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Drexel private equity guest lecture 10 20-2015
The document provides a comprehensive overview of private equity, detailing fund structures, investment processes, and market statistics. It outlines various forms of investment, such as venture capital and leveraged buyouts, while highlighting the roles of general and limited partners in private equity funds. Additionally, it discusses key financial metrics, challenges facing investors, and the due diligence process necessary for successful transactions.
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Drexel private equity guest lecture 10 20-2015
- 1. Private Equity Overview October20, 2015
- 2. 2 Background Justin Shuman Drexel Classof 2007 E-mail: Justin.Shuman@gmail.com Education • $20 B pension fund • $5 B private equity allocation • Invested in $750 MM+ of LBO, VC, RE funds, as well as co- investments and secondary interests • Boutique M&A investment bank • Predominantly sell- side advisory • Executed 5 live transactions; 3 sell- side and 2 buy-side, worth $1 B + • Fund-less private equity sponsor • Focused on transitional investing in micro-cap companies • Sourced 3 investments; worth $75 MM + • Healthcare IT company • Focused on reducing laboratory costs for insurance companies • Responsible for managing sales pipeline from introduction to contract Professional Experience Drexel University Cornell University Invested in private equity funds Sold companies for private equity funds Sourced investment opportunities and invested Build a company for a private equity fund DuPont Capital Management Analyst Harris Williams & Co. Associate Woodlawn Partners Senior Associate Avalon Healthcare Solutions Director 2002 – 2007 B.S., Business Administration Concentration: Finance 2009 – 2011 M.B.A. Concentration: Investment Banking 2007 2011 2013 2014
- 3. 3 Execute Summary Private Equity& Market Overview Fund Structure and Economics Investment Process Recommended Reading
- 4. 4 Private Equity Venture Capital Leverage Buyout Mezzanine Distressed Debt Real Estate •Investors acquire an entire company or other asset using significant amounts of debt and equity • Investors use substantial leverage make acquisitions to optimize the amount of equity capital necessary, thereby increasing potential returns and also increasing overall investment risk • Investors provide capital to a start-up in exchange for equity, convertible debt, or some other security to fund company development and growth • Investors with a tolerance for high-risk participate in this asset class because start-ups generally do not have access to capital markets • Investors acquire a hybrid of debt and equity securities, with little or no collateral provided by the borrower to secure the investment • Investments are aggressively priced to provide 20 – 30% IRR returns to the investor • Investors purchase debt securities that are trading at a distressed level, in anticipation that those securities will have a higher market valuation and generate profit at a future selling point • Investors often time purchase debt securities in an attempt to take control, through bankruptcy proceedings • Investors purchase both debt and equity investments in property • Investments typically involve an active management strategy ranging from moderate repositioning or releasing properties to be extensively developed or redeveloped
- 5. 5 Market Overview North America $290 B Source:Prequin Global Private Equity and Venture Capital Report Portfolio Unrealized Value and Dry Powder, 2004 – 2014 Capital Raised by Private Equity Funds in 2014 273 VC Funds LBOs Raised $177 B 11% CAGR Top Challenges Facing LP Investors in 2015 Significant capital raised Substantial economic representation Fees are investors’ big concernGrowing portfolios and dry-powder 39% 24% 21% 21% 18% 16% 0% 10% 20% 30% 40% 50% Fees Economic Environment Regulation Performance Transparency Investment Opportunities 554 675 8981,265 1,204 1,4131,7832,029 2,332 2,546 2,644 404 559 796 9991,066 1,057 954 1,002 940 1,0741,144 0 500 1,000 1,500 2,000 2,500 3,000 3,500 4,000 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 17% CAGR ($ Millions) • U.S. Private Equity (“PE”) Firms: 3,883 • PE Owned Companies: 12,992 • Employees of PE Owned Companies: 11.3 million Market Statistics
