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PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS
         Session 1. Private Equity landscape




                                                                       March 2013

                                                                   Alexey Milevskiy
                                                                    Gleb Fomichev


                  The presentation is prepared solely for the purposes of master classes
                                                      at the Higher School of Economics
INTRODUCTION


               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
UFG Private Equity




                 • Over $500 million of capital under management
                 • Strong and experienced team of 11 investment professionals
                 • 5 partners worked as CEO/CFO or had own businesses,
                   one partner is involved as CEO or a portfolio company
                 • Strong track record with 19 investments in FMCG, Consumer
                   and Business services, Metals and Mining, Banking, Specialty
                   Retail, TMT, Food and Beverages, Healthcare, Travel sectors
                   with aggregate transaction value of over $1 billion
                 • 7 projects were co-invested with other funds
                 • 8 exits performed with capability to create value
                 • International investor base including EBRD and well-known
                   US and Middle-Eastern state pension funds
                 • Part of UFG Asset Management group with $1.2 billion
                   under management in four investment areas: Private Equity,
                   Hedge Funds, Real Estate, Wealth Management



                                                                                  4
UFG Private Equity Fund II portfolio companies


  Fund Size $225m

                                    Yandex         Partially realized

                               Rising Star Media     Fully realized

                                   Russian         Fund II Portfolio
                                   Towers             company

                                   Enforta         Fund II Portfolio
                                                      company
                                  Brunswick        Fund II Portfolio
                                     Rail             company
                                                   Fund II Portfolio
                                     KDL
                                                      company

                                  Karo Film        Fund II Portfolio
                                                      company

                                                                        5
JSFC Sistema



               • Top public investment company in Russia
               • Market cap ~ $10 bln
               • Assets under management ~ $40 bln
               • Consists of 8 investment portfolios divided by
                 industry/investment team competencies




                                                                  6
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.




                                                                                                           7
Session 2. PE deal origination, execution and portfolio management


  Industry analysis
                                                                                       March, 14 (6pm – 9pm)
  • 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.

  Due diligence
  • Commercial, financial and tax, legal due diligence

  Deal structuring and negotiations
  • Legal documents for deal execution: NDA’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.


                                                                                                                  8
Private Equity
  definition


                 9
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




                                                      10
Private Equity value creation formula




                                                      Multiple
            EBITDA growth                 Leverage
                                                     Expansion

       Topline           Efficiency
       growth          improvement




                            Superior returns



                                                                 11
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

                                                                                                     12
Private Equity target returns




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




                                          13
Private Equity fund types


                                                    FUND
                                                 DESCRIPTIONS


    By stage                  By size              Ownership               Specialization               Purpose

 • Venture funds:         • Large-cap            • Captive/semi-           • Specialized             • Funds-of-funds:
  invest in early stage     funds: large LBO       captive: funds            funds: funds             funds created to
  or expanding             funds (could be        established by and        focusing on a             invest in a range of
  businesses that          greater than $20bn)    with strong links to a    portfolio companies       other private equity
  generally have                                  particular investor,      in specific segments      funds
  limited access to       • Mid-cap funds:        e.g. a financial          (e.g. IT/ real estate)
  other sources of         usually invest in      institution
  funding                  deals worth                                     • Regional funds:
                           between $10m and                                 target investments
 • Buyout funds:           $300m                                            in a particular region
  invest in mature
  businesses, usually
  taking controlling
  interest and
  leveraging their
  equity investment
  with substantial
  amount of third
  party debt




                                                                                                                        14
Specialist/ generalist funds


   Specialist funds

  • May be attractive to certain investors, i.e. those seeking to:
    I. Increase their exposure in a particular sector (healthcare, IT)
    II. Diversify their existing geographical/sector focus
  • Small funds may increase specialization to differentiate themselves
  • Disadvantages:
    I. May be more risky due to the lack of portfolio diversification
    II. May be difficult to raise a fund if there is little investor appetite
    III. Niche/hot sectors may lose favor


  Generalist funds

  • Most private equity funds are generalists
  • General fund may have specialist teams who may source and execute deals within certain
    market sectors

  • Generalist funds have the advantage of being able to limit their exposure to declining sectors
    and have more flexibility




                                                                                                     15
Key success
factors for PE
    deals

                 16
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


                                                      17
Investment approach and key success factors
Market leaders are typically winning


           Market leaders                        How to
                are                             determine
              winning                         market leader?

           UFG cases:
           • Yandex
           • RSM
           • Russian Towers     • Industry leader
           • Brunswick Rail     • Industry segment leader
           • Russian Alcohol
                                • Leader by market share
                                • Leader by margins
                                • Leader with first-mover advantage
                                • Leader with the most known brands
                                • Potential market leader through M&A
                                  or business scalability
                                • …

                                                                        18
Investment approach and key success factors
Strong and motivated shareholders and the management team


                                  Goal alignment
                                • Important to chose a partner you can
  Typical PE fund is
                                  deal with. High personal integrity, strong
   not a turnaround               commercial instincts, transparency,
    team which is                 flexibility should be among the qualities of
  coming and taking               the counterparty in the deal.
     operational                • Choice of the trusted management team
    management                    is important
                                • The company should not be 100%
                                  dependent on 1-2 key shareholders/
                                  managers
 We are all in the same boat    • Goal alignment should be in place to
                                  motivate managers and other
      PE      The management,
                                  shareholders:
     fund            founders
                                  Upside sharing scheme may be in place
                                  to motivate management on:
                                  I. Growing the company
                                  II. Exit

                                                                                 19
Investment approach and key success factors
Fair entry price

                                                       Entry
        Fair entry price should be
                negotiated



   • Clear exit path should be overseen
     from the beginning
   • Fair entry multiple is needed to
                                              x5 EBITDA*     x10 EBITDA*
     avoid multiple contraction at exit
                                                           + Full downside
     and achieve good returns
                                                            protection and
   • It is always a trade-off between:                     corporate rights
     I. low multiple
     II. high multiple and protection
                                                       Exit
         mechanisms
                                              35% IRR, 3x cash multiple

                                                               * example   20
Investment approach and key success factors
Clear exit strategy


  Exit types                      To consider at the time of entry
  • Trade sale                    • Clear exit path should be foreseen at
  • Secondary buyout                the time of entry
  • Sale to other shareholders/   • Partner should be focused on exit
    management                      and not to prevent it
  • IPO                           • Exit obligations may be in place to
                                    guarantee exit for the Fund in worst
  • Break-up
                                    case scenario
  • Share redemption
                                  • IPO should not be the base case:
                                    partial exit, continuing risk, lock-up
                                    period
                                  • The exit should be identified in the
                                    investment documents in terms of
                                    timing, profit-sharing, liability to exit


