and application for financial modeling;
  • Multiples variation by industries.

  Financial modeling and leveraged buyouts
  • Financial statement analysis: application for private equity;
  • Valuation methods: multiples approach, comparable transactions approach;
  • Private equity returns calculations: IRR, cash-on-cash, exit sensitivity analysis.
  • LBO and financing of M&A transactions: debt and mezzanine financing for PE deals.

  2nd part
  Due diligence
  • Commercial, financial and tax, legal due diligence

  Deal structuring and negotiations
  • Legal documents for deal execution: NDA’s, LOI’s, Term Sheets, SHA’s, SPA’s;
  • Off-shore holding structures: English law, possible holding schemes.
  • Deal structuring tools
  • Deal negotiations: habits for effective negotiations.

  Portfolio companies management
  • Fund representation on the board of directors: strategy formulation, veto and approval rights, audit and
    compensation committees;
  • Companies monitoring: weekly/monthly management reporting packs, frequent interaction with management;
  • Value creation strategies: fund raising, building corporate governance, management appointment, solving
    operational issues, attracting consultants, finding clients, exit preparation, synergy identification among portfolio
    companies.


                                                                                                                            20
Industry Analysis


                    21
Examples of attractive sectors in the current environment


     Sector                                    Investment rationale

     1   Undeveloped industries/ sectors with high growth potential

 •   Internet tech companies                  • High Internet growth rates
 •   E-commerce                               • Service infrastructure is still underdeveloped
 •   Medical Services                         • Limited modern private medical services
 •   Fast Food
 •   Logistics


     2   Traditional sectors

 •   Food retail                              • Import substitution
 •   FMCG                                     • M&A opportunities, important to find right
 •   Pharmaceutical industry                    platform for consolidation
 •   Media, telecom                           • Regional growth potential
                                              • New formats/ products development
                                              • Room for improvement (margins, working
                                                capital)



                                                                                             22
Two types of investment strategies investment strategies


 Two investment strategies

 “Bet-and-win”                                “Buy-and-build”

 • Industry with high growth potential    •   Good industry knowledge
 • Investment in market leader            •   Building market leadership through M&A
 • Investment in strong management        •   Strengthen management team
   team                                   •   “Discount entry price”
 • “Fair entry price”                     •   Majority stake buy-out
 • Minority investment

  Undeveloped industries/ sectors with        Traditional sectors
  high growth potential


 Common principles

 • The market in which the Company operates should be at least $100 million
 • The demand for the Company products or services should be justified by macro trends
 • The business model should be proven/ sustainable/ scalable


                                                                                       23
Private Equity focuses on rapidly growing sectors


                     Penetration Disposable   Consolidation Stable  Import       Regional   Growing       Under-
                       growth      income/     opportunity demand substitution    growth corporate and  developed
                                    private                                      potential government infrastructure
                                  spending                                                  spending
                                    growth

Tech/ Internet/ IT                                                                                       
E-commerce                                                                                               
Medical services                                                                                       
Fast food, casual
dining                                                                         
Logistics                                                                                                
Food retail                                                                    
FMCG                                                                           
Pharmaceutical                                                                           
Media, telecom                                                                                          
Auto components                                                                  
Pension funds                                                                                             
Infrastructure                                                                                             

                                                                                                                  24
Industry sector top-down scorecard example


 Sector description

 • Description of the sector

 Size and trends                                                          Regulations and environment

 • Estimated size of the sector (for the latest year available). Sector   • Assessment of the environment
     CAGR and expectations for short and medium run.                          (favorable or risky)
 • Key segments, information on segments’ share, trends, margins, etc.    • Information on state support/
 • Export and import information. Any info on taxes, export/ import           regulations within the sector
     quotas.                                                              •   Information on international players
 •   Key buyers and suppliers.                                                working within the sector
 •   Other information (e.g. recent trends, substitutes, etc)             •   Indication of PE activity in the sector
 •   Assessment of margins (EBITDA, other information) - can be gained
     from Annual Reports, analysts’ reports, SPARK, etc
 •   Some indications on capital expenditures (e.g. cost of production
     facilities, years to build/ get to full capacity)

 Fragmentation and key players Potential Growth and Exit Strategy         Overall conclusion and Exit Strategy

 • Assessment of market consolidation (consolidated or                    • Overall measure of the sector
     fragmented)                                                              attractiveness for the PE activity
 •   Key players, their market shares                                         (high or low score)
 •   Information on recent mergers/ acquisitions                          •   Decryption of potential targets
 •   Information on actioners, vertical integration of the players, etc   •   Description of exit strategy
 •   Competition assessment



                                                                                                                        25
Three different industry segment examples




        Online
         B2C
       business

                              Food
                              retail
                              chain

                                            Engineering
                                             business



                                                          26
Example 1. Online B2C business


  Key points to consider

  • Unit economics, CLV > Customer acquisition cost
  • Average check, churn, retention, repeat users
  • Visitors, conversion
  • Customer acquisition channels
  • Head office costs, cash burn
  • Logistics
  • Inventory




                                                      27
Example 2. Food retail


  Key points to consider

  • Store level performance/locations. Top-line and bottom-line by store.
      Revenue and EBITDA concentration.
  •   Store level economics: capex, revenue per store, target profitability
      level, payback period, revenue ramp-up, time to break-even, time of
      construction
  •   Benchmark against competitors. Revenue per sqm, profitability,
      prices, SKUs, locations.
  •   Logistics. How in-bound and out-bound logistics works? Who are the
      suppliers? Private labels?
  •   Rental agreements. How the stores locations are determined? What are
      the terms and timeframe of the rental agreements?
  •   Costs as % of revenue. Marketing expenditures, personnel expenses,
      head office expenses.
  •   Working capital. Inventory, a/r, a/p turnovers.
  •   Store opening pipeline. Geography of locations? Any preliminarily
      agreements in place? How much they opened historically?


                                                                              28
Example 3. Engineering


  Key points to consider

  • Customers. History of relationship. Blue-chip customers,
      creditworthiness. Revenue concentration.
  •   Customer contracts terms, time periods and payment terms
  •   Value chain. Which part of the value chain does the company operates?
  •   Personnel utilization, turnover, average wages. Contract
      agreements with personnel, motivational schemes in place
  •   Head office




                                                                              29
Financial modeling
  and leveraged
     buyouts

                     30
Analyzing the target




                                                    High-growth/start-up
                         Established business
                                                         business



                    Past performance
                     analysis (financial
                     statement analysis,          Management team
      Current
                     current market position       inspection
     positions
     analysis        inspection)                  Monetization model audit
                    Current conditions of
                     production facilities


                        Valuation based on
                                                  Future growth estimation
                         trade multiples
    Valuation/                                    Market prospective
                        DCF forecasting for
    prospects                                      analysis
                         scenario analysis and
    estimation           debt repayment           DCF forecasting for
                         capacity estimation       valuing business
Valuing the target

     Revenue
               Start-up     Expansion                 Growth                       Decline




               FFF,          Venture                                         Strategic investor,
                                               Private equity funds
               seed           funds                                         special situation fund




                                                                                                Time


Firm                                       Current business and assets,
                   Future growth                                              Current assets
value                                              future growth



Valuation                                                                 Comparable companies,
                   Negotiations              Comparable companies
method                                                                      liquidation method


Multiple if
                N/A       Extremely high   High, average industry level             Low
applied
Valuation methods. Multiples approach


  I. Equity value/Net income           IV. Industry specific multiples

   Highly depends on capital          Industry                    Multiple
    structure                                                       EV/Reserves
                                       1. Oil & gas
   Not widely used for private                                     EV/Production
    equity valuations                                               EV/EBITDAX

                                       2. Metal & mining            EV/Reserves
                                                                    EV/Production
  II. Enterprise value/Sales
                                       3. TMT, internet, media      EV/Subscribers
   Highly depends on business                                      EV/Population
    marginality (“quality” of sales)                                EV/Fiber miles

   The most simple in terms of        4. Financial institutions    Equity value/Book value
    calculation and quick value                                     Equity value/Net Asset
                                                                     value
    estimation
                                       5. Retail                    EV/EBITDAR
                                                                    EV/Square footage
  III. Enterprise value/EBITDA
                                       6. Real estate               EV/Square footage
                                                                    Equity Value/Net Asset
   Most commonly used                                               Value
Valuation methods. Multiples approach
Enterprise value derivation


                                                              Enterprise value
            Assets            Liabilities & Equity
                                                                        =
                                                                 Equity value
     Long term assets  Debt                                           +
      • Investments in         Convertible notes
        associates                                                 Total debt
                               Mezzanine
                                                                        +
                                                               Preferred stock
     Current assets
      • Cash & cash            Common Equity                           +
        equivalents            Preferred stock           Noncontroling interest
                               Noncontrolling                          -
                                interest
                                                        Cash & cash equivalents
                                                                        -
         Cash-flow             Investors claims           Associate companies
      generating assets
                               = Equity value + other              +
       = Enterprise value +      investor claims =
      assets not generating
                                                         Other claims on assets
                              Enterprise value + cash   (pension liabilities, employee stock
         cash flow (cash)                                              option)
Valuation methods. Multiples approach
EBITDA derivation




                 EBITDA calculation from IFRS and US GAAP reporting


     Adding back D&A, taxes and interest payments to Net Income
     Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring
      costs, assets revaluation, special projects costs)




                         EBITDA calculation from RAS reporting


     Adding back D&A, taxes and interest payments to Net Income
     Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring
      costs, assets revaluation, special projects costs)
     D&A is reported in COGS and SG&A section. Reporting notes should be
      investigated to detach it/simplified forecast of D&A based on PPE balance value
      can be performed
Valuation methods. Multiples approach
Commercial meaning



                                              EV


                                             EBITDA

                                                      -
         Not a capital intensive business
         Perfect conditions of current                         Extensive capex program
          production facilities                                 High tax rate
         Low tax rate                                          High cost of capital
         Low cost of capital                                   Low market growth estimation
         Outstanding growth prospective
    +

                          General rule:                                         General rule:
                                                         Oil & gas
    Retail               EV/EBITDA>5                                           EV/EBITDA<5
                                                         Metals & mining
    Internet
                                                         Development
    Healthcare
                                                         Infrastructure
Valuation methods. Transactions approach




      Special Data
      Bases use for          Criteria          Processing              Final
       transaction        determination        with sample           multiple
          search                                                    calculation




     MergerMarket       Target’s sector    Moving away          Median/average
     Factiva            Geography           deals without         multiple of a
     DealWatch          Deal type           financial details     selected sample
     Zephyr             Period             Moving away           of transactions
                                              outliers
                         Stake acquired
                                             Multiples check
Private equity returns calculations

                          ENTRY                                                            EXIT




                                                                  Equity value
                   Entry EV/EBITDA x
   Equity value




                      EBITDA LTM                                                  Exit EV/EBITDA x
                                                                                    EBITDA LTM

                  Net claims on assets


                                                                                 Net claims on assets
                  Funding from banks,
                  mezzanine funds, etc.