- 6. 6 Execute Summary Private Equity& Market Overview Fund Structure and Economics Investment Process Recommended Reading
- 7. 7 Investments Private Equity Structure GeneralPartner (“GP”) Investor #2 Limited Partner (“LP”) Investor #1 Limited Partner (“LP”) Private Equity Fund • Pension Funds • Endowments • Foundations • Bank Holding Companies • High-Net-Worth Individuals • Insurance Companies • Family Offices • Corporations Venture Capital Leverage Buyout Mezzanine Distressed Debt Real Estate Company Start-up Senior Debt Mezzanine Debt Real Estate Capital Commitment $ Investment $ Carried Interest $ Portfolio Fees $ 1 2 3 4 Source: Private Equity Fund Formation; Scott W. Naidech, Chadbourne & Parke LLP
- 8. 8 Fund Terms &Economics Term Definition Market Fund Life Private equity funds have long lives. The term of a fund begins following the first fund closing. 10 – 12 years Investment Period Capital contributions are funded on an as-needed basis to make investments. New investments are sourced for the fund during an investment period and investments are made on a deal-by- deal basis. 4 – 6 years Management Fee Investment Period % of committed capital 2% Harvest Period % of invested capital 1% Carried Interest % of profits, normally after a preferred return 20% Preferred Return1 Guaranteed return to LPs, before carried interest 8% (1) Venture capital funds typically do not guarantee investors a preferred return Source: Private Equity Fund Formation; Scott W. Naidech, Chadbourne & Parke LLP
- 9. 9 Year 1 Year2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Committed Capital 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ 100,000$ Invested Capital (20,000)$ (20,000)$ (20,000)$ (20,000)$ (20,000)$ Realized Capital (Cost Basis) 20,000$ 20,000$ 20,000$ 20,000$ 20,000$ Cumulative Invested Capital (20,000)$ (40,000)$ (60,000)$ (80,000)$ (100,000)$ (80,000)$ (60,000)$ (40,000)$ (20,000)$ -$ Management Fee 2,000$ 2,000$ 2,000$ 2,000$ 2,000$ 800$ 600$ 400$ 200$ -$ Year 1 Realization 60,000$ Year 1 Pref Return (21,600)$ (23,328)$ (25,194)$ (27,210)$ (29,387)$ Year 1 Net Profit (Less Pref Return) 30,613$ Year 1 Carried Interest 6,123$ Year 1 Invested Capital (20,000)$ Year 1 Total Return 60,000$ Year 1 Total Profit 40,000$ LP Preferred Return 9,387$ LP Profit Share 24,491$ GP Profit Share 6,123$ Fund Economics Example Assumptions • 20% carried interest • $20MM invested each year • 5 year hold, before realization • 3.0x return on invested capital Investment compounding at 8% annually 20% of profits, after preferred return 2% of committed capital 1% of cumulative invested capital • $100MM committed to private equity fund • 2% management fee during investment period • 1% management fee in harvest period • 8% preferred return Carried interest dilutes LP ROIC from 3.0x to 2.7x or IRR from 25% to 22%
- 10. 10 Execute Summary Private Equity& Market Overview Fund Structure and Economics Investment Process Recommended Reading
- 11. 11 Investment Process Source Lead Underwrite andGain Exclusivity Due Diligence Negotiate Purchase Agreement Raise Capital and Fund 1 – 2 Weeks 4 – 6 Weeks 4 – 6 Weeks 4 – 6 Weeks 4 – 6 Weeks • Personal network • Lawyers • Accountants • Industry Associations • Conferences • Brokers • Investment Banks • Create financial projections and returns model • Propose valuation and transaction structure to seller • Execute binding Letter of Intent (“LOI”) • Evaluate competitive landscape • Valid financial statements • Confirm growth plan • Assess management • Seek to uncover all business and legal risks • Negotiate purchase price and related terms, including roll-over equity, earn-out, and seller note, if applicable • Employment contracts for key management • Create Private Placement Memorandum (“PPM”) • Approach debt and equity investors to fund transaction An investment can take 4 months to 6 months to identify and close
