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Private Equity and Venture Capital 2

This document provides an overview of a private equity masterclass on deal origination, execution, and portfolio management. It discusses industry analysis, financial modeling, leveraged buyouts, due diligence, deal structuring, and portfolio company management. Specifically, it covers topics like investment strategies, industry KPIs, valuation methods, private equity returns calculations, debt financing, commercial and legal due diligence, legal deal documents, and portfolio company board representation.

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

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Private Equity and Venture Capital 2

  • 1.
    PRIVATE EQUITY ANDVENTURE CAPITAL MASTERCLASS Session 2. Private Equity deal origination, execution and portfolio management March 2013 Alexey Milevskiy Gleb Fomichev The presentation is prepared solely for the purposes of master classes at the Higher School of Economics
  • 2.
  • 3.
    Speakers Alexey Milevskiy Alexey Milevskiy is an Investment Manager at UFG Private Equity, leading Private Equity firm managing over $500 million across several funds in Russia and CIS. He participated in all stages of investment process: origination, due diligence, structuring and execution. Prior to UFG PE Alexey worked at European Private Equity division of GIMV in Belgium, KPMG Business Valuation group and ING Bank. Alexey holds masters degree from Vlerick Business School, Belgium and bachelors from Higher School of Economics. He is also the winner of several McKinsey&Co business case competitions. Gleb Fomichev Gleb Fomichev is an Analyst at JSFC Sistema, major Russian investment company. Gleb is one out of 7 investment professionals running Sistema’s $2 billion portfolio of high technology assets. He is engaged in strategy development and portfolio companies management as well as in new deals origination. Prior to Sistema Gleb worked at A&NN Group, one of the top performing Russian family office, where he managed fund’s assets in retail, telecommunications, logistics, publishing and financial services sectors. Gleb’s other experience includes E&Y business valuation team. Gleb holds masters and bachelors degree from Higher School of Economics. 3
  • 4.
    Session 1. PrivateEquity landscape 1st part • Private Equity definition; • Company funding lifecycle: FFF, business angels, venture capital, private equity, IPO; • Organizational structure of a PE fund: LP-GP agreements; • Typical activities performed by PE fund: fund raising, deal sourcing and originating, due diligence, management of portfolio companies, exits; • Key success factors for PE deals; 2nd part • Russian PE/VC landscape: PE funds, captive funds and family offices, government-backed funds, venture capital funds; • Russian vs Foreign PE industry; • Entry strategies: full buyout, growth capital, LBO, minority recapitalization, mezzanine, distressed situations. • Exit strategies: IPO, trade sale to strategic/financial investor, MBO, sale to other shareholder; • PE careers. 4
  • 5.
    Private Equity definition Private equity is a: • medium to long-term financing • provided in return for an equity stake • in potentially high growth • unquoted companies 5
  • 6.
    Private Equity valuecreation formula Multiple EBITDA growth Leverage Expansion Topline Efficiency growth improvement Superior returns 6
  • 7.
    What value PrivateEquity fund brings PE Entry Value creation within 3-5 years Exit Financial support - Raising new equity rounds and debt financing - Financial planning and cost control, IFRS implementation - Introducing transparent reporting system M&A support - Developing M&A strategy - Search and valuation of attractive acquisition targets - Legal support and deal structuring - Integration assistance Operational support - Help in bringing top experienced people to the team to bridge personnel gaps - Attracting independent board members and industry experts - Motivation schemes implementation - Development of tax and legal structure, IT-systems - Access to a new partner and client network, help in expanding abroad - Optimization business processes and internal decision-making Help in forming/ adapting company strategy - Business model adaptation to changing market realities - Implementing company development plan and setting KPI’s Preparing company for an IPO or trade sale - Improvement of corporate governance - Substituting investment banks at exit - Legal support and deal structuring 7
  • 8.
    Private Equity targetreturns IRR 30% Cash-on-cash 3x over 5 years 8
  • 9.
    Investment approach andkey success factors 1 Market leaders are typically winning 2 Strong and motivated management team 3 Fair entry price 4 Proper deal structuring 5 Proactive monitoring 6 Clear exit strategy 7 Industry growth and deep market expertise 9
  • 10.
    Private Equity fundstructure Limited Partners Distribution Institutional investors of proceeds • Pension funds • Sovereign wealth funds • Financial institutions HNWI Disbursement of commitments Carry Fund General Partners PE or VC firm Equity Exit Investment proceeds Investee company 10
  • 11.
