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Pepperdine Private Capital Markets Project 7.28.09 R1


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The Pepperdine Private Capital Markets Project, available at, is the first comprehensive and simultaneous investigation of the major private capital market segments. The initial research survey examined the behavior of the private capital market participants, investment types, expected and historical rates of return, financial ratio thresholds, coupon rate distributions and other investment characteristics.

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Pepperdine Private Capital Markets Project 7.28.09 R1

  1. 1. Returns, Risks, Recession: The Outlook for Private Capital<br />Dr. John K. Paglia<br />Associate Professor of Finance<br />
  2. 2. Agenda<br />Motivation for study<br />Pepperdine Private Capital Market Line<br />A view into five segments of the private capital markets<br />Funding and economic outlooks by private capital market segment<br />Conclusion<br />
  3. 3. Survey Timeline<br />Partnered with Rob Slee (2007)<br />Received Julian Virtue Award (2007-2009)<br />Launched Private Capital Markets class (Spring 2008)<br />Created surveys (2007-2009)<br />Surveyed banks, asset based lenders, mezzanine funds, private equity groups, and venture capital (March/April 2009)<br />Compiled results and created first survey report (May-July 2009) <br />
  4. 4. How Important are Small Businesses?<br />
  5. 5. A Bloodbath on Main Street?<br />Feb. 25 ( – -Small biz loan failure rate hits 11.9% according to the Small Business Administration.<br />July 20 (Bloomberg) -- Advanta Corp., the credit-card company that cut off almost 1 million small business accounts after posting three quarterly losses, said the default rate more than doubled in June from May to 56.95 percent. <br />July 20 (WSJ) -- Bondholders Plan CIT Rescue , Lender to Small Firms Set to Get $3 Billion; Financing Would Stave Off Bankruptcy<br />July 22 ( USA Today) -- Nearly four in 10 small business owners polled in the past few weeks said they are not able to get the financing they need to run their firms, according to a study Wednesday from the National Small Business Association. That&apos;s up from a third in December 2008. Additionally, JPM, BAC, and C all cut back 7(a) SBA lending by more than 80% during the first 7 months of 2009 compared to a year earlier. <br />
  6. 6. Private Capital Markets Survey <br />Web-based survey that included banks, asset based lenders, mezzanine funds, private equity, and venture capital<br />Focused on capital types required to build a private company capital structure<br />Typical survey contained 25 questions that asked about firm profile, credit box, historical returns, expected returns, view of next 12 months<br />Capital providers were surveyed in March/April 2009<br />
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  8. 8. Banks (Senior Lenders) <br />Refinancing and working capital fluctuations accounted for 59% of loans whereas equipment and building purchases stood at 17%<br />Debt service ratio is the most important factor when extending a loan, followed by fixed charge coverage ratios and personal guarantees<br />
  9. 9. Asset Based Lenders <br />Refinancing accounted for 53% of loans whereas growth financing accounted for 12% and acquisitions were 22%<br />Assets with highest advance rates included accounts receivable (85%), marketable securities (80%) and equipment (67.5%)<br />
  10. 10. Mezzanine Funds<br />Over the last four months, 33% said that refinancing was the motivation for the borrower to secure mezzanine capital while 23% indicated acquisition purposes, and 22% report financing growth as the primary reason<br />Of the factors important to consider when deciding whether to extend a loan or not, total debt to EBITDA was weighted as being the most important factor followed by fixed charge coverage and senior debt to EBITDA<br />Approximately 47.8% of respondents report charging a coupon interest rate of 12-13%. The median rate reported was 13%.<br />
  11. 11. Private Equity: Investing<br />Nineteen percent (19%) said that the minimum EBITDA growth expected over the next five years is 15% to 20% and another 19% said 5% to 10%, while 17% reported 10% to 15% growth expected.<br />In order to close one deal, survey participants report reviewing 80 business plans, conducting 15 meetings with principals, issuing 5 term sheets, and getting 2 letters of intent signed.<br />Survey participants report that exit plans often involve selling to another PE group (34.3%) or selling to a public company (34.7%). Just 9.2% plan on an initial public offering as a liquidity event.<br />
  12. 12. Private Equity: Returns<br />For the last closed fund, 35% of respondents report rates of return between 20% and 30%. Overall, approximately 75% of funds earned greater than 20%. The median was 31.9%.<br />For the current fund, including portfolio companies at fair value, the results indicate that approximately 78% of respondents are earning returns of between 0% and 30%, with the largest classification being in the 0% to 10% range. The median is 14%.<br />Economic conditions are cited as largest contributor to deviation from hurdle rate on current fund. Management is also significant.<br />
  13. 13. Venture Capital: Investing<br />Fifty-one percent (51%) report a minimum equity investment per deal of less than $1 million. Seventy-one percent (71%) indicate a minimum investment of $2 million or less. Twenty-nine percent (29%) do not invest in deals smaller than $2 million. <br />It takes a review of 100 business plans and 20 meetings with principals to close one deal.<br />Selling to a public company (49.9%) is the most likely expectation for a liquidity event. Nearly 24% indicate their plans to sell to a private company while 16.8% are planning for an initial public offering (IPO).<br />
  14. 14. Venture Capital: Returns<br />For the current fund, the implied returns based upon expectations of sales multiples along with estimates of liquidity event dates indicate expected returns between 40.5% and 43.5%. <br />For the last fund, the implied actual returns range from 24.4% to 29.8%, which are significantly less than the returns expected on new investments. Very little variability exists between the stages.<br />
  15. 15. 12-Month Outlook: Demand<br />Asset based lenders and mezzanine funds report the largest expectation for increases in demand <br />Banks report the lowest expected increase in demand among the private capital types surveyed<br />Overall, 76% believe demand for private capital will increase over the next year while just 11% believe it will decrease<br />
  16. 16. 12-Month Outlook: Restrictiveness<br />Access to private capital is expected to become more difficult. Less than 15% of all capital types report a decrease in restrictiveness, while the rest believe capital access will remain the same or become more difficult.<br />Overall, 55% report that they expect a higher degree of restrictiveness of capital, with private equity leading the way at 66% followed by mezzanine and venture capital, both above 60%. <br />
  17. 17. 12-Month Outlook: Interest Rates<br />Mezzanine funds, banks, and asset based lenders believe interest rates are most likely to increase next year. Sixty-four percent (64%) of mezzanine funds and asset based lenders believe there will be increases. <br />Overall, 60% believe we will see higher interest rates over the next year while just 3% believe rates will decline. Nearly 37% believe rates will remain somewhat constant. <br />
  18. 18. 12-Month Outlook: GDP<br />Venture capitalists and asset based lenders are most pessimistic about the economy as over 60% of respondents believe GDP will decline. Banks are relatively more optimistic as 27% believe GDP will increase versus 31% who believe a decline is forthcoming. <br />Overall, median estimates of GDP growth are consistently negative. PEGs and ABLs believe GDP will decline by 1.8% while mezzanine funds believe a decline of 0.8% is likely. The average is -1.5%.<br />
  19. 19. Thank You!<br />Dr. John K. Paglia<br />Associate Professor of Finance<br />Director, Pepperdine Private Capital Markets Project<br /><br /><br />