                                                                                21
Investment approach and key success factors
Clear exit strategy: trade buyers exit scorecard example
 Financial Fit                                                     Strategic Fit
 1. Revenue                       2. Net Debt/ EBITDA              1. Product fit
      > 1 bln USD                        < 0x                      1.1. Companies with services portfolio complementary
      500 mln to 1 bln USD               0x to 1x                       to ABC which aim to:
                                                                      • enter ABC segment;
     250 mln to 500 mln USD              1x to 3x                     • complement offerings for the current clients.
     100 mln to 250 mln USD             3x to 5x                   1.2. Companies already present in ABC segment
                                                                        (<50%), which aim to:
      < 100 mln USD                      > 5x                         • strengthen ABC segment.
                                                                   1.3. Companies which aim to:
                                  Only companies with a low
Large firms are more likely to                                        • realize cost synergies;
                                  Net Debt/EBITDA ratio will          • build market share.
acquire ABC and leverage its
                                 have willingness and ability to
         capabilities
                                             acquire               2. Geographical fit

 3. Organic revenue growth        4. EBITDA                        2.1. Companies which aim to enter Russian/
                                                                        emerging markets
      < 5%                             > 200 mln USD
     5% to 10%                         100 mln to 200 mln USD      3. Acquisitions growth fit

     10% to 15%                        75 mln to 100 mln USD       3.1. Companies with expressed intention in M&A
                                                                   3.2. Companies which have successful past track
     15% to 20%                        50mln to 75 mln USD              record of doing acquisitions
     > 20%                             < 50 mln USD
                                                                   4. Client fit
   Companies with limited         ABC is more appealing to         4.1. Companies which want to access new
 organic growth opportunities     companies with a positive             clients of ABC
    are more focused on             EBITDA and aiming to           4.2. Companies which want to provide support to
         acquisitions               maintain high margins               existing multinational clients


                                                                                                                          22
Investment approach and key success factors
Proper deal structuring


       Proper deal               The following deal structuring
    structuring is key           elements could be used:
    to align parties
                                 • Put and call options, redemption
      and establish
                                   rights
       downside
                                 • Deferral consideration and earn-outs
       protection
                                 • Covenants
                                 • Drag along and Tag along
                                 • Share ratchets
                                 • Preferred shares and liquidation
                                   preference
                                 • Right of first refusal
                                 • Board representation and approval
                                   rights
                                 • …




                                                                          23
Investment approach and key success factors
Proactive monitoring


      Proactive                • Building 100 days plan and clear 3-5
    monitoring of                years roadmap
       portfolio               • Building proper corporate governance
    companies is               • Fund active involvement on the Board
      important                  of Directors
                               • Monthly reporting from portfolio
                                 companies
                               • Monthly review of budgeted and actual
                                 numbers
                               • Early warning of issues
                               • Frequent interaction with
                                 management
                               • Strengthening CFO/ financial controller




                                                                           24
Investment approach and key success factors
Industry growth and deep market expertise
     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
 •   Medical Services                           underdeveloped
 •   Fast Food                                • Limited modern private medical services
 •   Logistics

     2     Traditional sectors

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

                                                                                          25
Investment approach and key success factors
Industry growth and deep market expertise

 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


                                                                                       26
Sequoia Capital investment approach


 ELEMENTS OF SUSTAINABLE COMPANIES
 Start-ups with these characteristics have the best chance of becoming enduring
 companies. We like to partner with start-ups that have:
  1    CLARITY OF PURPOSE
       Summarize the company’s business on the back of a business card.
  2    LARGE MARKETS
       Address existing markets poised for rapid growth or change. A market on the
       path to a $1B potential allows for error and time for real margins to develop.
  3    RICH CUSTOMERS
       Target customers who will move fast and pay a premium for a unique offering.
  4    FOCUS
       Customers will only buy a simple product with a singular value proposition.
  5    PAIN KILLERS
       Pick the one thing that is of burning importance to the customer then delight
       them with a compelling solution.



 Source: Sequoia Capital                                                                27
Sequoia Capital investment approach


  6    THINK DIFFERENTLY
       Constantly challenge conventional wisdom. Take the contrarian route. Create
       novel solutions. Outwit the competition.
  7    TEAM DNA
       A company’s DNA is set in the first 90 days. All team members are the smartest
       or most clever in their domain. “A” level founders attract an “A” level team.
  8    AGILITY
       Stealth and speed will usually help beat-out large companies.
  9    FRUGALITY
       Focus spending on what’s critical. Spend only on the priorities and maximize
       profitability.
  10 INFERNO
       Start with only a little money. It forces discipline and focus. A huge market with
       customers yearning for a product developed by great engineers requires very
       little firepower.



 Source: Sequoia Capital                                                                    28
LP-GP agreements


                   29
Private Equity fund structure terminology




                                 Investors which allocate money to PE/VC
                                 funds. They commit money directly (e.g.,
         Limited Partners (LP)   Family Offices), or on behalf of others (e.g.,
                                 Pension funds)




                                 PE/VC fund manager who raises
        General Partners (GP)
                                 money through a fund legal vehicle




                                 Investee companies or entrepreneurs who get
        Investee company         money and generate returns for GPs and LPs




                                                                                  30
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


                                                                                      31
Private Equity fund landscape




                    LP               LP        LP




        GP        GP            GP        GP    GP       GP




       C     C      C       C        C     C   C     C    C




                                                              32
LP-GP relationship


  Limited partnership structure entails arms’ length relationship and a five-ten year
  commitment
  • LPs choice comes out of a solving a broader asset allocation problem, which includes:
    risk/return, liquidity, transparency
  • LP makes three decisions:
        1. Alternative assets among all investment options
        2. VC/PE within alternative assets
        3. Choice of the fund manager (GP) - the most important!
  • Once a GP is selected LPs want to ensure they will earn high returns. This requires that:
      1.   GPs do not act opportunistically
      2.   GPs devote full effort to the ‘fund’
      3.   Right companies are selected
      4.   GPs report their returns faithfully
      5.   Exits from companies are efficient


  •   GPs have to raise funds and choose LPs.
  •   They also need to manage long-term relationships, as fundraising is repeated.
  •   For this, they need to generate high returns (at least the perception of them)
  •   GPs want LPs to provide commitments on time and keep their investment decisions as
      independent as possible


                                                                                                33
LP-GP relationship


  Criteria for selecting GPs in first funds

                  Partners' previous success in PE

                        Proposed investment strategy

        Quality of the partners' network of contacts

  Partners' previous experience in working together

                     The level and structure of fees

      Partners' previous experience in non-PE jobs

                                      The fund's size

                        Partners' quality of education

              Commitments to this fund by top LPs

         The opportunity to access follow-on funds

                         Co-investment opportunities

                                 The advisor opinion

                                                         0   1   2   3   4


 Source: Marco Da Rin                                                        34
LP-GP relationship


    Criteria for selecting GPs in seasoned funds

                            Proposed investment strategy
                      Stability of the team at partner level
     GP's reported aggregate multiples on previous funds
                                           GP's reputation
                     GP's reported IRR on previous funds
                 Quality of the partner network of contacts
                            The level and structure of fees
     Renewed commitment to this fund by its existing LPs
                                           The fund's size
 Valuation of unrealized investments (NAV) in GP portfolio
             The change in fund size from previous funds
                     Commitments to this fund by top LPs
                             Partners' quality of education
                              Co-investment opportunities
                                      The advisor opinion

                                                               0   1   2   3   4


  Source: Marco Da Rin                                                         35
LP-GP relationship


  Reasons for refusing re-investment


  30%




  20%




  10%




  0%
           The fund's size   Strategy changed   Disappointing   Key GP partners left   Other reasons
        increased too much                      performance




                                                                                                       36
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.