    Typical PE/VC fundremuneration structure Management fee 2% LP GP Carry 20% Management fee of 2% is charged on the total amount of committed/invested capital. Carry is received upon exit from portfolio investments. • First, LPs get total commitments at cost plus hurdle rate (8-10% annual). • Second, remaining exit proceeds split while 80% goes to LPs and 20% to GPs. Carry is the main part of total remuneration and its existence ensures that the interests of LPs and GP are aligned and GP focused on value maximization and successful exits. 11
  • 12.
    Company funding lifecycle Revenue IPO Private Equity Venture Capital Business angels FFF Time Start-up Early Growth Mature 12
  • 13.
    Typical activities performedby PE fund Pre-deal Deal origination Deal screening Due Diligence Deal Negotiation Structuring Deal sourcing Company Post-deal management, Exit value creation 13
  • 14.
    Deal screening example Number of deals Deal received 500 Signing NDA 200 Investment Committee 20 Due diligence 3 Docs drafting and 2 closing 14
  • 15.
    Russian PE industrylandscape Institutional funds Captive funds Government- Family offices backed 15
  • 16.
    Russian VC industrylandscape International funds Russian funds Accelerators Government- backed 16
  • 17.
    Entry strategies Target Stake Deal Deal Fund’s Type of company acquired structure funding strategy fund stage Classical Current PE funds, Growth/ Debt/Self Buy and Buyouts Mature >50% shareholders financed build cash out mezzanine funds New issued stock Financial Venture Growth/ purchase/current Self investor Growth capital Mature <20% shareholders financed (funds for funds, PE funds partial cash out growth) Financial Venture Development New issued stock Self investor Early/Growth <20% funds, PE capital purchase financed (funds for funds growth) Financial Current Minority Growth/ Self investor Classical <50% shareholders recapitalization Mature financed (funds for PE funds cash out growth Reorganizati Special Distressed Mature/ Debt obligations Self >50%/100% on and situations situations Decline assignment financed restructuring funds 17
  • 18.
    Exit strategies  Acquisition of a target by it’s current management Company team size/maturity MBO  Management’s stake before MBO - zero/ insignificant  Example: buyout of a non-core subsidiary  Disagreements on company’s development Sale to other strategy  Dead lock danger shareholder  Spin offs, non cash-deals  Acquisition by a new vehicle created by new PE investor/strategic Secondary buyout investor  The third, forth, etc buyout rounds may also take place  Most IPO proceeds – growth and development capital IPO  Only partial cash out of current shareholders is Likelihood possible of positive target’s performance 18
  • 19.
    PE careers Entry strategy Exit opportunities Partner Unlimited  Work experience in  Top management Investment director Unlimited Private equity positions in industry  Successful completed  Top management deals track record position in fund’s  Recruiters, networking company/project  Own business/project VP/ Associate 1-3 director launch years  Work experience in Big4,  Middle level IB, Industry is required Associate/ 1-3 management positions  Recruiters, networking years in industry Investment manager  Upside position in a smaller fund  Own project launch 1-3 Analyst years  Last year students Internships  Applications on career sites 19
  • 20.
    Session 2. PEdeal origination, execution and portfolio management 1st part Industry analysis • Investment strategies: buy-and-build vs bet-and-win; • Industry KPIs and application for financial modeling; • Multiples variation by industries. Financial modeling and leveraged buyouts • Financial statement analysis: application for private equity; • Valuation methods: multiples approach, comparable transactions approach; • Private equity returns calculations: IRR, cash-on-cash, exit sensitivity analysis. • LBO and financing of M&A transactions: debt and mezzanine financing for PE deals. 2nd part Due diligence • Commercial, financial and tax, legal due diligence Deal structuring and negotiations • Legal documents for deal execution: NDA’s, LOI’s, Term Sheets, SHA’s, SPA’s; • Off-shore holding structures: English law, possible holding schemes. • Deal structuring tools • Deal negotiations: habits for effective negotiations. Portfolio companies management • Fund representation on the board of directors: strategy formulation, veto and approval rights, audit and compensation committees; • Companies monitoring: weekly/monthly management reporting packs, frequent interaction with management; • Value creation strategies: fund raising, building corporate governance, management appointment, solving operational issues, attracting consultants, finding clients, exit preparation, synergy identification among portfolio companies. 20
  • 21.