                  Equity consideration       Dividends payments                  Equity stake of a PE
                    paid by PE fund                                                      fund



       Value           Dividends                               Value + Dividends + Value
                                                       Σ
                   +                                       -
                                    Cash-on-cash                                                        0
                  Value                                                          (1+IRR)   k
LBO deal case. General structure



     Current            New investor 1
   shareholders               (PE fund)
                                                      New investor 2
                                                          (PE/mezzanine
                                                              fund)

Ownership

                        Equity                                              New investor 3
                                                                                (Bank)
                                                Subordinated
                                                   notes,
                                                 convertible
                                                   notes                    Senior
                                                                             debt



                     Target


                                                 Growth capital component
                                                    of LBO transaction


                                          Capex program


                                                                                         39
LBO deal case. Valuation and funding structure

  I. Valuation and structure                           II. Deal funding
 Company financials                                   Funding structure                 %   mln $
 Sales'12                              mln $   400    Equity contribution             30%      78
 EBITDA'12                             mln $    48    Senior debt                     40%    104
 Net debt                              mln $    20    Subordinated notes              20%      52
 Noncontroling interest                mln $    15    Convertible notes               10%      26
                                                      Total                          100%    261
 Valuation multiples
 EV/EBITDA on entry                    x         7                          Total investments
 EV/EBITDA on exit                     x         7

 Pre-money valuation
 Enterprise value                      mln $   336    Entry mult x EBITDA’12-Net debt-NI
 Equity value                          mln $   301

 Transaction issues
 Growth capital investment             mln $     50
 Current shareholders stake for sale   %       70%
                                                      Pre-money equity valuation + growth
 Post-money valuation                                              capital
 Enterprise value                      mln $   386
 Equity value                          mln $   351

 Total investments                     mln $   261     Stake for sale x Equity pre-money
 Cash out                              mln $   211        valuation + growth capital
 Cash in                               mln $    50
LBO deal case. Debt & equity parameters


        I. Senior debt
        Term                        years                   8
        Interest rate                 %                    8%
        Principal amount            mln $                  104
        Repayment                                   annuity payments

        II. Subordinated notes
        Term                        years                   8
        Cash interest rate            %                   10%
        PIK interest                  %                    4%
        Principal amount            mln $                  52
        Conversion warrant                                  -

        III. Convertible notes
        Term before conversion      years     min (10; new investment round)

        Conversion price           10 years        1,5 x entry valuation
                                  new round    0,8 x new investor valuation

        Interest rate                %                     8%
        Principal amount            mln $                  26

        IV. Common equity
        Dividend payout ratio        %                    10%
        Par value                   mln $                  78
LBO deal case. Debt schedules

                                A      1      2      3      4      5      6      7      8
 mln $                       2012   2013   2014   2015   2016   2017   2018   2019   2020

 I. Senior debt
 Annuity payments                      9     18     18     18     18     18     18     18
 Outstading amount, b-o-p       0      0     99     89     78     66     53     40     25
 Principal repayment            0      5     10     11     12     13     14     15     16
 Interest payment               0      4      8      7      6      5      4      3      2
 Outstanding amount, e-o-p      0     99     89     78     66     53     40     25      8

 II. Subordinated notes
 Outstanding amount, b-o-p      0      0     52     54     56     59     61     64     66
 PIK interest                   0      0      2      2      2      2      2      3      3
 Outstanding amount, e-o-p      0     52     54     56     59     61     64     66     69
 Cash interest payments         0      3      5      6      6      6      6      6      7

 III. Convertible notes
 Outstanding amount, b-o-p      0      0     26     26     26     26     26     26     26
 Outstanding amount, e-o-p      0     26     26     26     26     26     26     26     26
 Interest payments              0      1      2      2      2      2      2      2      2


 Total interests                0      8     17     17     16     16     15     14     13
 Cash interest payments         0      8     15     15     14     13     13     12     11


              P&L
LBO deal case. P&L forecast

                          A          1      2      3      4      5      6      7      8
  mln $                2012       2013   2014   2015   2016   2017   2018   2019   2020

  Sales                    400     392    392    412    453    498    508    518    529

  COGS                     -232   -231   -231   -235   -240   -264   -269   -275   -280

  Gross profit              168    161    161    177    213    234    239    244    248
  Gross margin             42%    41%    41%    43%    47%    47%    47%    47%    47%

  EBITDA                     48     43     43     54     77     85     86     88     90
  EBITDA margin            12%    11%    11%    13%    17%    17%    17%    17%    17%

  D&A                        -5     -5     -7     -7     -7     -7     -7     -7     -7

  EBIT                       43     38     36     46     70     77     79     81     83
  EBIT margin              11%    10%     9%    11%    15%    16%    16%    16%    16%

  Interest payments          0      -8    -17    -17    -16    -16    -15    -14    -13

  EBT                       43      30     18     29     53     62     64     67     69

  Net income                 34     24     15     23     43     49     51     53     55
  Net income margin         9%     6%     4%     6%     9%    10%    10%    10%    10%

  Dividends on
  common equity              0      -2     -1     -2     -4     -5     -5     -5     -6
                      BS
LBO deal case. BS entries

                                     A                                                                                    1
mln $                               2012                                  Adjustments                                   2013
I. Non current assets
PP&E                                100                      Capex from new investment proceeds                         145
Intangibles                          10                                                                                  10
Goodwill                              0              Pre money equity valuation – Initial shareholders equity           201
Total non current assets            110                                                                                 356

II. Current assets
Cash                                 80                                                                                  3
Inventories                          25                                                                                 25
Reveivables                          20                                                                                 20
Total current assets                125                                                                                 47

Total assets                        235                                                                                 404
III. Long term liabilities
Existing loan facility              100       Debt repayment from cumulative cash and operating cash flow of 2013         0
Senior debt                          0                  Principal amount – repayment of principal in 2013                99
Subordinated notes                   0                          Value of the notes issued in 2013                        52
Convertible notes                    0                          Value of the notes issued in 2013                        26
Total long term liabilities         100                                                                                 178

IV. Current liabilities
Current portion of long term debt    0                                                                                   0
Payables                            20                                                                                  20
Total current liabilities           20                                                                                  20

V. Equity
Shareholders equity                 100    Pre-money equity*(1-cash out stake)+equity contribution by PE+NI-dividends   191
Noncontrolling interest              15                                                                                  15
Total equity                        115                                                                                 206

Total equity & liabilities          235                                                                                 403
LBO deal case. BS forecast

                                     A            1          2          3          4          5          6          7          8
mln $                               2012   2013       2014       2015       2016       2017       2018       2019       2020
I. Non current assets
PP&E                                100    145        145        145        145        145        145        145        145
Intangibles                          10     10         10         10         10         10         10         10         10
Goodwill                              0    201        201        201        201        201        201        201        201
Total non current assets            110    356        356        356        356        356        356        356        356

II. Current assets
Cash                                 80     3          8         19         46          77        111        146        181
Inventories                          25    25         25         25         26          28         29         30         30
Reveivables                          20    20         20         21         23          25         25         26         26
Total current assets                125    47         52         65         94         130        165        201        238

Total assets                        235    404        409        421        451        487        522        558        594
III. Long term liabilities
Existing loan facility              100      0          0          0          0          0          0          0          0
Senior debt                          0      99         89         78         66         53         40         25          8
Subordinated notes                   0      52         54         56         59         61         64         66         69
Convertible notes                    0      26         26         26         26         26         26         26         26
Total long term liabilities         100    178        170        161        151        141        129        117        103

IV. Current liabilities
Current portion of long term debt    0      0          0          0          0          0          0          0          0
Payables                            20     20         20         20         21         23         23         24         24
Total current liabilities           20     20         20         20         21         23         23         24         24

V. Equity
Shareholders equity                 100    191        204        225        263        308        354        402        452
Noncontrolling interest              15     15         15         15         15         15         15         15         15
Total equity                        115    206        219        240        278        323        369        417        467

Total equity & liabilities          235    403        408        421        450        486        521        557        594
LBO deal case. CF forecast

                              A            1          2          3          4          5          6          7          8
mln $                        2012   2013       2014       2015       2016       2017       2018       2019       2020

Operating cash flow
Net income                    34     24         15         23         43         49         51         53         55
PIK interest                   0     0           2          2          2         2           2         3           3
D&A                            5     5           7          7          7         7           7         7           7
Changes in receivables         0     0           0         -1         -2         -2          0         -1         -1
Changes in inventories         0     0           0          0         -1         -3         -1         -1         -1
Changes in payables            0     0           0          0          0         2           0         0           0
Cash flow from operations     39     30         24         32         50         56         60         62         65

Investment cash flow
Capex                         -5    -50         -7         -7         -7         -7         -7         -7         -7
Cash flow from investments    -5    -50         -7         -7         -7         -7         -7         -7         -7

Financing cash flow
Existing debt                 0     -100        0          0          0          0          0          0          0
Senior debt                   0      99        -10        -11        -12        -13        -14        -15        -16
Subordinated notes            0      52         0          0          0          0          0          0          0
Convertible notes             0      26         0          0          0          0          0          0          0
Common equity contribution    0      78         0          0          0          0          0          0          0
Common equity repayment       0     -211        0          0          0          0          0          0          0
Dividends                     0       -2        -1         -2         -4         -5         -5         -5         -6
Cash flow from financing      0      -57       -12        -13        -16        -18        -19        -20        -22

Total cash flow               34    -78         5          11         27         31         34         35         36
LBO deal case. Exit valuation

                                                  1          2          3          4          5          6          7          8
mln $                                      2013       2014       2015       2016       2017       2018       2019       2020
EBITDA                                      43         43         54         77         85         86         88         90
Exit multiple                         x7
Enterprise value at exit                   302        302        375        539        593        605        617        629