                                                                                       37
Typical PE/VC fund remuneration structure: simplified example



                              Management fee 2%


                     LP                                 GP

                                  Carry 20%

            $300mln fund
        1   Management fee
            300*2% = $6mln annually
        2   Carry
            Assumption that the fund makes 3x cash-on-cash over 5 years
            Exit proceeds 3*300 = $900mln
            1) Cost plus hurdle goes to LP: 300*(1+0.08)^5 = $441mln
            2) LP gets 80% of remaining proceeds: 80%*(900-441) = $367mln
            3) GP gets carry of 20%: 20%*(900-441) = $92mln


                                                                            38
Alternative structure of Family Office or captive PE fund




                                   PE/VC fund integrated with an investor
               LP                  • Family office
                                   • Captive fund

                                   May have different goals:
                                   • No need to raise funding
                                   • Non-financial goals
               GP




           Companies




                                                                            39
Company funding
   lifecycle


                  40
Company funding lifecycle


  Revenue




                                                         IPO


                                        Private Equity


                             Venture Capital

                   Business
                    angels

            FFF                                                    Time

        Start-up            Early              Growth     Mature


                                                                          41
VC funding lifecycle


   Funding stage     Source of investment               Use of proceeds                              Size, USD
                     Start-up competitions, grant       Incorporation of a company, building
   Grant
                     programs                           prototype, first sales

                     Angels, seed stage VC firms,
   Seed                                                 Developing product to first sales            up to 1m
                     qualified investors

                     Primarily VC firms, other qualified
   Round A                                               Scaling operations                          1m-3m
                     investors and sometimes angels

                     Primarily VC firms, other qualified
   Round B                                               Scaling operations, new markets entry       >3m
                     investors and sometimes angels
                                                         Scaling operations, strengthening brand,
   Round C and       Primarily VC firms, other qualified
                                                         new markets entry, technology                >3m
   later rounds      investors
                                                         improvement (ERP, CRM, etc.)
                                                         Expanding business, providing exit for early
   IPO               Equity capital markets                                                           undefined
                                                         investors




 Source: Fast Lane Ventures                                                                                       42
Typical activities
performed by PE
      fund

                     43
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

                                                                                                     44
Typical activities: big picture




      Pre-deal        Deal origination     Deal screening    Due Diligence




      Deal              Negotiation            Structuring
                               Deal sourcing



                        Company
     Post-deal        management,                 Exit
                      value creation




                                                                             45
Deal sourcing



                               Reputation




     Proactive research                            Investment strategy


                               Deal sourcing


      Direct approach                                Intermediaries




                          Personal/ professional
                                network



                                                                         46
Deal origination and execution


   1                                2                              3
        Deal teaser received             Quick screening                Signing NDA
        - Proactive search               - Meeting with
        - Conferences                      management/
        - Proprietary connections          shareholders
        - Investment bankers
   4                                5                              6
       Reviewing info pack               Market research                Financial modeling
       - Information memorandum          - Expert interviews            - Returns calculation
       - Business plan                                                  - Sensitivity
       - Additional meetings                                            - Stress tests

  7                                 8                              9
       Negotiations                      Investment Committee           Due diligence
       - Deal price                      - Preparing docs               - Consultants tender
       - Deal structure                                                 - Working with consultants
                                                                        - Reviewing VDR
  10                                11                             12
       Final negotiations                Deal docs drafting with        Deal closing and
       - Final price and terms           lawyers and signing            payment
         adjustment based on DD          - SPA                          - party
         findings                        - SHA


                                             3-12 months
                                                                                                     47
Deal screening example



                                      Number of
                                        deals

                   Deal received       500

                   Signing NDA         200

               Investment Committee     20

                   Due diligence         3

                 Docs drafting and       2
                     closing

                                                  48
Initial screening process                                                            1

   Market               Size, growth, major trends, macro drivers, competition
                        level, technologies, industry historical overview,
   overview
                        seasonality and cyclicality, capacity, concentration level



   Product              What are the product’s characteristics, value
                        added/commodity, key value differences


                        Fragmentation, product positioning, vertical integration,
   Competitors          size and growth rates of competitors, profitability,
                        leverage level, strengths / weaknesses


   Entry barriers       Economies of scale, brand identity, proprietary
   and substitution     technologies, capital requirements, switching costs,
   threats              access to distribution, learning curve, government policy

                       STOP. Is it an attractive industry? Project team discussion.
                                                                   If “yes”, continue

                                                                                        49
Initial screening process                                                                     2

   Management           Overall impression, experience, motivation, goals vs. historical
   team and             achievements, what are the hidden agendas and are your
   shareholders         interest aligned


                      • Operations: key business units, cost position, productivity,
   Company              technology, capacity utilization, capex requirements, equipment
                      • Financials: look at the crisis years, top-line growth per business
                        unit, one-time revenue, profitability levels in comparison with the
                        industry, identify money-generating and loss-making units,
                        operating leverage, Capex, WC, tax liabilities, capital structure,
                        debt financing terms, historical performance vs. historical
                        budget, accounting, ROIC, ROE, ROA, break-even, payback
                        period, etc.
                      • Sales/Marketing: brand, product positioning, marketing
                        efficiency, customers acquisition costs, sales efficiency,
                        distribution channels, logistics
                      • Personnel: productivity, turnover, compensation level, earn-outs,
                        parachutes, pension liabilities
                      • Technology/Engineering: IT system, Intellectual property,
                        technological advantage, development skills, product renewals,
                        product pipeline

                                                                                              50
Initial screening process                                                              2

                        Differentiation of inputs, switching costs, substitutes,
   Suppliers            supplier concentration, volume-cost function, integration
                        threats


                        Buyers’ concentration, volumes, switching costs,
   Customers            information, threat of backward integration, substitute
                        products, share in total purchases of the buyer, buyer
                        profits




                            STOP. Is it an attractive target? Project team discussion.
                                                                      If “yes”, continue

                                                                                           51
Initial screening process                                                                    3

                        •   Fund uses: construction, marketing, m&a etc.
   Build                •   Forecasted efficiency of fund uses vs. historical: focus on
   business case            ROE, ROIC for the project in comparison with historical data
                            and industry standards


   Comparables          •   Create comparables set in order to understand valuation
                            metrics


                        •   Identify key value drivers. Understand possible
   Financial                improvements, issues
   model                •   Build several scenarios
                        •   Model UFG returns

                        •   Identify list of potential buyers and reasons for the interest
   Exit scenarios


                        •   Protect Fund position: put option, ratchet mechanisms,
   Deal structure           accelerated put, liquidation preference, drag/tag along,
                        •   Add a sweetener: upside sharing, call option

                                     STOP. Prepare presentation for team discussion

                                                                                             52
Russian PE/VC
  landscape


                53
Russian PE industry landscape


   Institutional funds   Captive funds                    Government-
                                         Family offices
                                                            backed




                                                                        54
Russian VC industry landscape


   International funds    Russian funds   Accelerators   Government-
                                                           backed




                                                                   55
Russian vs Foreign
   PE industry


                     56
Russian vs Foreign PE sector performance




      EBRD PE Portfolio



 Cambridge EM VC&PE                                                        One year
        Index                                                              Five years