- 12. 12 Required Skills byPhase Source Lead Underwrite and Gain Exclusivity Due Diligence Negotiate Purchase Agreement Raise Capital and Fund Broad business skill-set required to execute investment from beginning to end Interpersonal Writing / Contracting Financial Statement Analysis Valuation Business Acumen Marketing Strategy
- 13. 13 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund • Business Owners • Personal network • Industry Associations • Conferences More Proprietary Less Proprietary • Lawyers • Accountants • Investment Banks Prospecting Methods • Brokers Networking ReferralsCold CallingE-mail Campaigns Prospecting Sources • Brokers list • Databases (e.g. LexusNexus, Dun & Bradstreet, etc.) • LinkedIn • Industry Association Lists • LinkedIn • Industry Association Lists Finding quality investments requires resourcefulness and hustle
- 14. 14 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund Indication of Interest (“IOI”) No Exclusivity Negotiations Letter of Intent (“LOI”) Exclusivity • Valuation • Management roll-over equity • Transaction Structure • Valuation • Management roll-over equity • Transaction Structure Principal Agreement Binding Agreement Valuation and transaction structure are key to gaining exclusivity
- 15. 15 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund (1) Total debt less cash (2) Discount applied to equity value to adjust for size difference between transaction set and target (3) Premium that investors are willing to pay for the equity of a public company, in order to have a controlling interest Public Comparable Valuation Analysis Equity Market Valuation Multiple Company Value Enterprise Value Sales EBITDA EBITDA $10,000 Company Z $15,000.0 $15,310.0 0.9x 5.9x Multiple 6.0x Company Y $12,300.0 $12,500.0 1.9x 3.4x Company X $14,500.0 $16,200.0 2.3x 7.3x Implied Enterprise Value $60,000 Company W $21,000.0 $18,400.0 1.7x 6.0x Company V $32,000.0 $35,900.0 4.7x 9.3x Less: Net Debt1 $20,000 Low of Entire Group $12,500.0 0.9x 3.4x Equity Value $40,000 Median of Entire Group $16,200.0 1.9x 6.0x Size Discount2 10% Control Premium3 20% High of Entire Group $35,900.0 4.7x 9.3x Adjusted Enterprise Value $63,200 • Identify public companies as similar to the target as possible, with respect to service or product offering, customer base, geography, and other factors • Identify closed transactions, as recent as possible; typically 18-24 months is reasonable • Companies that are as similar to the target as possible, with respect to service or product offering, customer base, geography and other characteristics Comparable Transaction Valuation Analysis Valuation Multiple Target Acquirer Enterprise Value Sales EBITDA EBITDA $10,000 Company A Company 1 $640.0 1.7x 11.7x Multiple 9.8x Company B Company 2 $1,190.0 1.4x 9.8x Company C Company 3 $315.0 1.7x 8.9x Implied Enterprise Value $98,000 Company D Company 4 $155.0 0.4x 4.3x Company E Company 5 $3,010.0 0.8x 17.2x Less: Net Debt1 $20,000 Low of Entire Group $155.0 0.4x 4.3x Equity Value $78,000 Median of Entire Group $640.0 1.4x 9.8x Size Discount2 10% High of Entire Group $3,010.0 1.7x 17.2x Adjusted Enterprise Value $90,200