Net debt
Initial loan facility                        0          0          0          0          0          0          0          0
Senior debt                                 -99        -89        -78        -66        -53        -40        -25         -8
Subordinated notes                          -52        -54        -56        -59        -61        -64        -66        -69
Convertible notes                           -26        -26        -26        -26        -26        -26        -26        -26
Total debt                                 -178       -170       -161       -151       -141       -129       -117       -103
Cash                                         3          8         19         46         77         111       146        181
Total net debt                             -175       -162       -142       -106        -64        -18        29         78


Equity value at exit                       127        140        233        433        529        586        645        707
PE fund stake in equity                    70%        70%        70%        70%        70%        70%        70%        70%


Conversion of convertible notes
Equity value after conversion                         166        259        459        555        612        672        733
Share of a converter                                  19%        12%         7%        6%         5%          5%        4%
Share of a PE fund after conversion                   57%        88%        93%        94%        95%        95%        96%
PE fund stake value                                    94        227        427        523        580        639        701
LBO deal case. Returns calculation


                                                         Exit year
                        2014       2015           2016         2017        2018     2019    2020
 2013                    -78        -78            -78           -78        -78      -78     -78
 2014                      96         1              1              1         1         1       1
 2015                       0       229              2              2         2         2       2
 2016                       0         0            431              4         4         4       4
 2017                       0         0              0           527          5         5       5
 2018                       0         0              0              0       585         5       5
 2019                       0         0              0              0         0      645        5
 2020                       0         0              0              0         0         0    706
 IRR                    22%        72%            78%           63%        51%      44%     39%
 Cash-on-cash             1,2       2,9            5,6            6,8       7,6       8,5     9,3

    Alternative scenario: fully equity financed buyout
                                                  Exit year
                      2014      2015      2016          2017       2018     2019    2020
   2013               -261      -261      -261          -261       -261     -261    -261
   2014                238          3         3            3           3        3       3
   2015                   0      444          4            4           4        4       4
   2016                   0         0      658             6           6        6       6
   2017                   0         0         0          765           6        6       6
   2018                   0         0         0            0        834         6       6
   2019                   0         0         0            0           0     903        6
   2020                   0         0         0            0           0        0    974
   IRR                 -9%      31%       37%           32%        27%      24%     22%
   Cash-on-cash         0,9       1,7       2,5          3,0         3,3      3,6     3,9
Exit strategies. Returns on exit


                                                                   Alternative
 Valuation




                                                      Valuation
                                                                   scenario: fully
                                                                   equity financed
                                                                   buyout


                              PE fund equity




             PE fund equity                                                          PE fund equity

                               Convertible
              Convertible        notes
                notes

             Subordinated     Subordinated                        PE fund equity
                notes            notes



               Senior           Senior
                Debt             Debt

                 2013             2017         Time                   2013               2017         Time


                                                                                                        49
Due Diligence


                50
Due diligence types



      Due diligence                  Due Diligence types

      • Typically takes 4-5 weeks       Commercial
      • Can be organized through
       VDR (Vendor Data Room)
      • Serves as a basis for           Operational
       negotiations on warranties,
       indemnities
      • Possible adjustment to         Financial and
       EBITDA and purchase price
       may be negotiated based on
                                            tax
       due diligence results
                                           Legal

                                       Environmental


                                                           51
Due diligence consultants


  Commercial                Financial and tax    Legal

    Large deals             Mid-size deals       Generalists




   Mid-size deals

                            Mid-to-small deals
                                                  Law firms




   Mid-to-small deals



                                                         Also doing transaction
                                                                documentation



                                                                                  52
Deal structuring
and negotiations


                   53
A typical example of deal structuring in Russia




     Shareholder A            Shareholder B         Shareholder C
                100%                 100%                      100%

           BVICo                 BVICo                   BVICo

                30%                  30%                      40%

                                               Shareholders’ Agreement
                              Cyprus HoldCo                                 Buyer SPV
                                              Sale and Purchase Agreement

                     Joint           50%                                       50%
                    Venture

                                                    Cyprus SPV

                                                            100%

                                                      Russian
                                                     LLC/CJSC



 Source: Goltsblat, Salans                                                              54
Why English law is used in Russian transactions?


                                                              Use of legal concepts not available
   Key merits of English law                                  under Russian law or untested in
                                                              Russian courts. For example:

   •   Flexible                                               • representations, warranties,
   •   Adaptable                                                indemnities
   •   Commercial                                             • put and call options
   •   Freedom of contract                                    • drag and tag along
   •   Predictable                                            • conditions precedent
   •   Reputable judiciary                                    • restrictive and negative covenants
   •   Common law and precedents                              • retention and escrow accounts
                                                              • deadlock mechanisms

 • English law is widely used in international transactions (often in conjunction with local laws)
   across a variety of jurisdictions, including on many deals in the Middle East, Africa, Singapore,
   Hong Kong, China, India, Russia and the CIS
 • English law is a common law system, based on a combination of legislation and case
   precedent. This makes English law flexible, adaptable and practical
 • The laws and rules themselves are less prescriptive when interpreting the intentions and
   actions of the parties and instead the courts will interpret what the parties have written in the
   contract
 • English courts have a strong reputation for reaching fair, balanced and unbiased judgments
   and rulings

 Source: Goltsblat, Salans                                                                             55
Typical deal documents for PE transactions



                 NDA - non-disclosure agreement, is a legal contract that outlines
                 confidential information that the parties wish to share with one another for
       NDA       certain purposes, but wish to restrict access to or by third parties. NDA
                 protects confidential nonpublic business information

                 LOI/MOU - letter of intent/ memorandum of understanding is a
                 document outlining an agreement between two or more parties before the
    LOI/ MOU
                 agreement is finalized, written in letter form and focuses on the parties'
                 intentions. Non-binding.

                 TS - term sheet is a bullet-point document outlining the material terms and
       TS        conditions of a potential deal. After execution TS guides legal counsels in
                 preparation of a final agreement (SPA, SHA). Non-binding.

                 SHA - shareholders’ agreement is an agreement among a company’s
       SHA       shareholders describing how the company should be operated and the
                 shareholders' rights and obligations. Binding.

                 SPA - share purchase agreement is a legal contract which outlines terms
       SPA
                 and conditions for acquiring a company's shares Binding.




                                                                                                56
NDA



                 NDA - non-disclosure agreement, is a legal contract that outlines
                 confidential information that the parties wish to share with one another for
        NDA      certain purposes, but wish to restrict access to or by third parties. NDA
                 protects confidential nonpublic business information

                 LOI/MOU - letter of intent/ memorandum of understanding is a
                 document outlining an agreement between two or more parties before the
      LOI/ MOU
                 agreement is finalized, written in letter form and focuses on the parties'
                 intentions. Non-binding.

                 TS - term sheet is a bullet-point document outlining the material terms and
        TS       conditions of a potential deal. After execution TS guides legal counsels in
                 preparation of a final agreement (SPA, SHA). Non-binding.

                 SHA - shareholders’ agreement is an agreement among a company’s
        SHA      shareholders describing how the company should be operated and the
                 shareholders' rights and obligations. Binding.

                 SPA - share purchase agreement is a legal contract which outlines terms
        SPA
                 and conditions for acquiring a company's shares Binding.




                                                                                                57
NDA



  Common issues addressed
  • Parties
  • The definition of information to be held confidential
  • The exclusions from what must be kept confidential
  • The disclosure period - information not disclosed during the disclosure
    period (e.g., one year after the date of the NDA) is not deemed
    confidential
  • The term (time period) of the confidentiality
  • Obligations of the recipient regarding the confidential information
  • Insider trading (in case of public company)
  • The law and jurisdiction governing the parties

      However, it is hard to prove breach of an agreement and quantify losses, so
      typically NDA is just a formality…



                                                                                    58
LOI/ MOU



               NDA - non-disclosure agreement, is a legal contract that outlines
               confidential information that the parties wish to share with one another for
      NDA      certain purposes, but wish to restrict access to or by third parties. NDA
               protects confidential nonpublic business information

               LOI/MOU - letter of intent/ memorandum of understanding is a
               document outlining an agreement between two or more parties before the
    LOI/ MOU
               agreement is finalized, written in letter form and focuses on the parties'
               intentions. Non-binding.

               TS - term sheet is a bullet-point document outlining the material terms and
      TS       conditions of a potential deal. After execution TS guides legal counsels in
               preparation of a final agreement (SPA, SHA). Non-binding.

               SHA - shareholders’ agreement is an agreement among a company’s
      SHA      shareholders describing how the company should be operated and the
               shareholders' rights and obligations. Binding.

               SPA - share purchase agreement is a legal contract which outlines terms
      SPA
               and conditions for acquiring a company's shares Binding.




                                                                                              59
LOI/ MOU



  Common issues addressed
  • Parties
  • Consideration - price for the assets and business to be purchased
  • Term Sheet
  • Timing for Term Sheet signing and transaction completion
  • Public announcements restrictions
  • Non-binding nature of the document


  Differences between LOI/MOU
  • LOI outlines the intent of one party toward another with regard to an
    agreement, and may only be signed by the party expressing intent
  • MOU must be signed by all parties to be a valid outline of an
    agreement



                                                                            60
Term Sheet



               NDA - non-disclosure agreement, is a legal contract that outlines
               confidential information that the parties wish to share with one another for
      NDA      certain purposes, but wish to restrict access to or by third parties. NDA
               protects confidential nonpublic business information

               LOI/MOU - letter of intent/ memorandum of understanding is a
               document outlining an agreement between two or more parties before the
    LOI/ MOU
               agreement is finalized, written in letter form and focuses on the parties'
               intentions. Non-binding.

               TS - term sheet is a bullet-point document outlining the material terms and
       TS      conditions of a potential deal. After execution TS guides legal counsels in
               preparation of a final agreement (SPA, SHA). Non-binding.

               SHA - shareholders’ agreement is an agreement among a company’s
      SHA      shareholders describing how the company should be operated and the
               shareholders' rights and obligations. Binding.

               SPA - share purchase agreement is a legal contract which outlines terms
      SPA
               and conditions for acquiring a company's shares Binding.