                                                                           Ten years
   EBRD Russia/CIS PE
        portfolio

                                0%     5%     10% 15% 20% 25% 30%




 Source: Cambridge Associates, EVCA/ Thomson Reuters, Bloomberg and EBRD                57
Emerging market PE investments by region




 Source: Bain                              58
Difficulties for LBO deals in Russia



              In global: debt financing of PE deals is about 55%
                  In Russia: debt financing is less than 20%




    Very few mezzanine funds operates in Russia
    Central bank set strict limits for such deals (high reserves,
      advance requirements for capital) for local banks
    Prudent approach in apprising pledge
    Off-shore payments
    High inflation rate (so high bank`s credit rates)
    Still high return opportunities for equity investments




                                                                     59
Entry strategies of
 PE investments


                      60
Entry strategies. Overview


                     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


                                                                                                        61
Entry strategies. Rationale for LBO deals



                  Tax deductibility of debt interest
  Cost of         Lower cost of debt if compare with equity
  capital
                  Cost of capital reduction as a result of company’s gearing growth


                  Substantial increase in equity value as a result of relatively small
  Gearing          increase in company’s enterprise value
  effect          Higher IRR for equity investors as the interest on a debt funding is
                   fixed


  Cost            High gearing – reduction of company’s cash flow
  reduction       Management is obliged to focus on driving costs down measures
  trigger         The problem of excess capex is eliminated


                  IRR for equity investors has a great upside potential
  Managemen
                  Flexible ratchet mechanisms allow managers increases their stake
  t incentives
                   in circumstances of higher IRR achievement


                                                                                          62
Entry strategies. LBO candidates


   LBO
  suitable
  targets

                                         Leading market
                 Strong&Stable                                     Low capex
                                          position/clear
                    cash flow                                     requirements
                                              niche




                                Extensive             Margin
               Strong                                                   Clear exit
                                 growth              increase
             management                                                 strategy
                               opportunities         potential



                                   Volatile/poor cash flow
            LBO
        inconsistent      Weak market position/search for a new niche
           stories         Unsuccessful management’s track record
                                           Small size

                                                                                     63
Entry strategies. Forms of debt funding under LBO deal

                                            Most common conditions
 Lower                                      Provided by bank/syndicate of banks
  risk
                                            Secured by firms assets
                                            Structured in up to three tranches: A,B,C
                    Senior debt             Repayment in equal installments
                                            Period ~ 7-10 years
                                         Floating rate of interest (LIBOR + 2-3% )

                                         Looser covenant package as compared with
                                          senior debt
                    Subordinated debt    Higher lending costs as compared with senior
                                          debt, fixed interest rate
                                         Common form – high yield bonds

                                         High risk subordinated debt (less provision,
                                          looser covenants)
                                         Interest include:
                    Mezzanine                 • Variable rate (LIBOR + 4%) – payable periodically
                                              • PIK (4-5%) – roll up into the principal
                                              • Equity warrant

                                         Loan stork - notes convertible to equity at a
                    Loan stock/           fixed conversion ratio
                                         Preferred stock – fixed dividend, higher
         Lower
         priority
                    preferred stock       priority in case of liquidation as compared
                                          with ordinary shares
Entry strategies. LBO deal basic structure
 Ownership



                                     Investor(s)                                        Senior
   level


                                     (PE fund(s))                Debt                   Lender
                                                              investment


                          Equity and debt     Loan notes                    Term loan
                            investment        and shares
Holding level




                                                            Payment of
                                                           consideration
                    SPV                Newco                                            Seller(s)

                                            Ownership                                        Ownership
Operational level




                                                           Sale of shares
                                       Target                                           Target




                                    Subsidiaries                                    Subsidiaries


                                                                                                         65
Entry strategies. LBO deal complex structure
   Ownership


                                  Investor(s)                      Mezzanine                                Senior
     level


                                  (PE fund(s))                       fund                                   Lender
                                                    Warrant
                       Equity
                     investment

                                                               Mezzanine
                       Topco1
Holding level




                                       Loan                      debt
                                                                                           Senior debt
                    100%
                                  Midco1
                           100%
                                           Midco2
                                                                            Payment of
                                    100%                                   consideration
                                                       Bidco                                         Seller(s)

                                                              Ownership                                      Ownership
Operational level




                                                                           Sale of shares
                                                       Target                                            Target


                                                    Subsidiaries                                   Subsidiaries


                                                                                                                         66
Entry strategies. Growth and development capital


                   Minority investments
 Form and          Most common forms – preferred equity and mezzanine
 structure         Priority position in the capital structure relative to the common
                    equity owners

                   Business growth initiative enhancement/maintenance
 Use of funding    New markets expansion, M&A strategy implementation
                   No/insignificant cash out for current shareholders

                   No control on the Board of Directors
 Corporate         Certain controls on management decision concerning operating
 governance         and capital budgets, M&A strategy, funding attraction, capex
                    program

                   Certain exit plan requirement – put features (time/performance
 Exit               triggers)
 opportunities
                   Defense mechanisms in equity agreements: tag along rights

     Limited influence on company’s management in exchange for a priority in
              proceeds distribution and a fixed return from investment

                                                                                        67
Entry strategies. Growth capital deal structure



                                                                                              New investor
                      Current                            New investor
                                                                                             (PE/mezzanine
                    shareholders                          (PE fund)
                                                                                                 fund)
                                               Equity growth
Funding level




                                                 capital
                           Ownership                                                          Mezzanine
                                                                                            growth capital
                             Equity pre-money valuation = $X


                                                        $Z                      Use of
                                                                               proceeds         M&A, capex
                                       Target ($X)           $Y          $V
Operational level




                                                                                                 program


                                                     Cash out     Growth capital = $Y+V-Z
                                                      = $Y-Z

                              Equity post-money valuation = $X+Y-Z


                                    Enterprise value = $X+Y-Z+V

                                                                                                             68
Entry strategies. Distressed situations




                                  Corporate
                                reorganization
   Debt restructuring                                     Change of
                                                         management




                             Entry value creation




     Contract base                                   Corporate governance
       extension                                         optimization

                              Synergies with other
                             investors’ companies



                                                                        69
Exit strategies for
     PE funds


                      70
Exit strategies. Returns on exit


                                   Unsuccessful                                                    Successful




                                                                   Valuation
                                    investment                                                     investment
   Valuation




                                                            EV on exit

                                                                                                           Management
                                                                                                             equity
               Management equity

               PE fund equity

                 Redeemable                                                                                 PE fund
                    stock                                                      Management equity             equity
                                                                               PE fund equity
               Mezzanine/Su                                EV on
                 bordinated                                                      Redeemable
                                                                                                           Redeemable
                                                            exit                    stock                     stock
                   notes                     Mezzanine

                                                                               Mezzanine/Su               Mezzanine/Su
                  Senior                     Senior                              bordinated                 bordinated
                                                                                   notes                      notes
                   Debt                       Debt

                                                    Time                          Senior                    Senior
                                                                                   Debt                      Debt