  • 22.
    Examples of attractivesectors in the current environment Sector Investment rationale 1 Undeveloped industries/ sectors with high growth potential • Internet tech companies • High Internet growth rates • E-commerce • Service infrastructure is still underdeveloped • Medical Services • Limited modern private medical services • Fast Food • Logistics 2 Traditional sectors • Food retail • Import substitution • FMCG • M&A opportunities, important to find right • Pharmaceutical industry platform for consolidation • Media, telecom • Regional growth potential • New formats/ products development • Room for improvement (margins, working capital) 22
  • 23.
    Two types ofinvestment strategies investment strategies Two investment strategies “Bet-and-win” “Buy-and-build” • Industry with high growth potential • Good industry knowledge • Investment in market leader • Building market leadership through M&A • Investment in strong management • Strengthen management team team • “Discount entry price” • “Fair entry price” • Majority stake buy-out • Minority investment Undeveloped industries/ sectors with Traditional sectors high growth potential Common principles • The market in which the Company operates should be at least $100 million • The demand for the Company products or services should be justified by macro trends • The business model should be proven/ sustainable/ scalable 23
  • 24.
    Private Equity focuseson rapidly growing sectors Penetration Disposable Consolidation Stable Import Regional Growing Under- growth income/ opportunity demand substitution growth corporate and developed private potential government infrastructure spending spending growth Tech/ Internet/ IT      E-commerce      Medical services        Fast food, casual dining      Logistics      Food retail      FMCG      Pharmaceutical        Media, telecom       Auto components    Pension funds     Infrastructure    24
  • 25.
    Industry sector top-downscorecard example Sector description • Description of the sector Size and trends Regulations and environment • Estimated size of the sector (for the latest year available). Sector • Assessment of the environment CAGR and expectations for short and medium run. (favorable or risky) • Key segments, information on segments’ share, trends, margins, etc. • Information on state support/ • Export and import information. Any info on taxes, export/ import regulations within the sector quotas. • Information on international players • Key buyers and suppliers. working within the sector • Other information (e.g. recent trends, substitutes, etc) • Indication of PE activity in the sector • Assessment of margins (EBITDA, other information) - can be gained from Annual Reports, analysts’ reports, SPARK, etc • Some indications on capital expenditures (e.g. cost of production facilities, years to build/ get to full capacity) Fragmentation and key players Potential Growth and Exit Strategy Overall conclusion and Exit Strategy • Assessment of market consolidation (consolidated or • Overall measure of the sector fragmented) attractiveness for the PE activity • Key players, their market shares (high or low score) • Information on recent mergers/ acquisitions • Decryption of potential targets • Information on actioners, vertical integration of the players, etc • Description of exit strategy • Competition assessment 25
  • 26.
    Three different industrysegment examples Online B2C business Food retail chain Engineering business 26
  • 27.
    Example 1. OnlineB2C business Key points to consider • Unit economics, CLV > Customer acquisition cost • Average check, churn, retention, repeat users • Visitors, conversion • Customer acquisition channels • Head office costs, cash burn • Logistics • Inventory 27
  • 28.
    Example 2. Foodretail Key points to consider • Store level performance/locations. Top-line and bottom-line by store. Revenue and EBITDA concentration. • Store level economics: capex, revenue per store, target profitability level, payback period, revenue ramp-up, time to break-even, time of construction • Benchmark against competitors. Revenue per sqm, profitability, prices, SKUs, locations. • Logistics. How in-bound and out-bound logistics works? Who are the suppliers? Private labels? • Rental agreements. How the stores locations are determined? What are the terms and timeframe of the rental agreements? • Costs as % of revenue. Marketing expenditures, personnel expenses, head office expenses. • Working capital. Inventory, a/r, a/p turnovers. • Store opening pipeline. Geography of locations? Any preliminarily agreements in place? How much they opened historically? 28
  • 29.
    Example 3. Engineering Key points to consider • Customers. History of relationship. Blue-chip customers, creditworthiness. Revenue concentration. • Customer contracts terms, time periods and payment terms • Value chain. Which part of the value chain does the company operates? • Personnel utilization, turnover, average wages. Contract agreements with personnel, motivational schemes in place • Head office 29
  • 30.
    Financial modeling and leveraged buyouts 30
  • 31.