                                                                                              61
Term Sheet



  Common issues addressed
  • Parties
  • Total price consideration, formula for calculation, adjustments
  • Debt and working capital
  • Payment tranches
  • Transaction calendar and deal closing date
  • Short list of conditions precedent, representations and warranties,
    existence of certain indemnities
  • Exclusivity
  • Break-up fee
  • Subject to due diligence
  • Confidentiality
  • Governing law



                                                                          62
SHA/SPA



              NDA - non-disclosure agreement, is a legal contract that outlines
              confidential information that the parties wish to share with one another for
     NDA      certain purposes, but wish to restrict access to or by third parties. NDA
              protects confidential nonpublic business information

              LOI/MOU - letter of intent/ memorandum of understanding is a
              document outlining an agreement between two or more parties before the
   LOI/ MOU
              agreement is finalized, written in letter form and focuses on the parties'
              intentions. Non-binding.

              TS - term sheet is a bullet-point document outlining the material terms and
      TS      conditions of a potential deal. After execution TS guides legal counsels in
              preparation of a final agreement (SPA, SHA). Non-binding.

              SHA - shareholders’ agreement is an agreement among a company’s
     SHA      shareholders describing how the company should be operated and the
              shareholders' rights and obligations. Binding.

              SPA - share purchase agreement is a legal contract which outlines terms
     SPA
              and conditions for acquiring a company's shares Binding.




                                                                                             63
Deal structuring entails negotiations




              SPA                                   I win
          structuring                    I win     You win
                                        You lose      =
                                                    DEAL



                                         I lose     I lose
              SHA                       You lose   You win
          structuring


                                                             64
SPA related deal structuring




              SPA                          I win
          structuring           I win     You win
                               You lose      =
                                           DEAL



                                I lose     I lose
              SHA              You lose   You win
          structuring


                                                    65
Representations, warranties and indemnities


  Representations
  • Representations are statements by one party (usually the seller) which induce
    another party (usually the purchaser) to enter into a contract
  • If the statement relied on is untrue or incorrect and the position misrepresented, the
    other party may be entitled to terminate or rescind the contract and/or claim
    damages
  Warranties
  • Warranties are terms of a contract which, if breached, will entitle the innocent
    party to claim damages
  • The contractual measure of damages aim to put the innocent party in the
    position it would have been in had the breach not occurred
  • Used in order to provide reassurance from the seller on factual matters or future
    promises concerning the status of the target company and its business, assets,
    liabilities and financial position
  Possible warranties (but not limited to):
  • Accuracy of financial information • Employment arrangements
  • Ownership of assets                • Recent material changes to the business
  • Nature and extent of contracts     • Intellectual property, appropriate licences
  • Absence of any disputes            • Share structure and ownership of the target

 Source: Goltsblat, Salans                                                                   66
Representations, warranties and indemnities


  Indemnities
  • Indemnity is a promise to reimburse the buyer in respect of a particular type of
    liability, should it arise
  • Easier to establish than a warranty claim as there is no need to calculate loss
  • Used where there is a known or potential, clearly identifiable liability, the risk of
    which is to be borne by the party giving the indemnity, such as unpaid tax, a
    potential environmental claim, or a specific issue arising from due diligence
  • Warranties may be given on an indemnity basis
  Tax deed
  • Tax dead is a document containing tax indemnities
  • If there are any unexpected tax problems associated with the target, the buyer
    will expect that the price is reduced by an amount equal to the consequential tax
    liability (buyer’s protection)
  • The tax deed also contains lengthy provisions limiting the ability of the buyer to
    bring claims under the tax deed (seller’s protection)
  Indemnity security
  • Retention, escrow accounts
  • Pledge over assets
  • Parent guarantee

 Source: Goltsblat, Salans                                                                  67
Purchase price/ consideration


  Purchase price mechanisms
  • Completion accounts mechanism may be included, whereby an audit of the
    target company and its business is conducted and the purchase price is
    adjusted.
  • The completion accounts process includes accounting assumptions and
    valuation methodology or formula for price calculation.
  • Contracts will sometimes also include deferred consideration payments at
    agreed stages after completion
  • Escrow accounts can be used, while money is deposited with a third party, who
    holds it ‘in escrow’ for the parties and only releases it in accordance with the
    terms of the escrow contract
  • These can sometimes be linked to earn-out provisions, which compare future
    economic performance against agreed targets (such as revenue or profits) and
    then adjust the deferred payments according to whether or not these targets are
    met.
  • Price can be adjusted both sides according to ratchet scheme




 Source: Goltsblat, Salans                                                             68
Conditions precedent


  Conditions precedent
  • Conditions precedent (CPs) are clauses which provide that certain parts of the
    contract will only come into force if and when agreed conditions are met
  • There is no obligation to complete the transaction until the CPs are met. If SPA is
    signed the buyer has no obligation to pay until the CPs are met
  • The contract will typically include provisions dealing with the legal obligations of
    the parties pending satisfaction of all the conditions and the efforts to which they
    must go in order to achieve satisfaction of the CPs themselves
  Possible CPs (but not limited to):
  •   Obtaining anti-monopoly approval
  •   Bank consent
  •   Change of control
  •   Approvals from key customers and suppliers to assign contracts
  •   Investment Committee approval
  •   Absence of any material adverse change in the financial condition of the target

  Termination rights
  • Material adverse change
  • Material breach of warranty

 Source: Goltsblat, Salans                                                                 69
Restrictive covenants



  • Restrictive covenants are contractual promises, preventing the seller of the
    business from competing with the business sold (non-compete), together with
    non-poaching undertakings in relation to key staff, suppliers and customers
    (non-solicit).
  • They must be restricted in time and scope to be effective and enforceable




 Source: Goltsblat, Salans                                                         70
SHA related deal structuring




              SPA                          I win
          structuring           I win     You win
                               You lose      =
                                           DEAL



                                I lose     I lose
              SHA              You lose   You win
          structuring


                                                    71
Put and call options

  Put option
                       Right to put its
                      shares on Party B
                                                            • The right, not an obligation
      Party A                                 Party B       • Put and call options should
                      Obligation to pay $                     contain price of execution,
                          to Party A                          terms and possible triggers.
       50%                                                  • Put price may be linked to IRR
   shareholding                                  50%
                                             shareholding     or cash-on-cash multiple of the
    (subject to
    ‘put’ right)         Company                              investor
                                                            • May be used to give an exit
                                                              strategy or as an enforcement
  Call option
                                                              mechanism on default under
                       Right to call for
                     shares from Party A
                                                              shareholders’ agreements
      Party A                                 Party B       • Redemption shares are often
                                                              used as a ‘soft’ put option, but
                    Obligation to transfer
                    shares to party B, in                     can be redeemed only from net
                       exchange for $                         profit
       50%                payment
                                                 50%
   shareholding
                                             shareholding   • Call and put often used in
    (subject to
    ‘call’ right)        Company                              parallel, limiting downside as
                                                              well as upside

 Source: Goltsblat, Salans                                                                       72
Covenants and veto rights


  Covenants
  • A covenant is an agreement or promise to do (positive covenant) or refrain
    from doing something (negative covenant), binding on the party who gives it
   Possible positive covenants:                    Possible negative covenants:
   • Provide financial information on request      • Not to issue new shares
   • Inform about break of warranty                • Not to dispose any material assets
   • Maintain Debt/EBITDA below 3x

  Veto rights
  • A veto right is the right of a party to withhold its approval to a proposed course
    of action or decision that requires its consent
   Possible veto rights on:
   • Issuing or selling shares
   • Making capital expenditures over $X
   • Taking loans over $X
   • Terminating employment with key employees




 Source: Goltsblat, Salans                                                                73
Drag along and tag along

  Drag along
                                                     • A drag along right allows a shareholder of
                                                       a company to force the remaining
                                Buyer                  shareholders to accept an offer from a
                                                       third party to purchase the whole
                                                       company.
                                                     • The other shareholders are then
                                                       ‘dragged along’ and forced to sell their
                                                       shares at the same time and price.
                                                     • Used to give liquidity and an exit route
                                                       on an assumption that most buyers will
       Party A                 Party B
                                                       want to acquire 100% of the company

                      shareholding
                                                     • The offer may also need to match or
                                     3. Party B is     exceed a minimum agreed price or
              shareholding           forced to
                                     accept            minimum time period before the drag
                                     and sell its      along right can be triggered
                                     shares
                  Company
                                                     • The other shareholder may be given a
                                                       right to match the offer and buy the
                                                       shares itself (Right of first refusal)

 Source: Goltsblat, Salans                                                                          74
Drag along and tag along

  Tag along
                                                     • Tag along provision is a corresponding
                                                       right that entitles shareholder to
                                 Buyer                 participate in a sale by the other
         1. Party A                                    shareholders at the same time and at
         decides                                       the same price per share.
         to sell its
         shares                                      • The minority shareholder then ‘tags
                                                       along’ with the majority shareholder’s
                                                       sale.
                                                     • Can state that, if the tag along
                                                       procedures are not followed by the
       Party A                  Party B
                                                       purchaser, then its attempt to buy any of
                                                       the shares is not valid and will not be
                       shareholding
                                      2. Party B       registered
              shareholding            can force
                                      the buyer to
                                      buy its
                                      shares as
                                      well
                   Company




 Source: Goltsblat, Salans                                                                         75
Good leaver/ Bad leaver provisions


  • Leaver provisions are contractual       Possible provisions
    mechanisms covering employees               Good        Intermediate      Bad
    who are also shareholders in a             Leaver          Leaver        Leaver
    company
                                               Death          Serious/     Resignation
  • When an employee leaves the                              permanent       prior to
    company, he is required to transfer                        illness      an agreed
    his shares back to the company                           of spouse      minimum
                                                                              period
  • Typically used for the shares granted
                                              Serious/      Resignation    Dismissal for
    to managers as a motivation scheme
                                             permanent       after an         gross
  • Good leavers tend to receive market        illness        agreed       misconduct
    value for their shares, whereas the                      minimum
    price paid to bad leavers tends to be                     period
    heavily discounted                      Retirement at   Dismissal on   Dismissal for
                                             retirement      grounds of        fraud
                                                 age            poor       or dishonesty
                                                            performance
                                                            Redundancy      Breach of
                                                                            restrictive
                                                                            covenants


 Source: Goltsblat, Salans                                                                 76
Other SHA tools