                                                                                                                    Time

                                                                                                                         71
Exit strategies. Overview


                                           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


                                                                                             72
Exit strategies. MBO/MBI deal basic structure


    Current
                   Equity
   managers
                 investment
    (MBO)
                            Investor(s)
                              Investor                                         Senior
                            (PE fund(s))
                             (PE fund)
                                                        Debt                   Lender
 New managers                                        investment

     (MBI)
                 Mezzanine and       Loan notes                    Term loan
                 debt investment
       Equity                                                                         Previous round
   investment                                      Payment of                            investor
     (“sweety                                     consideration
      equity”)                Newco                                            Seller(s)

                                   Ownership                                        Ownership



                                                  Sale of shares
                              Target                                            Target




                           Subsidiaries                                    Subsidiaries


                                                                                                16
                                                                                                     73
Exit strategies. Secondary buyout: rationales




       Rationales for seller and target      Rationales for new PE investor



     End of the fund life reach             Possibility to obtain more value
                                              out of the investment because
     Next capital injection is needed in
                                              of an exclusive sector expertise
      order to achieve further growth
                                              and etc
     Change in investment
                                             Investment in a proven
      profile/strategy of a fund
                                              business carrying stable
     Good price and deal conditions          dividends flow with a proven
      proposed by secondary investor          management team




                                                                                 74
Exit strategies. IPO process




                                 Investment
     Grooming a                   bank and                     Due                 Underwriting
     company for                legal advisor               Diligence               agreement
        IPO                     appointment



  The executive            Pre-IPO research –        Full commercial,         Setting out in details
   management team:          educating potential        financial, tax, legal     the mechanics of the
   • reliance on current     investors about the        business inspection       fundraising and
      CEO/CFO                investment case           Performed by              admission process
   • change of              Investment                 independent
      management             presentation – key         accounting firm and
                             marketing document for     company’s legal
  Potential due diligence   presenting company’s       advisers
   issues – in-house DD in   story to potential
   order to prepare          investors
   company for a rigorous
                            Disclosure document –
   pre-IPO inspection
                             prepared by
                             advisers/key part of a
                             marketing process


                                                                                                           75
Exit strategies. IPO structure




                                                                    Public
        PE investor
                                                                  investors

                                   Post –
                                    IPO
     No full exit in an IPO       stake
                                                       Cash-out               IPO proceeds
     The level of the retained
      stake depends on the
      investors demand (fixed
      cash-in is needed, the                Private equity backed
      extent will result in a                     company
      cash-out of current
      shareholders)

     New investors wish the
      initial investor retains a
      stake to assure the
      alignment of their
      interests
                                                  Private equity backed       New shares
                                                  stake public offering         issue



                                                                                             76
Exit strategies. IPO pros and cons




            IPO advantages                      IPO disadvantages

     Higher exit valuation           Lack of complete exit
     Increased liquidity                PE stake to large to be fully sold
     Management support                 Full cash out - negative message to new
                                          investors
                                         Better if IPO cash proceeds are
                                          allocated to the company
                                      Timing
                                      Cost and distraction of
                                       management’s attention
                                      Info disclosure obligations
                                      Loss of control
                                      Risk of failure
                                      Lock-up



                                                                                    77
PE Careers


             78
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 management
   IB, Industry is required                                 1-3         positions in industry
  Recruiters, networking              Associate/Invest    years       Upside position in
                                        ment manager                    smaller fund
                                                                       Own project launch


                                                            1-3
                                           Analyst         years

  Last year students
                                         Internships
  Applications on career sites

                                                                                                 79

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Private Equity and Venture Capital