- 16. 16 Discounted Cash FlowAnalysis Net Present Value Calculation Enterprise Value Sensitivity ($ in 000s) ($ in 000s) Dec-15 hoh5 NPV of Free Cash Flow $49,999 EBITDA Exit Multiples in Year 5 NPV of Terminal Value 154,612 7.0x 7.5x 8.0x 8.5x 9.0x NPV of Tax Shields 0 14.0% $192,604 $202,698 $212,793 $222,887 $232,982 Enterprise Value $204,611 14.5% 188,898 198,774 208,650 218,526 228,402 15.0% 185,284 194,947 204,611 214,274 223,937 Plus: Cash & Equivalents 12,162 15.5% 181,759 191,215 200,671 210,127 219,583 Less: Total Debt (32,162) 16.0% 178,321 187,575 196,829 206,083 215,337 Equity Value $184,611 Assumptions: EBITDA Multiple 8.0x Base Discount Rate 15.0% Tax Rate 40.0% WACC Source Lead Underwrite and Gain Exclusivity Due Diligence Negotiate Purchase Agreement Raise Capital and Fund Leveraged Buyout Analysis Enterprise Value: Returns Sensitivity Enterprise Value: Leverage Sensitivity ($ in 000s) ($ in 000s) EBITDA Exit Multiple EBITDA Exit Multiple 7.0x 7.5x 8.0x 8.5x 9.0x 7.0x 7.5x 8.0x 8.5x 9.0x 21.0% $190,138 $197,631 $205,125 $212,618 $220,112 4.00x $177,941 $184,319 $190,697 $197,076 $203,454 22.0% 187,281 194,472 201,663 208,855 216,046 4.25x 181,776 188,154 194,533 200,911 207,290 23.0% 184,561 191,464 198,368 205,272 212,176 4.50x 185,611 191,990 198,368 204,747 211,125 24.0% 181,970 188,600 195,230 201,859 208,489 4.75x 189,447 195,825 202,203 208,582 214,960 25.0% 179,502 185,871 192,239 198,608 204,977 5.00x 193,282 199,660 206,039 212,417 218,796TotalLeverage EquityIRR • Ensure reasonableness of sales growth, profit margin, capex investment, tax, and exit multiple assumptions • Terminal value can significantly impact and potentially skew valuation • Determine key leverage levels and capital structure (senior and subordinated debt, mezzanine financing, etc.) that result in realistic financial coverage and credit statistics. • Solve for the price that can be paid to achieve an investor’s required IRR target
- 17. 17 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund Enterprise Value $166 $173 $180 $187 $194 $201 $208 $215 $222 $229 $235 $242 $249 Comparable Public Companies Comparable Transactions Discounted Cash Flow Analysis Leveraged Buyout Analysis 6.00x 6.25x 6.50x 6.75x 7.00x 7.25x 7.50x 7.75x 8.00x 8.25x 8.50x 8.75x 9.00x Enterprise Value as a Multiple of 2013P Adjusted EBITDA $211-$239 $190-$218 $218-$245 $203-$231 Overlap of analyses creates a reasonable valuation range for negotiation
- 18. 18 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund Accounting • Accounting controls • Validate historical financials Market • Evaluate market size and projected growth • Assess competition Business • Review product/service offering • Understand customers, profitability, and overall business drivers Legal • Search to identify legal liabilities, which could impact transaction Due diligence is conducted to discover risks, prior to investment
- 19. 19 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund Purchase agreement codifies valuation, structure, and risk mitigation controls Valuation • Purchase Price • Working Capital Estimate Structure • Debt • Equity • Earn-out • Seller- financing Risk Mitigation • Tax Liability Contingencies • Environmental Liability Contingencies • Escrow Other • Management Employment Agreement • Non-Compete Agreement
- 20. 20 Source Lead Underwrite and Gain Exclusivity DueDiligence Negotiate Purchase Agreement Raise Capital and Fund Investor Create Confidential Information Memorandum (“CIM”) Distribute CIM to potential investors Request Term Sheets Negotiate Final Terms Execute Subscription Agreements Fund Capital • PE Fund • Fund-less Sponsor • Bank • Mezzanine Fund EquityDebt Dedicated PE Fund Does Not Require This Process
- 21. 21 Execute Summary Private Equity& Market Overview Fund Structure and Economics Investment Process Recommended Reading
- 22. 22 Recommended Reading • Books o“Applied Mergers & Acquisitions” – Robert F. Bruner o “Investment Banking: Valuation, Leverage Buyouts, and Mergers & Acquisitions” – Joshua Rosenbaum and Joshua Pearl • Websites o www.prequin.com o www.pehub.com o www.pitchbook.com o www.thedeal.com o www.dealbook.com o www.altassets.com o www.bloggingbuyouts.com