                        Upside sharing


                     Deadlock mechanism


                         Anti-dilution


            Preferred shares/Liquidity preference


                  Corporate governance rights

                                                    77
Portfolio
 companies
management

              78
Corporate governance issues



                                                             Management
          Structuring Board of
                                                          compensation and
               Directors
                                                         incentives programs




                                 Corporate governance

      Monitoring                                                 CEO replacement




                                 Influence on strategy
Board of Directors



                                  Structuring Board of Directors



   Board size                       Board composition              Board committees

    Key point while deal            3 categories:                 Two main committees:
     structuring (as well as          entrepreneurs (founders),      compensation and audit
     board composition)               investors, independent        Compensation committee
    Smaller boards – more            directors                      area: salaries, stock option
     effective in decision           PE investor does not have      for top managers (chaired
     making                           a majority of board seats      by independent director,
    Typical PE-backed                as a rule                      excludes CEO)
     company Board – 5-7             Balanced composition: 2       Audit committee area:
     members (half of a size of       managers, 2 investors, 1 –     compliance with legal
     a public company Board)          independent director (the      requirements on financial
    Monthly frequency of             swing vote)                    reporting (members with
     Board meeting is common         Composition changes            accounting expertise
     for early-stage companies        subject to company             independent from
                                      performance                    management)
Companies monitoring and value creation

 I. Monitoring process

 High frequency of interaction with      Medium to high frequency of      Low frequency of interaction with
  management. Level: analyst +          interaction with management.      management. Level: VP/director +
                                          Level: analyst/associate +
   Weekly operational reports

                         Monthly reporting packs

                       BoD, committees presence, general reporting forms review


       Start-ups                             Profitable growing            Mature company           Maturity of a
                                                businesses                                           business


 II. Value creation



                                                                 Negotiations
      Fund team – in-                 Fund raising:                                         Synergy
                                                                with external
          house                        other funds                                           among
                                                                 consultants,
     consultants for a                 assets as a                                          portfolio
                                                                bankers, legal
        company                          pledge                                            companies
                                                               and government
                                                                  authorities
Management incentive tools

 General incentive scheme
    Bonus scheme
                                       Management share in
               IRR
                                        additional payment
       min             max
        0%             15%                      0%
       16%             20%                      0%
       21%             25%                      0%
       26%             30%                      0%
       30%             35%                      0%
       35%             40%                      30%
       40%             50%                      50%
       50%            100%                      70%


                             Example
                             Bonus & IRR calculation
                             Enterprise value                    $mln   423
                             Equity value                        $mln   422
                             Fund share                          $mln   396
                             IRR (Fund)                           %     57%
                             min IRR                              %     35%
                             Additional gain to the Management   $mln   114
                             real IRR (Fund)                      %     39%
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Private Equity and Venture Capital 2