  • 1. PRIVATE EQUITY AND VENTURE CAPITAL MASTERCLASS Session 1. Private Equity landscape 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. UFG Private Equity • Over $500 million of capital under management • Strong and experienced team of 11 investment professionals • 5 partners worked as CEO/CFO or had own businesses, one partner is involved as CEO or a portfolio company • Strong track record with 19 investments in FMCG, Consumer and Business services, Metals and Mining, Banking, Specialty Retail, TMT, Food and Beverages, Healthcare, Travel sectors with aggregate transaction value of over $1 billion • 7 projects were co-invested with other funds • 8 exits performed with capability to create value • International investor base including EBRD and well-known US and Middle-Eastern state pension funds • Part of UFG Asset Management group with $1.2 billion under management in four investment areas: Private Equity, Hedge Funds, Real Estate, Wealth Management 4
  • 5. UFG Private Equity Fund II portfolio companies Fund Size $225m Yandex Partially realized Rising Star Media Fully realized Russian Fund II Portfolio Towers company Enforta Fund II Portfolio company Brunswick Fund II Portfolio Rail company Fund II Portfolio KDL company Karo Film Fund II Portfolio company 5
  • 6. JSFC Sistema • Top public investment company in Russia • Market cap ~ $10 bln • Assets under management ~ $40 bln • Consists of 8 investment portfolios divided by industry/investment team competencies 6
  • 7. 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. 7
  • 8. Session 2. PE deal origination, execution and portfolio management Industry analysis March, 14 (6pm – 9pm) • 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. Due diligence • Commercial, financial and tax, legal due diligence Deal structuring and negotiations • Legal documents for deal execution: NDA’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. 8
  • 9. Private Equity definition 9
  • 10. 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 10
  • 11. Private Equity value creation formula Multiple EBITDA growth Leverage Expansion Topline Efficiency growth improvement Superior returns 11
  • 12. 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 12
  • 13. Private Equity target returns IRR 30% Cash-on-cash 3x over 5 years 13
  • 14. Private Equity fund types FUND DESCRIPTIONS By stage By size Ownership Specialization Purpose • Venture funds: • Large-cap • Captive/semi- • Specialized • Funds-of-funds: invest in early stage funds: large LBO captive: funds funds: funds funds created to or expanding funds (could be established by and focusing on a invest in a range of businesses that greater than $20bn) with strong links to a portfolio companies other private equity generally have particular investor, in specific segments funds limited access to • Mid-cap funds: e.g. a financial (e.g. IT/ real estate) other sources of usually invest in institution funding deals worth • Regional funds: between $10m and target investments • Buyout funds: $300m in a particular region invest in mature businesses, usually taking controlling interest and leveraging their equity investment with substantial amount of third party debt 14
  • 15. Specialist/ generalist funds Specialist funds • May be attractive to certain investors, i.e. those seeking to: I. Increase their exposure in a particular sector (healthcare, IT) II. Diversify their existing geographical/sector focus • Small funds may increase specialization to differentiate themselves • Disadvantages: I. May be more risky due to the lack of portfolio diversification II. May be difficult to raise a fund if there is little investor appetite III. Niche/hot sectors may lose favor Generalist funds • Most private equity funds are generalists • General fund may have specialist teams who may source and execute deals within certain market sectors • Generalist funds have the advantage of being able to limit their exposure to declining sectors and have more flexibility 15
  • 16. Key success factors for PE deals 16
  • 17. 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 17
  • 18. Investment approach and key success factors Market leaders are typically winning Market leaders How to are determine winning market leader? UFG cases: • Yandex • RSM • Russian Towers • Industry leader • Brunswick Rail • Industry segment leader • Russian Alcohol • Leader by market share • Leader by margins • Leader with first-mover advantage • Leader with the most known brands • Potential market leader through M&A or business scalability • … 18
  • 19. Investment approach and key success factors Strong and motivated shareholders and the management team Goal alignment • Important to chose a partner you can Typical PE fund is deal with. High personal integrity, strong not a turnaround commercial instincts, transparency, team which is flexibility should be among the qualities of coming and taking the counterparty in the deal. operational • Choice of the trusted management team management is important • The company should not be 100% dependent on 1-2 key shareholders/ managers We are all in the same boat • Goal alignment should be in place to motivate managers and other PE The management, shareholders: fund founders Upside sharing scheme may be in place to motivate management on: I. Growing the company II. Exit 19
  • 20. Investment approach and key success factors Fair entry price Entry Fair entry price should be negotiated • Clear exit path should be overseen from the beginning • Fair entry multiple is needed to x5 EBITDA* x10 EBITDA* avoid multiple contraction at exit + Full downside and achieve good returns protection and • It is always a trade-off between: corporate rights I. low multiple II. high multiple and protection Exit mechanisms 35% IRR, 3x cash multiple * example 20
  • 21. Investment approach and key success factors Clear exit strategy Exit types To consider at the time of entry • Trade sale • Clear exit path should be foreseen at • Secondary buyout the time of entry • Sale to other shareholders/ • Partner should be focused on exit management and not to prevent it • IPO • Exit obligations may be in place to guarantee exit for the Fund in worst • Break-up case scenario • Share redemption • IPO should not be the base case: partial exit, continuing risk, lock-up period • The exit should be identified in the investment documents in terms of timing, profit-sharing, liability to exit 21
  • 22. Investment approach and key success factors Clear exit strategy: trade buyers exit scorecard example Financial Fit Strategic Fit 1. Revenue 2. Net Debt/ EBITDA 1. Product fit > 1 bln USD < 0x 1.1. Companies with services portfolio complementary 500 mln to 1 bln USD 0x to 1x to ABC which aim to: • enter ABC segment; 250 mln to 500 mln USD 1x to 3x • complement offerings for the current clients. 100 mln to 250 mln USD 3x to 5x 1.2. Companies already present in ABC segment (<50%), which aim to: < 100 mln USD > 5x • strengthen ABC segment. 1.3. Companies which aim to: Only companies with a low Large firms are more likely to • realize cost synergies; Net Debt/EBITDA ratio will • build market share. acquire ABC and leverage its have willingness and ability to capabilities acquire 2. Geographical fit 3. Organic revenue growth 4. EBITDA 2.1. Companies which aim to enter Russian/ emerging markets < 5% > 200 mln USD 5% to 10% 100 mln to 200 mln USD 3. Acquisitions growth fit 10% to 15% 75 mln to 100 mln USD 3.1. Companies with expressed intention in M&A 3.2. Companies which have successful past track 15% to 20% 50mln to 75 mln USD record of doing acquisitions > 20% < 50 mln USD 4. Client fit Companies with limited ABC is more appealing to 4.1. Companies which want to access new organic growth opportunities companies with a positive clients of ABC are more focused on EBITDA and aiming to 4.2. Companies which want to provide support to acquisitions maintain high margins existing multinational clients 22
  • 23. Investment approach and key success factors Proper deal structuring Proper deal The following deal structuring structuring is key elements could be used: to align parties • Put and call options, redemption and establish rights downside • Deferral consideration and earn-outs protection • Covenants • Drag along and Tag along • Share ratchets • Preferred shares and liquidation preference • Right of first refusal • Board representation and approval rights • … 23
  • 24. Investment approach and key success factors Proactive monitoring Proactive • Building 100 days plan and clear 3-5 monitoring of years roadmap portfolio • Building proper corporate governance companies is • Fund active involvement on the Board important of Directors • Monthly reporting from portfolio companies • Monthly review of budgeted and actual numbers • Early warning of issues • Frequent interaction with management • Strengthening CFO/ financial controller 24
  • 25. Investment approach and key success factors Industry growth and deep market expertise 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 • Medical Services underdeveloped • Fast Food • Limited modern private medical services • Logistics 2 Traditional sectors • Food retail • Import substitution • FMCG • M&A opportunities, important to find right • Pharmaceutical industry platform for consolidation • TMT • Regional growth potential • New formats/ products development • Room for improvement (margins, working capital) 25
  • 26. Investment approach and key success factors Industry growth and deep market expertise 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 26
  • 27. Sequoia Capital investment approach ELEMENTS OF SUSTAINABLE COMPANIES Start-ups with these characteristics have the best chance of becoming enduring companies. We like to partner with start-ups that have: 1 CLARITY OF PURPOSE Summarize the company’s business on the back of a business card. 2 LARGE MARKETS Address existing markets poised for rapid growth or change. A market on the path to a $1B potential allows for error and time for real margins to develop. 3 RICH CUSTOMERS Target customers who will move fast and pay a premium for a unique offering. 4 FOCUS Customers will only buy a simple product with a singular value proposition. 5 PAIN KILLERS Pick the one thing that is of burning importance to the customer then delight them with a compelling solution. Source: Sequoia Capital 27
  • 28. Sequoia Capital investment approach 6 THINK DIFFERENTLY Constantly challenge conventional wisdom. Take the contrarian route. Create novel solutions. Outwit the competition. 7 TEAM DNA A company’s DNA is set in the first 90 days. All team members are the smartest or most clever in their domain. “A” level founders attract an “A” level team. 8 AGILITY Stealth and speed will usually help beat-out large companies. 9 FRUGALITY Focus spending on what’s critical. Spend only on the priorities and maximize profitability. 10 INFERNO Start with only a little money. It forces discipline and focus. A huge market with customers yearning for a product developed by great engineers requires very little firepower. Source: Sequoia Capital 28
  • 30. Private Equity fund structure terminology Investors which allocate money to PE/VC funds. They commit money directly (e.g., Limited Partners (LP) Family Offices), or on behalf of others (e.g., Pension funds) PE/VC fund manager who raises General Partners (GP) money through a fund legal vehicle Investee companies or entrepreneurs who get Investee company money and generate returns for GPs and LPs 30
  • 31. 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 31
  • 32. Private Equity fund landscape LP LP LP GP GP GP GP GP GP C C C C C C C C C 32
  • 33. LP-GP relationship Limited partnership structure entails arms’ length relationship and a five-ten year commitment • LPs choice comes out of a solving a broader asset allocation problem, which includes: risk/return, liquidity, transparency • LP makes three decisions: 1. Alternative assets among all investment options 2. VC/PE within alternative assets 3. Choice of the fund manager (GP) - the most important! • Once a GP is selected LPs want to ensure they will earn high returns. This requires that: 1. GPs do not act opportunistically 2. GPs devote full effort to the ‘fund’ 3. Right companies are selected 4. GPs report their returns faithfully 5. Exits from companies are efficient • GPs have to raise funds and choose LPs. • They also need to manage long-term relationships, as fundraising is repeated. • For this, they need to generate high returns (at least the perception of them) • GPs want LPs to provide commitments on time and keep their investment decisions as independent as possible 33
  • 34. LP-GP relationship Criteria for selecting GPs in first funds Partners' previous success in PE Proposed investment strategy Quality of the partners' network of contacts Partners' previous experience in working together The level and structure of fees Partners' previous experience in non-PE jobs The fund's size Partners' quality of education Commitments to this fund by top LPs The opportunity to access follow-on funds Co-investment opportunities The advisor opinion 0 1 2 3 4 Source: Marco Da Rin 34
  • 35. LP-GP relationship Criteria for selecting GPs in seasoned funds Proposed investment strategy Stability of the team at partner level GP's reported aggregate multiples on previous funds GP's reputation GP's reported IRR on previous funds Quality of the partner network of contacts The level and structure of fees Renewed commitment to this fund by its existing LPs The fund's size Valuation of unrealized investments (NAV) in GP portfolio The change in fund size from previous funds Commitments to this fund by top LPs Partners' quality of education Co-investment opportunities The advisor opinion 0 1 2 3 4 Source: Marco Da Rin 35
  • 36. LP-GP relationship Reasons for refusing re-investment 30% 20% 10% 0% The fund's size Strategy changed Disappointing Key GP partners left Other reasons increased too much performance 36
  • 37. 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. 37
  • 38. Typical PE/VC fund remuneration structure: simplified example Management fee 2% LP GP Carry 20% $300mln fund 1 Management fee 300*2% = $6mln annually 2 Carry Assumption that the fund makes 3x cash-on-cash over 5 years Exit proceeds 3*300 = $900mln 1) Cost plus hurdle goes to LP: 300*(1+0.08)^5 = $441mln 2) LP gets 80% of remaining proceeds: 80%*(900-441) = $367mln 3) GP gets carry of 20%: 20%*(900-441) = $92mln 38
  • 39. Alternative structure of Family Office or captive PE fund PE/VC fund integrated with an investor LP • Family office • Captive fund May have different goals: • No need to raise funding • Non-financial goals GP Companies 39
  • 40. Company funding lifecycle 40
  • 41. Company funding lifecycle Revenue IPO Private Equity Venture Capital Business angels FFF Time Start-up Early Growth Mature 41
  • 42. VC funding lifecycle Funding stage Source of investment Use of proceeds Size, USD Start-up competitions, grant Incorporation of a company, building Grant programs prototype, first sales Angels, seed stage VC firms, Seed Developing product to first sales up to 1m qualified investors Primarily VC firms, other qualified Round A Scaling operations 1m-3m investors and sometimes angels Primarily VC firms, other qualified Round B Scaling operations, new markets entry >3m investors and sometimes angels Scaling operations, strengthening brand, Round C and Primarily VC firms, other qualified new markets entry, technology >3m later rounds investors improvement (ERP, CRM, etc.) Expanding business, providing exit for early IPO Equity capital markets undefined investors Source: Fast Lane Ventures 42
  • 44. 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 44
  • 45. Typical activities: big picture Pre-deal Deal origination Deal screening Due Diligence Deal Negotiation Structuring Deal sourcing Company Post-deal management, Exit value creation 45
  • 46. Deal sourcing Reputation Proactive research Investment strategy Deal sourcing Direct approach Intermediaries Personal/ professional network 46
  • 47. Deal origination and execution 1 2 3 Deal teaser received Quick screening Signing NDA - Proactive search - Meeting with - Conferences management/ - Proprietary connections shareholders - Investment bankers 4 5 6 Reviewing info pack Market research Financial modeling - Information memorandum - Expert interviews - Returns calculation - Business plan - Sensitivity - Additional meetings - Stress tests 7 8 9 Negotiations Investment Committee Due diligence - Deal price - Preparing docs - Consultants tender - Deal structure - Working with consultants - Reviewing VDR 10 11 12 Final negotiations Deal docs drafting with Deal closing and - Final price and terms lawyers and signing payment adjustment based on DD - SPA - party findings - SHA 3-12 months 47
  • 48. Deal screening example Number of deals Deal received 500 Signing NDA 200 Investment Committee 20 Due diligence 3 Docs drafting and 2 closing 48
  • 49. Initial screening process 1 Market Size, growth, major trends, macro drivers, competition level, technologies, industry historical overview, overview seasonality and cyclicality, capacity, concentration level Product What are the product’s characteristics, value added/commodity, key value differences Fragmentation, product positioning, vertical integration, Competitors size and growth rates of competitors, profitability, leverage level, strengths / weaknesses Entry barriers Economies of scale, brand identity, proprietary and substitution technologies, capital requirements, switching costs, threats access to distribution, learning curve, government policy STOP. Is it an attractive industry? Project team discussion. If “yes”, continue 49
  • 50. Initial screening process 2 Management Overall impression, experience, motivation, goals vs. historical team and achievements, what are the hidden agendas and are your shareholders interest aligned • Operations: key business units, cost position, productivity, Company technology, capacity utilization, capex requirements, equipment • Financials: look at the crisis years, top-line growth per business unit, one-time revenue, profitability levels in comparison with the industry, identify money-generating and loss-making units, operating leverage, Capex, WC, tax liabilities, capital structure, debt financing terms, historical performance vs. historical budget, accounting, ROIC, ROE, ROA, break-even, payback period, etc. • Sales/Marketing: brand, product positioning, marketing efficiency, customers acquisition costs, sales efficiency, distribution channels, logistics • Personnel: productivity, turnover, compensation level, earn-outs, parachutes, pension liabilities • Technology/Engineering: IT system, Intellectual property, technological advantage, development skills, product renewals, product pipeline 50
  • 51. Initial screening process 2 Differentiation of inputs, switching costs, substitutes, Suppliers supplier concentration, volume-cost function, integration threats Buyers’ concentration, volumes, switching costs, Customers information, threat of backward integration, substitute products, share in total purchases of the buyer, buyer profits STOP. Is it an attractive target? Project team discussion. If “yes”, continue 51