  • 1. PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS Session 2. Private Equity deal origination, execution and portfolio management March 2013 Alexey Milevskiy Gleb Fomichev The presentation is prepared solely for the purposes of master classes at the Higher School of Economics
  • 3. Speakers Alexey Milevskiy Alexey Milevskiy is an Investment Manager at UFG Private Equity, leading Private Equity firm managing over $500 million across several funds in Russia and CIS. He participated in all stages of investment process: origination, due diligence, structuring and execution. Prior to UFG PE Alexey worked at European Private Equity division of GIMV in Belgium, KPMG Business Valuation group and ING Bank. Alexey holds masters degree from Vlerick Business School, Belgium and bachelors from Higher School of Economics. He is also the winner of several McKinsey&Co business case competitions. Gleb Fomichev Gleb Fomichev is an Analyst at JSFC Sistema, major Russian investment company. Gleb is one out of 7 investment professionals running Sistema’s $2 billion portfolio of high technology assets. He is engaged in strategy development and portfolio companies management as well as in new deals origination. Prior to Sistema Gleb worked at A&NN Group, one of the top performing Russian family office, where he managed fund’s assets in retail, telecommunications, logistics, publishing and financial services sectors. Gleb’s other experience includes E&Y business valuation team. Gleb holds masters and bachelors degree from Higher School of Economics. 3
  • 4. Session 1. Private Equity landscape 1st part • Private Equity definition; • Company funding lifecycle: FFF, business angels, venture capital, private equity, IPO; • Organizational structure of a PE fund: LP-GP agreements; • Typical activities performed by PE fund: fund raising, deal sourcing and originating, due diligence, management of portfolio companies, exits; • Key success factors for PE deals; 2nd part • Russian PE/VC landscape: PE funds, captive funds and family offices, government-backed funds, venture capital funds; • Russian vs Foreign PE industry; • Entry strategies: full buyout, growth capital, LBO, minority recapitalization, mezzanine, distressed situations. • Exit strategies: IPO, trade sale to strategic/financial investor, MBO, sale to other shareholder; • PE careers. 4
  • 5. Private Equity definition Private equity is a: • medium to long-term financing • provided in return for an equity stake • in potentially high growth • unquoted companies 5
  • 6. Private Equity value creation formula Multiple EBITDA growth Leverage Expansion Topline Efficiency growth improvement Superior returns 6
  • 7. What value Private Equity fund brings PE Entry Value creation within 3-5 years Exit Financial support - Raising new equity rounds and debt financing - Financial planning and cost control, IFRS implementation - Introducing transparent reporting system M&A support - Developing M&A strategy - Search and valuation of attractive acquisition targets - Legal support and deal structuring - Integration assistance Operational support - Help in bringing top experienced people to the team to bridge personnel gaps - Attracting independent board members and industry experts - Motivation schemes implementation - Development of tax and legal structure, IT-systems - Access to a new partner and client network, help in expanding abroad - Optimization business processes and internal decision-making Help in forming/ adapting company strategy - Business model adaptation to changing market realities - Implementing company development plan and setting KPI’s Preparing company for an IPO or trade sale - Improvement of corporate governance - Substituting investment banks at exit - Legal support and deal structuring 7
  • 8. Private Equity target returns IRR 30% Cash-on-cash 3x over 5 years 8
  • 9. Investment approach and key success factors 1 Market leaders are typically winning 2 Strong and motivated management team 3 Fair entry price 4 Proper deal structuring 5 Proactive monitoring 6 Clear exit strategy 7 Industry growth and deep market expertise 9
  • 10. Private Equity fund structure Limited Partners Distribution Institutional investors of proceeds • Pension funds • Sovereign wealth funds • Financial institutions HNWI Disbursement of commitments Carry Fund General Partners PE or VC firm Equity Exit Investment proceeds Investee company 10
  • 11. Typical PE/VC fund remuneration structure Management fee 2% LP GP Carry 20% Management fee of 2% is charged on the total amount of committed/invested capital. Carry is received upon exit from portfolio investments. • First, LPs get total commitments at cost plus hurdle rate (8-10% annual). • Second, remaining exit proceeds split while 80% goes to LPs and 20% to GPs. Carry is the main part of total remuneration and its existence ensures that the interests of LPs and GP are aligned and GP focused on value maximization and successful exits. 11
  • 12. Company funding lifecycle Revenue IPO Private Equity Venture Capital Business angels FFF Time Start-up Early Growth Mature 12
  • 13. Typical activities performed by PE fund Pre-deal Deal origination Deal screening Due Diligence Deal Negotiation Structuring Deal sourcing Company Post-deal management, Exit value creation 13
  • 14. Deal screening example Number of deals Deal received 500 Signing NDA 200 Investment Committee 20 Due diligence 3 Docs drafting and 2 closing 14
  • 15. Russian PE industry landscape Institutional funds Captive funds Government- Family offices backed 15
  • 16. Russian VC industry landscape International funds Russian funds Accelerators Government- backed 16
  • 17. Entry strategies Target Stake Deal Deal Fund’s Type of company acquired structure funding strategy fund stage Classical Current PE funds, Growth/ Debt/Self Buy and Buyouts Mature >50% shareholders financed build cash out mezzanine funds New issued stock Financial Venture Growth/ purchase/current Self investor Growth capital Mature <20% shareholders financed (funds for funds, PE funds partial cash out growth) Financial Venture Development New issued stock Self investor Early/Growth <20% funds, PE capital purchase financed (funds for funds growth) Financial Current Minority Growth/ Self investor Classical <50% shareholders recapitalization Mature financed (funds for PE funds cash out growth Reorganizati Special Distressed Mature/ Debt obligations Self >50%/100% on and situations situations Decline assignment financed restructuring funds 17
  • 18. Exit strategies  Acquisition of a target by it’s current management Company team size/maturity MBO  Management’s stake before MBO - zero/ insignificant  Example: buyout of a non-core subsidiary  Disagreements on company’s development Sale to other strategy  Dead lock danger shareholder  Spin offs, non cash-deals  Acquisition by a new vehicle created by new PE investor/strategic Secondary buyout investor  The third, forth, etc buyout rounds may also take place  Most IPO proceeds – growth and development capital IPO  Only partial cash out of current shareholders is Likelihood possible of positive target’s performance 18
  • 19. PE careers Entry strategy Exit opportunities Partner Unlimited  Work experience in  Top management Investment director Unlimited Private equity positions in industry  Successful completed  Top management deals track record position in fund’s  Recruiters, networking company/project  Own business/project VP/ Associate 1-3 director launch years  Work experience in Big4,  Middle level IB, Industry is required Associate/ 1-3 management positions  Recruiters, networking years in industry Investment manager  Upside position in a smaller fund  Own project launch 1-3 Analyst years  Last year students Internships  Applications on career sites 19
  • 20. Session 2. PE deal origination, execution and portfolio management 1st part Industry analysis • Investment strategies: buy-and-build vs bet-and-win; • Industry KPIs and application for financial modeling; • Multiples variation by industries. Financial modeling and leveraged buyouts • Financial statement analysis: application for private equity; • Valuation methods: multiples approach, comparable transactions approach; • Private equity returns calculations: IRR, cash-on-cash, exit sensitivity analysis. • LBO and financing of M&A transactions: debt and mezzanine financing for PE deals. 2nd part Due diligence • Commercial, financial and tax, legal due diligence Deal structuring and negotiations • Legal documents for deal execution: NDA’s, LOI’s, Term Sheets, SHA’s, SPA’s; • Off-shore holding structures: English law, possible holding schemes. • Deal structuring tools • Deal negotiations: habits for effective negotiations. Portfolio companies management • Fund representation on the board of directors: strategy formulation, veto and approval rights, audit and compensation committees; • Companies monitoring: weekly/monthly management reporting packs, frequent interaction with management; • Value creation strategies: fund raising, building corporate governance, management appointment, solving operational issues, attracting consultants, finding clients, exit preparation, synergy identification among portfolio companies. 20
  • 22. Examples of attractive sectors in the current environment Sector Investment rationale 1 Undeveloped industries/ sectors with high growth potential • Internet tech companies • High Internet growth rates • E-commerce • Service infrastructure is still underdeveloped • Medical Services • Limited modern private medical services • Fast Food • Logistics 2 Traditional sectors • Food retail • Import substitution • FMCG • M&A opportunities, important to find right • Pharmaceutical industry platform for consolidation • Media, telecom • Regional growth potential • New formats/ products development • Room for improvement (margins, working capital) 22
  • 23. Two types of investment strategies investment strategies Two investment strategies “Bet-and-win” “Buy-and-build” • Industry with high growth potential • Good industry knowledge • Investment in market leader • Building market leadership through M&A • Investment in strong management • Strengthen management team team • “Discount entry price” • “Fair entry price” • Majority stake buy-out • Minority investment Undeveloped industries/ sectors with Traditional sectors high growth potential Common principles • The market in which the Company operates should be at least $100 million • The demand for the Company products or services should be justified by macro trends • The business model should be proven/ sustainable/ scalable 23
  • 24. Private Equity focuses on rapidly growing sectors Penetration Disposable Consolidation Stable Import Regional Growing Under- growth income/ opportunity demand substitution growth corporate and developed private potential government infrastructure spending spending growth Tech/ Internet/ IT      E-commerce      Medical services        Fast food, casual dining      Logistics      Food retail      FMCG      Pharmaceutical        Media, telecom       Auto components    Pension funds     Infrastructure    24
  • 25. Industry sector top-down scorecard example Sector description • Description of the sector Size and trends Regulations and environment • Estimated size of the sector (for the latest year available). Sector • Assessment of the environment CAGR and expectations for short and medium run. (favorable or risky) • Key segments, information on segments’ share, trends, margins, etc. • Information on state support/ • Export and import information. Any info on taxes, export/ import regulations within the sector quotas. • Information on international players • Key buyers and suppliers. working within the sector • Other information (e.g. recent trends, substitutes, etc) • Indication of PE activity in the sector • Assessment of margins (EBITDA, other information) - can be gained from Annual Reports, analysts’ reports, SPARK, etc • Some indications on capital expenditures (e.g. cost of production facilities, years to build/ get to full capacity) Fragmentation and key players Potential Growth and Exit Strategy Overall conclusion and Exit Strategy • Assessment of market consolidation (consolidated or • Overall measure of the sector fragmented) attractiveness for the PE activity • Key players, their market shares (high or low score) • Information on recent mergers/ acquisitions • Decryption of potential targets • Information on actioners, vertical integration of the players, etc • Description of exit strategy • Competition assessment 25
  • 26. Three different industry segment examples Online B2C business Food retail chain Engineering business 26
  • 27. Example 1. Online B2C business Key points to consider • Unit economics, CLV > Customer acquisition cost • Average check, churn, retention, repeat users • Visitors, conversion • Customer acquisition channels • Head office costs, cash burn • Logistics • Inventory 27
  • 28. Example 2. Food retail Key points to consider • Store level performance/locations. Top-line and bottom-line by store. Revenue and EBITDA concentration. • Store level economics: capex, revenue per store, target profitability level, payback period, revenue ramp-up, time to break-even, time of construction • Benchmark against competitors. Revenue per sqm, profitability, prices, SKUs, locations. • Logistics. How in-bound and out-bound logistics works? Who are the suppliers? Private labels? • Rental agreements. How the stores locations are determined? What are the terms and timeframe of the rental agreements? • Costs as % of revenue. Marketing expenditures, personnel expenses, head office expenses. • Working capital. Inventory, a/r, a/p turnovers. • Store opening pipeline. Geography of locations? Any preliminarily agreements in place? How much they opened historically? 28