  • 52. Initial screening process 3 • Fund uses: construction, marketing, m&a etc. Build • Forecasted efficiency of fund uses vs. historical: focus on business case ROE, ROIC for the project in comparison with historical data and industry standards Comparables • Create comparables set in order to understand valuation metrics • Identify key value drivers. Understand possible Financial improvements, issues model • Build several scenarios • Model UFG returns • Identify list of potential buyers and reasons for the interest Exit scenarios • Protect Fund position: put option, ratchet mechanisms, Deal structure accelerated put, liquidation preference, drag/tag along, • Add a sweetener: upside sharing, call option STOP. Prepare presentation for team discussion 52
  • 53. Russian PE/VC landscape 53
  • 54. Russian PE industry landscape Institutional funds Captive funds Government- Family offices backed 54
  • 55. Russian VC industry landscape International funds Russian funds Accelerators Government- backed 55
  • 56. Russian vs Foreign PE industry 56
  • 57. Russian vs Foreign PE sector performance EBRD PE Portfolio Cambridge EM VC&PE One year Index Five years Ten years EBRD Russia/CIS PE portfolio 0% 5% 10% 15% 20% 25% 30% Source: Cambridge Associates, EVCA/ Thomson Reuters, Bloomberg and EBRD 57
  • 58. Emerging market PE investments by region Source: Bain 58
  • 59. Difficulties for LBO deals in Russia In global: debt financing of PE deals is about 55% In Russia: debt financing is less than 20%  Very few mezzanine funds operates in Russia  Central bank set strict limits for such deals (high reserves, advance requirements for capital) for local banks  Prudent approach in apprising pledge  Off-shore payments  High inflation rate (so high bank`s credit rates)  Still high return opportunities for equity investments 59
  • 60. Entry strategies of PE investments 60
  • 61. Entry strategies. Overview 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 61
  • 62. Entry strategies. Rationale for LBO deals  Tax deductibility of debt interest Cost of  Lower cost of debt if compare with equity capital  Cost of capital reduction as a result of company’s gearing growth  Substantial increase in equity value as a result of relatively small Gearing increase in company’s enterprise value effect  Higher IRR for equity investors as the interest on a debt funding is fixed Cost  High gearing – reduction of company’s cash flow reduction  Management is obliged to focus on driving costs down measures trigger  The problem of excess capex is eliminated  IRR for equity investors has a great upside potential Managemen  Flexible ratchet mechanisms allow managers increases their stake t incentives in circumstances of higher IRR achievement 62
  • 63. Entry strategies. LBO candidates LBO suitable targets Leading market Strong&Stable Low capex position/clear cash flow requirements niche Extensive Margin Strong Clear exit growth increase management strategy opportunities potential Volatile/poor cash flow LBO inconsistent Weak market position/search for a new niche stories Unsuccessful management’s track record Small size 63
  • 64. Entry strategies. Forms of debt funding under LBO deal Most common conditions Lower  Provided by bank/syndicate of banks risk  Secured by firms assets  Structured in up to three tranches: A,B,C Senior debt  Repayment in equal installments  Period ~ 7-10 years  Floating rate of interest (LIBOR + 2-3% )  Looser covenant package as compared with senior debt Subordinated debt  Higher lending costs as compared with senior debt, fixed interest rate  Common form – high yield bonds  High risk subordinated debt (less provision, looser covenants)  Interest include: Mezzanine • Variable rate (LIBOR + 4%) – payable periodically • PIK (4-5%) – roll up into the principal • Equity warrant  Loan stork - notes convertible to equity at a Loan stock/ fixed conversion ratio  Preferred stock – fixed dividend, higher Lower priority preferred stock priority in case of liquidation as compared with ordinary shares
  • 65. Entry strategies. LBO deal basic structure Ownership Investor(s) Senior level (PE fund(s)) Debt Lender investment Equity and debt Loan notes Term loan investment and shares Holding level Payment of consideration SPV Newco Seller(s) Ownership Ownership Operational level Sale of shares Target Target Subsidiaries Subsidiaries 65
  • 66. Entry strategies. LBO deal complex structure Ownership Investor(s) Mezzanine Senior level (PE fund(s)) fund Lender Warrant Equity investment Mezzanine Topco1 Holding level Loan debt Senior debt 100% Midco1 100% Midco2 Payment of 100% consideration Bidco Seller(s) Ownership Ownership Operational level Sale of shares Target Target Subsidiaries Subsidiaries 66
  • 67. Entry strategies. Growth and development capital  Minority investments Form and  Most common forms – preferred equity and mezzanine structure  Priority position in the capital structure relative to the common equity owners  Business growth initiative enhancement/maintenance Use of funding  New markets expansion, M&A strategy implementation  No/insignificant cash out for current shareholders  No control on the Board of Directors Corporate  Certain controls on management decision concerning operating governance and capital budgets, M&A strategy, funding attraction, capex program  Certain exit plan requirement – put features (time/performance Exit triggers) opportunities  Defense mechanisms in equity agreements: tag along rights Limited influence on company’s management in exchange for a priority in proceeds distribution and a fixed return from investment 67
  • 68. Entry strategies. Growth capital deal structure New investor Current New investor (PE/mezzanine shareholders (PE fund) fund) Equity growth Funding level capital Ownership Mezzanine growth capital Equity pre-money valuation = $X $Z Use of proceeds M&A, capex Target ($X) $Y $V Operational level program Cash out Growth capital = $Y+V-Z = $Y-Z Equity post-money valuation = $X+Y-Z Enterprise value = $X+Y-Z+V 68
  • 69. Entry strategies. Distressed situations Corporate reorganization Debt restructuring Change of management Entry value creation Contract base Corporate governance extension optimization Synergies with other investors’ companies 69
  • 70. Exit strategies for PE funds 70
  • 71. Exit strategies. Returns on exit Unsuccessful Successful Valuation investment investment Valuation EV on exit Management equity Management equity PE fund equity Redeemable PE fund stock Management equity equity PE fund equity Mezzanine/Su EV on bordinated Redeemable Redeemable exit stock stock notes Mezzanine Mezzanine/Su Mezzanine/Su Senior Senior bordinated bordinated notes notes Debt Debt Time Senior Senior Debt Debt Time 71
  • 72. Exit strategies. Overview  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 72
  • 73. Exit strategies. MBO/MBI deal basic structure Current Equity managers investment (MBO) Investor(s) Investor Senior (PE fund(s)) (PE fund) Debt Lender New managers investment (MBI) Mezzanine and Loan notes Term loan debt investment Equity Previous round investment Payment of investor (“sweety consideration equity”) Newco Seller(s) Ownership Ownership Sale of shares Target Target Subsidiaries Subsidiaries 16 73
  • 74. Exit strategies. Secondary buyout: rationales Rationales for seller and target Rationales for new PE investor  End of the fund life reach  Possibility to obtain more value out of the investment because  Next capital injection is needed in of an exclusive sector expertise order to achieve further growth and etc  Change in investment  Investment in a proven profile/strategy of a fund business carrying stable  Good price and deal conditions dividends flow with a proven proposed by secondary investor management team 74
  • 75. Exit strategies. IPO process Investment Grooming a bank and Due Underwriting company for legal advisor Diligence agreement IPO appointment  The executive  Pre-IPO research –  Full commercial,  Setting out in details management team: educating potential financial, tax, legal the mechanics of the • reliance on current investors about the business inspection fundraising and CEO/CFO investment case  Performed by admission process • change of  Investment independent management presentation – key accounting firm and marketing document for company’s legal  Potential due diligence presenting company’s advisers issues – in-house DD in story to potential order to prepare investors company for a rigorous  Disclosure document – pre-IPO inspection prepared by advisers/key part of a marketing process 75
  • 76. Exit strategies. IPO structure Public PE investor investors Post – IPO  No full exit in an IPO stake Cash-out IPO proceeds  The level of the retained stake depends on the investors demand (fixed cash-in is needed, the Private equity backed extent will result in a company cash-out of current shareholders)  New investors wish the initial investor retains a stake to assure the alignment of their interests Private equity backed New shares stake public offering issue 76
  • 77. Exit strategies. IPO pros and cons IPO advantages IPO disadvantages  Higher exit valuation  Lack of complete exit  Increased liquidity  PE stake to large to be fully sold  Management support  Full cash out - negative message to new investors  Better if IPO cash proceeds are allocated to the company  Timing  Cost and distraction of management’s attention  Info disclosure obligations  Loss of control  Risk of failure  Lock-up 77
  • 79. 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 management IB, Industry is required 1-3 positions in industry  Recruiters, networking Associate/Invest years  Upside position in ment manager smaller fund  Own project launch 1-3 Analyst years  Last year students Internships  Applications on career sites 79