  • 29. Example 3. Engineering Key points to consider • Customers. History of relationship. Blue-chip customers, creditworthiness. Revenue concentration. • Customer contracts terms, time periods and payment terms • Value chain. Which part of the value chain does the company operates? • Personnel utilization, turnover, average wages. Contract agreements with personnel, motivational schemes in place • Head office 29
  • 30. Financial modeling and leveraged buyouts 30
  • 31. Analyzing the target High-growth/start-up Established business business  Past performance analysis (financial statement analysis,  Management team Current current market position inspection positions analysis inspection)  Monetization model audit  Current conditions of production facilities  Valuation based on  Future growth estimation trade multiples Valuation/  Market prospective  DCF forecasting for prospects analysis scenario analysis and estimation debt repayment  DCF forecasting for capacity estimation valuing business
  • 32. Valuing the target Revenue Start-up Expansion Growth Decline FFF, Venture Strategic investor, Private equity funds seed funds special situation fund Time Firm Current business and assets, Future growth Current assets value future growth Valuation Comparable companies, Negotiations Comparable companies method liquidation method Multiple if N/A Extremely high High, average industry level Low applied
  • 33. Valuation methods. Multiples approach I. Equity value/Net income IV. Industry specific multiples  Highly depends on capital Industry Multiple structure  EV/Reserves 1. Oil & gas  Not widely used for private  EV/Production equity valuations  EV/EBITDAX 2. Metal & mining  EV/Reserves  EV/Production II. Enterprise value/Sales 3. TMT, internet, media  EV/Subscribers  Highly depends on business  EV/Population marginality (“quality” of sales)  EV/Fiber miles  The most simple in terms of 4. Financial institutions  Equity value/Book value calculation and quick value  Equity value/Net Asset value estimation 5. Retail  EV/EBITDAR  EV/Square footage III. Enterprise value/EBITDA 6. Real estate  EV/Square footage  Equity Value/Net Asset  Most commonly used Value
  • 34. Valuation methods. Multiples approach Enterprise value derivation Enterprise value Assets Liabilities & Equity = Equity value  Long term assets  Debt + • Investments in  Convertible notes associates Total debt  Mezzanine + Preferred stock  Current assets • Cash & cash  Common Equity + equivalents  Preferred stock Noncontroling interest  Noncontrolling - interest Cash & cash equivalents - Cash-flow Investors claims Associate companies generating assets = Equity value + other + = Enterprise value + investor claims = assets not generating Other claims on assets Enterprise value + cash (pension liabilities, employee stock cash flow (cash) option)
  • 35. Valuation methods. Multiples approach EBITDA derivation EBITDA calculation from IFRS and US GAAP reporting  Adding back D&A, taxes and interest payments to Net Income  Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring costs, assets revaluation, special projects costs) EBITDA calculation from RAS reporting  Adding back D&A, taxes and interest payments to Net Income  Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring costs, assets revaluation, special projects costs)  D&A is reported in COGS and SG&A section. Reporting notes should be investigated to detach it/simplified forecast of D&A based on PPE balance value can be performed
  • 36. Valuation methods. Multiples approach Commercial meaning EV EBITDA -  Not a capital intensive business  Perfect conditions of current  Extensive capex program production facilities  High tax rate  Low tax rate  High cost of capital  Low cost of capital  Low market growth estimation  Outstanding growth prospective + General rule: General rule:  Oil & gas  Retail EV/EBITDA>5 EV/EBITDA<5  Metals & mining  Internet  Development  Healthcare  Infrastructure
  • 37. Valuation methods. Transactions approach Special Data Bases use for Criteria Processing Final transaction determination with sample multiple search calculation  MergerMarket  Target’s sector  Moving away  Median/average  Factiva  Geography deals without multiple of a  DealWatch  Deal type financial details selected sample  Zephyr  Period  Moving away of transactions outliers  Stake acquired  Multiples check
  • 38. Private equity returns calculations ENTRY EXIT Equity value Entry EV/EBITDA x Equity value EBITDA LTM Exit EV/EBITDA x EBITDA LTM Net claims on assets Net claims on assets Funding from banks, mezzanine funds, etc. Equity consideration Dividends payments Equity stake of a PE paid by PE fund fund Value Dividends Value + Dividends + Value Σ + - Cash-on-cash 0 Value (1+IRR) k
  • 39. LBO deal case. General structure Current New investor 1 shareholders (PE fund) New investor 2 (PE/mezzanine fund) Ownership Equity New investor 3 (Bank) Subordinated notes, convertible notes Senior debt Target Growth capital component of LBO transaction Capex program 39
  • 40. LBO deal case. Valuation and funding structure I. Valuation and structure II. Deal funding Company financials Funding structure % mln $ Sales'12 mln $ 400 Equity contribution 30% 78 EBITDA'12 mln $ 48 Senior debt 40% 104 Net debt mln $ 20 Subordinated notes 20% 52 Noncontroling interest mln $ 15 Convertible notes 10% 26 Total 100% 261 Valuation multiples EV/EBITDA on entry x 7 Total investments EV/EBITDA on exit x 7 Pre-money valuation Enterprise value mln $ 336 Entry mult x EBITDA’12-Net debt-NI Equity value mln $ 301 Transaction issues Growth capital investment mln $ 50 Current shareholders stake for sale % 70% Pre-money equity valuation + growth Post-money valuation capital Enterprise value mln $ 386 Equity value mln $ 351 Total investments mln $ 261 Stake for sale x Equity pre-money Cash out mln $ 211 valuation + growth capital Cash in mln $ 50
  • 41. LBO deal case. Debt & equity parameters I. Senior debt Term years 8 Interest rate % 8% Principal amount mln $ 104 Repayment annuity payments II. Subordinated notes Term years 8 Cash interest rate % 10% PIK interest % 4% Principal amount mln $ 52 Conversion warrant - III. Convertible notes Term before conversion years min (10; new investment round) Conversion price 10 years 1,5 x entry valuation new round 0,8 x new investor valuation Interest rate % 8% Principal amount mln $ 26 IV. Common equity Dividend payout ratio % 10% Par value mln $ 78
  • 42. LBO deal case. Debt schedules A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 I. Senior debt Annuity payments 9 18 18 18 18 18 18 18 Outstading amount, b-o-p 0 0 99 89 78 66 53 40 25 Principal repayment 0 5 10 11 12 13 14 15 16 Interest payment 0 4 8 7 6 5 4 3 2 Outstanding amount, e-o-p 0 99 89 78 66 53 40 25 8 II. Subordinated notes Outstanding amount, b-o-p 0 0 52 54 56 59 61 64 66 PIK interest 0 0 2 2 2 2 2 3 3 Outstanding amount, e-o-p 0 52 54 56 59 61 64 66 69 Cash interest payments 0 3 5 6 6 6 6 6 7 III. Convertible notes Outstanding amount, b-o-p 0 0 26 26 26 26 26 26 26 Outstanding amount, e-o-p 0 26 26 26 26 26 26 26 26 Interest payments 0 1 2 2 2 2 2 2 2 Total interests 0 8 17 17 16 16 15 14 13 Cash interest payments 0 8 15 15 14 13 13 12 11 P&L
  • 43. LBO deal case. P&L forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 Sales 400 392 392 412 453 498 508 518 529 COGS -232 -231 -231 -235 -240 -264 -269 -275 -280 Gross profit 168 161 161 177 213 234 239 244 248 Gross margin 42% 41% 41% 43% 47% 47% 47% 47% 47% EBITDA 48 43 43 54 77 85 86 88 90 EBITDA margin 12% 11% 11% 13% 17% 17% 17% 17% 17% D&A -5 -5 -7 -7 -7 -7 -7 -7 -7 EBIT 43 38 36 46 70 77 79 81 83 EBIT margin 11% 10% 9% 11% 15% 16% 16% 16% 16% Interest payments 0 -8 -17 -17 -16 -16 -15 -14 -13 EBT 43 30 18 29 53 62 64 67 69 Net income 34 24 15 23 43 49 51 53 55 Net income margin 9% 6% 4% 6% 9% 10% 10% 10% 10% Dividends on common equity 0 -2 -1 -2 -4 -5 -5 -5 -6 BS
  • 44. LBO deal case. BS entries A 1 mln $ 2012 Adjustments 2013 I. Non current assets PP&E 100 Capex from new investment proceeds 145 Intangibles 10 10 Goodwill 0 Pre money equity valuation – Initial shareholders equity 201 Total non current assets 110 356 II. Current assets Cash 80 3 Inventories 25 25 Reveivables 20 20 Total current assets 125 47 Total assets 235 404 III. Long term liabilities Existing loan facility 100 Debt repayment from cumulative cash and operating cash flow of 2013 0 Senior debt 0 Principal amount – repayment of principal in 2013 99 Subordinated notes 0 Value of the notes issued in 2013 52 Convertible notes 0 Value of the notes issued in 2013 26 Total long term liabilities 100 178 IV. Current liabilities Current portion of long term debt 0 0 Payables 20 20 Total current liabilities 20 20 V. Equity Shareholders equity 100 Pre-money equity*(1-cash out stake)+equity contribution by PE+NI-dividends 191 Noncontrolling interest 15 15 Total equity 115 206 Total equity & liabilities 235 403
  • 45. LBO deal case. BS forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 I. Non current assets PP&E 100 145 145 145 145 145 145 145 145 Intangibles 10 10 10 10 10 10 10 10 10 Goodwill 0 201 201 201 201 201 201 201 201 Total non current assets 110 356 356 356 356 356 356 356 356 II. Current assets Cash 80 3 8 19 46 77 111 146 181 Inventories 25 25 25 25 26 28 29 30 30 Reveivables 20 20 20 21 23 25 25 26 26 Total current assets 125 47 52 65 94 130 165 201 238 Total assets 235 404 409 421 451 487 522 558 594 III. Long term liabilities Existing loan facility 100 0 0 0 0 0 0 0 0 Senior debt 0 99 89 78 66 53 40 25 8 Subordinated notes 0 52 54 56 59 61 64 66 69 Convertible notes 0 26 26 26 26 26 26 26 26 Total long term liabilities 100 178 170 161 151 141 129 117 103 IV. Current liabilities Current portion of long term debt 0 0 0 0 0 0 0 0 0 Payables 20 20 20 20 21 23 23 24 24 Total current liabilities 20 20 20 20 21 23 23 24 24 V. Equity Shareholders equity 100 191 204 225 263 308 354 402 452 Noncontrolling interest 15 15 15 15 15 15 15 15 15 Total equity 115 206 219 240 278 323 369 417 467 Total equity & liabilities 235 403 408 421 450 486 521 557 594
  • 46. LBO deal case. CF forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 Operating cash flow Net income 34 24 15 23 43 49 51 53 55 PIK interest 0 0 2 2 2 2 2 3 3 D&A 5 5 7 7 7 7 7 7 7 Changes in receivables 0 0 0 -1 -2 -2 0 -1 -1 Changes in inventories 0 0 0 0 -1 -3 -1 -1 -1 Changes in payables 0 0 0 0 0 2 0 0 0 Cash flow from operations 39 30 24 32 50 56 60 62 65 Investment cash flow Capex -5 -50 -7 -7 -7 -7 -7 -7 -7 Cash flow from investments -5 -50 -7 -7 -7 -7 -7 -7 -7 Financing cash flow Existing debt 0 -100 0 0 0 0 0 0 0 Senior debt 0 99 -10 -11 -12 -13 -14 -15 -16 Subordinated notes 0 52 0 0 0 0 0 0 0 Convertible notes 0 26 0 0 0 0 0 0 0 Common equity contribution 0 78 0 0 0 0 0 0 0 Common equity repayment 0 -211 0 0 0 0 0 0 0 Dividends 0 -2 -1 -2 -4 -5 -5 -5 -6 Cash flow from financing 0 -57 -12 -13 -16 -18 -19 -20 -22 Total cash flow 34 -78 5 11 27 31 34 35 36
  • 47. LBO deal case. Exit valuation 1 2 3 4 5 6 7 8 mln $ 2013 2014 2015 2016 2017 2018 2019 2020 EBITDA 43 43 54 77 85 86 88 90 Exit multiple x7 Enterprise value at exit 302 302 375 539 593 605 617 629 Net debt Initial loan facility 0 0 0 0 0 0 0 0 Senior debt -99 -89 -78 -66 -53 -40 -25 -8 Subordinated notes -52 -54 -56 -59 -61 -64 -66 -69 Convertible notes -26 -26 -26 -26 -26 -26 -26 -26 Total debt -178 -170 -161 -151 -141 -129 -117 -103 Cash 3 8 19 46 77 111 146 181 Total net debt -175 -162 -142 -106 -64 -18 29 78 Equity value at exit 127 140 233 433 529 586 645 707 PE fund stake in equity 70% 70% 70% 70% 70% 70% 70% 70% Conversion of convertible notes Equity value after conversion 166 259 459 555 612 672 733 Share of a converter 19% 12% 7% 6% 5% 5% 4% Share of a PE fund after conversion 57% 88% 93% 94% 95% 95% 96% PE fund stake value 94 227 427 523 580 639 701
  • 48. LBO deal case. Returns calculation Exit year 2014 2015 2016 2017 2018 2019 2020 2013 -78 -78 -78 -78 -78 -78 -78 2014 96 1 1 1 1 1 1 2015 0 229 2 2 2 2 2 2016 0 0 431 4 4 4 4 2017 0 0 0 527 5 5 5 2018 0 0 0 0 585 5 5 2019 0 0 0 0 0 645 5 2020 0 0 0 0 0 0 706 IRR 22% 72% 78% 63% 51% 44% 39% Cash-on-cash 1,2 2,9 5,6 6,8 7,6 8,5 9,3 Alternative scenario: fully equity financed buyout Exit year 2014 2015 2016 2017 2018 2019 2020 2013 -261 -261 -261 -261 -261 -261 -261 2014 238 3 3 3 3 3 3 2015 0 444 4 4 4 4 4 2016 0 0 658 6 6 6 6 2017 0 0 0 765 6 6 6 2018 0 0 0 0 834 6 6 2019 0 0 0 0 0 903 6 2020 0 0 0 0 0 0 974 IRR -9% 31% 37% 32% 27% 24% 22% Cash-on-cash 0,9 1,7 2,5 3,0 3,3 3,6 3,9
  • 49. Exit strategies. Returns on exit Alternative Valuation Valuation scenario: fully equity financed buyout PE fund equity PE fund equity PE fund equity Convertible Convertible notes notes Subordinated Subordinated PE fund equity notes notes Senior Senior Debt Debt 2013 2017 Time 2013 2017 Time 49
  • 51. Due diligence types Due diligence Due Diligence types • Typically takes 4-5 weeks Commercial • Can be organized through VDR (Vendor Data Room) • Serves as a basis for Operational negotiations on warranties, indemnities • Possible adjustment to Financial and EBITDA and purchase price may be negotiated based on tax due diligence results Legal Environmental 51
  • 52. Due diligence consultants Commercial Financial and tax Legal Large deals Mid-size deals Generalists Mid-size deals Mid-to-small deals Law firms Mid-to-small deals Also doing transaction documentation 52
  • 54. A typical example of deal structuring in Russia Shareholder A Shareholder B Shareholder C 100% 100% 100% BVICo BVICo BVICo 30% 30% 40% Shareholders’ Agreement Cyprus HoldCo Buyer SPV Sale and Purchase Agreement Joint 50% 50% Venture Cyprus SPV 100% Russian LLC/CJSC Source: Goltsblat, Salans 54
  • 55. Why English law is used in Russian transactions? Use of legal concepts not available Key merits of English law under Russian law or untested in Russian courts. For example: • Flexible • representations, warranties, • Adaptable indemnities • Commercial • put and call options • Freedom of contract • drag and tag along • Predictable • conditions precedent • Reputable judiciary • restrictive and negative covenants • Common law and precedents • retention and escrow accounts • deadlock mechanisms • English law is widely used in international transactions (often in conjunction with local laws) across a variety of jurisdictions, including on many deals in the Middle East, Africa, Singapore, Hong Kong, China, India, Russia and the CIS • English law is a common law system, based on a combination of legislation and case precedent. This makes English law flexible, adaptable and practical • The laws and rules themselves are less prescriptive when interpreting the intentions and actions of the parties and instead the courts will interpret what the parties have written in the contract • English courts have a strong reputation for reaching fair, balanced and unbiased judgments and rulings Source: Goltsblat, Salans 55
  • 56. Typical deal documents for PE transactions NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 56
  • 57. NDA NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 57
  • 58. NDA Common issues addressed • Parties • The definition of information to be held confidential • The exclusions from what must be kept confidential • The disclosure period - information not disclosed during the disclosure period (e.g., one year after the date of the NDA) is not deemed confidential • The term (time period) of the confidentiality • Obligations of the recipient regarding the confidential information • Insider trading (in case of public company) • The law and jurisdiction governing the parties However, it is hard to prove breach of an agreement and quantify losses, so typically NDA is just a formality… 58
  • 59. LOI/ MOU NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 59
  • 60. LOI/ MOU Common issues addressed • Parties • Consideration - price for the assets and business to be purchased • Term Sheet • Timing for Term Sheet signing and transaction completion • Public announcements restrictions • Non-binding nature of the document Differences between LOI/MOU • LOI outlines the intent of one party toward another with regard to an agreement, and may only be signed by the party expressing intent • MOU must be signed by all parties to be a valid outline of an agreement 60
  • 61. Term Sheet NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 61
  • 62. Term Sheet Common issues addressed • Parties • Total price consideration, formula for calculation, adjustments • Debt and working capital • Payment tranches • Transaction calendar and deal closing date • Short list of conditions precedent, representations and warranties, existence of certain indemnities • Exclusivity • Break-up fee • Subject to due diligence • Confidentiality • Governing law 62
  • 63. SHA/SPA NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 63
  • 64. Deal structuring entails negotiations SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 64
  • 65. SPA related deal structuring SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 65
  • 66. Representations, warranties and indemnities Representations • Representations are statements by one party (usually the seller) which induce another party (usually the purchaser) to enter into a contract • If the statement relied on is untrue or incorrect and the position misrepresented, the other party may be entitled to terminate or rescind the contract and/or claim damages Warranties • Warranties are terms of a contract which, if breached, will entitle the innocent party to claim damages • The contractual measure of damages aim to put the innocent party in the position it would have been in had the breach not occurred • Used in order to provide reassurance from the seller on factual matters or future promises concerning the status of the target company and its business, assets, liabilities and financial position Possible warranties (but not limited to): • Accuracy of financial information • Employment arrangements • Ownership of assets • Recent material changes to the business • Nature and extent of contracts • Intellectual property, appropriate licences • Absence of any disputes • Share structure and ownership of the target Source: Goltsblat, Salans 66
  • 67. Representations, warranties and indemnities Indemnities • Indemnity is a promise to reimburse the buyer in respect of a particular type of liability, should it arise • Easier to establish than a warranty claim as there is no need to calculate loss • Used where there is a known or potential, clearly identifiable liability, the risk of which is to be borne by the party giving the indemnity, such as unpaid tax, a potential environmental claim, or a specific issue arising from due diligence • Warranties may be given on an indemnity basis Tax deed • Tax dead is a document containing tax indemnities • If there are any unexpected tax problems associated with the target, the buyer will expect that the price is reduced by an amount equal to the consequential tax liability (buyer’s protection) • The tax deed also contains lengthy provisions limiting the ability of the buyer to bring claims under the tax deed (seller’s protection) Indemnity security • Retention, escrow accounts • Pledge over assets • Parent guarantee Source: Goltsblat, Salans 67
  • 68. Purchase price/ consideration Purchase price mechanisms • Completion accounts mechanism may be included, whereby an audit of the target company and its business is conducted and the purchase price is adjusted. • The completion accounts process includes accounting assumptions and valuation methodology or formula for price calculation. • Contracts will sometimes also include deferred consideration payments at agreed stages after completion • Escrow accounts can be used, while money is deposited with a third party, who holds it ‘in escrow’ for the parties and only releases it in accordance with the terms of the escrow contract • These can sometimes be linked to earn-out provisions, which compare future economic performance against agreed targets (such as revenue or profits) and then adjust the deferred payments according to whether or not these targets are met. • Price can be adjusted both sides according to ratchet scheme Source: Goltsblat, Salans 68
  • 69. Conditions precedent Conditions precedent • Conditions precedent (CPs) are clauses which provide that certain parts of the contract will only come into force if and when agreed conditions are met • There is no obligation to complete the transaction until the CPs are met. If SPA is signed the buyer has no obligation to pay until the CPs are met • The contract will typically include provisions dealing with the legal obligations of the parties pending satisfaction of all the conditions and the efforts to which they must go in order to achieve satisfaction of the CPs themselves Possible CPs (but not limited to): • Obtaining anti-monopoly approval • Bank consent • Change of control • Approvals from key customers and suppliers to assign contracts • Investment Committee approval • Absence of any material adverse change in the financial condition of the target Termination rights • Material adverse change • Material breach of warranty Source: Goltsblat, Salans 69
  • 70. Restrictive covenants • Restrictive covenants are contractual promises, preventing the seller of the business from competing with the business sold (non-compete), together with non-poaching undertakings in relation to key staff, suppliers and customers (non-solicit). • They must be restricted in time and scope to be effective and enforceable Source: Goltsblat, Salans 70
  • 71. SHA related deal structuring SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 71
  • 72. Put and call options Put option Right to put its shares on Party B • The right, not an obligation Party A Party B • Put and call options should Obligation to pay $ contain price of execution, to Party A terms and possible triggers. 50% • Put price may be linked to IRR shareholding 50% shareholding or cash-on-cash multiple of the (subject to ‘put’ right) Company investor • May be used to give an exit strategy or as an enforcement Call option mechanism on default under Right to call for shares from Party A shareholders’ agreements Party A Party B • Redemption shares are often used as a ‘soft’ put option, but Obligation to transfer shares to party B, in can be redeemed only from net exchange for $ profit 50% payment 50% shareholding shareholding • Call and put often used in (subject to ‘call’ right) Company parallel, limiting downside as well as upside Source: Goltsblat, Salans 72
  • 73. Covenants and veto rights Covenants • A covenant is an agreement or promise to do (positive covenant) or refrain from doing something (negative covenant), binding on the party who gives it Possible positive covenants: Possible negative covenants: • Provide financial information on request • Not to issue new shares • Inform about break of warranty • Not to dispose any material assets • Maintain Debt/EBITDA below 3x Veto rights • A veto right is the right of a party to withhold its approval to a proposed course of action or decision that requires its consent Possible veto rights on: • Issuing or selling shares • Making capital expenditures over $X • Taking loans over $X • Terminating employment with key employees Source: Goltsblat, Salans 73
  • 74. Drag along and tag along Drag along • A drag along right allows a shareholder of a company to force the remaining Buyer shareholders to accept an offer from a third party to purchase the whole company. • The other shareholders are then ‘dragged along’ and forced to sell their shares at the same time and price. • Used to give liquidity and an exit route on an assumption that most buyers will Party A Party B want to acquire 100% of the company shareholding • The offer may also need to match or 3. Party B is exceed a minimum agreed price or shareholding forced to accept minimum time period before the drag and sell its along right can be triggered shares Company • The other shareholder may be given a right to match the offer and buy the shares itself (Right of first refusal) Source: Goltsblat, Salans 74
  • 75. Drag along and tag along Tag along • Tag along provision is a corresponding right that entitles shareholder to Buyer participate in a sale by the other 1. Party A shareholders at the same time and at decides the same price per share. to sell its shares • The minority shareholder then ‘tags along’ with the majority shareholder’s sale. • Can state that, if the tag along procedures are not followed by the Party A Party B purchaser, then its attempt to buy any of the shares is not valid and will not be shareholding 2. Party B registered shareholding can force the buyer to buy its shares as well Company Source: Goltsblat, Salans 75
  • 76. Good leaver/ Bad leaver provisions • Leaver provisions are contractual Possible provisions mechanisms covering employees Good Intermediate Bad who are also shareholders in a Leaver Leaver Leaver company Death Serious/ Resignation • When an employee leaves the permanent prior to company, he is required to transfer illness an agreed his shares back to the company of spouse minimum period • Typically used for the shares granted Serious/ Resignation Dismissal for to managers as a motivation scheme permanent after an gross • Good leavers tend to receive market illness agreed misconduct value for their shares, whereas the minimum price paid to bad leavers tends to be period heavily discounted Retirement at Dismissal on Dismissal for retirement grounds of fraud age poor or dishonesty performance Redundancy Breach of restrictive covenants Source: Goltsblat, Salans 76
  • 77. Other SHA tools Upside sharing Deadlock mechanism Anti-dilution Preferred shares/Liquidity preference Corporate governance rights 77
  • 79. Corporate governance issues Management Structuring Board of compensation and Directors incentives programs Corporate governance Monitoring CEO replacement Influence on strategy
  • 80. Board of Directors Structuring Board of Directors Board size Board composition Board committees  Key point while deal  3 categories:  Two main committees: structuring (as well as entrepreneurs (founders), compensation and audit board composition) investors, independent  Compensation committee  Smaller boards – more directors area: salaries, stock option effective in decision  PE investor does not have for top managers (chaired making a majority of board seats by independent director,  Typical PE-backed as a rule excludes CEO) company Board – 5-7  Balanced composition: 2  Audit committee area: members (half of a size of managers, 2 investors, 1 – compliance with legal a public company Board) independent director (the requirements on financial  Monthly frequency of swing vote) reporting (members with Board meeting is common  Composition changes accounting expertise for early-stage companies subject to company independent from performance management)
  • 81. Companies monitoring and value creation I. Monitoring process High frequency of interaction with Medium to high frequency of Low frequency of interaction with management. Level: analyst + interaction with management. management. Level: VP/director + Level: analyst/associate + Weekly operational reports Monthly reporting packs BoD, committees presence, general reporting forms review Start-ups Profitable growing Mature company Maturity of a businesses business II. Value creation Negotiations Fund team – in- Fund raising: Synergy with external house other funds among consultants, consultants for a assets as a portfolio bankers, legal company pledge companies and government authorities
  • 82. Management incentive tools General incentive scheme Bonus scheme Management share in IRR additional payment min max 0% 15% 0% 16% 20% 0% 21% 25% 0% 26% 30% 0% 30% 35% 0% 35% 40% 30% 40% 50% 50% 50% 100% 70% Example Bonus & IRR calculation Enterprise value $mln 423 Equity value $mln 422 Fund share $mln 396 IRR (Fund) % 57% min IRR % 35% Additional gain to the Management $mln 114 real IRR (Fund) % 39%
  • 83. Q&A