    Analyzing the target High-growth/start-up Established business business  Past performance analysis (financial statement analysis,  Management team Current current market position inspection positions analysis inspection)  Monetization model audit  Current conditions of production facilities  Valuation based on  Future growth estimation trade multiples Valuation/  Market prospective  DCF forecasting for prospects analysis scenario analysis and estimation debt repayment  DCF forecasting for capacity estimation valuing business
  • 32.
    Valuing the target Revenue Start-up Expansion Growth Decline FFF, Venture Strategic investor, Private equity funds seed funds special situation fund Time Firm Current business and assets, Future growth Current assets value future growth Valuation Comparable companies, Negotiations Comparable companies method liquidation method Multiple if N/A Extremely high High, average industry level Low applied
  • 33.
    Valuation methods. Multiplesapproach I. Equity value/Net income IV. Industry specific multiples  Highly depends on capital Industry Multiple structure  EV/Reserves 1. Oil & gas  Not widely used for private  EV/Production equity valuations  EV/EBITDAX 2. Metal & mining  EV/Reserves  EV/Production II. Enterprise value/Sales 3. TMT, internet, media  EV/Subscribers  Highly depends on business  EV/Population marginality (“quality” of sales)  EV/Fiber miles  The most simple in terms of 4. Financial institutions  Equity value/Book value calculation and quick value  Equity value/Net Asset value estimation 5. Retail  EV/EBITDAR  EV/Square footage III. Enterprise value/EBITDA 6. Real estate  EV/Square footage  Equity Value/Net Asset  Most commonly used Value
  • 34.
    Valuation methods. Multiplesapproach Enterprise value derivation Enterprise value Assets Liabilities & Equity = Equity value  Long term assets  Debt + • Investments in  Convertible notes associates Total debt  Mezzanine + Preferred stock  Current assets • Cash & cash  Common Equity + equivalents  Preferred stock Noncontroling interest  Noncontrolling - interest Cash & cash equivalents - Cash-flow Investors claims Associate companies generating assets = Equity value + other + = Enterprise value + investor claims = assets not generating Other claims on assets Enterprise value + cash (pension liabilities, employee stock cash flow (cash) option)
  • 35.
    Valuation methods. Multiplesapproach EBITDA derivation EBITDA calculation from IFRS and US GAAP reporting  Adding back D&A, taxes and interest payments to Net Income  Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring costs, assets revaluation, special projects costs) EBITDA calculation from RAS reporting  Adding back D&A, taxes and interest payments to Net Income  Adjusted EBITDA (OIBDA) – removing away all one-off expenses (restructuring costs, assets revaluation, special projects costs)  D&A is reported in COGS and SG&A section. Reporting notes should be investigated to detach it/simplified forecast of D&A based on PPE balance value can be performed
  • 36.
    Valuation methods. Multiplesapproach Commercial meaning EV EBITDA -  Not a capital intensive business  Perfect conditions of current  Extensive capex program production facilities  High tax rate  Low tax rate  High cost of capital  Low cost of capital  Low market growth estimation  Outstanding growth prospective + General rule: General rule:  Oil & gas  Retail EV/EBITDA>5 EV/EBITDA<5  Metals & mining  Internet  Development  Healthcare  Infrastructure
  • 37.
    Valuation methods. Transactionsapproach Special Data Bases use for Criteria Processing Final transaction determination with sample multiple search calculation  MergerMarket  Target’s sector  Moving away  Median/average  Factiva  Geography deals without multiple of a  DealWatch  Deal type financial details selected sample  Zephyr  Period  Moving away of transactions outliers  Stake acquired  Multiples check
  • 38.
    Private equity returnscalculations ENTRY EXIT Equity value Entry EV/EBITDA x Equity value EBITDA LTM Exit EV/EBITDA x EBITDA LTM Net claims on assets Net claims on assets Funding from banks, mezzanine funds, etc. Equity consideration Dividends payments Equity stake of a PE paid by PE fund fund Value Dividends Value + Dividends + Value Σ + - Cash-on-cash 0 Value (1+IRR) k
  • 39.
    LBO deal case.General structure Current New investor 1 shareholders (PE fund) New investor 2 (PE/mezzanine fund) Ownership Equity New investor 3 (Bank) Subordinated notes, convertible notes Senior debt Target Growth capital component of LBO transaction Capex program 39
  • 40.
    LBO deal case.Valuation and funding structure I. Valuation and structure II. Deal funding Company financials Funding structure % mln $ Sales'12 mln $ 400 Equity contribution 30% 78 EBITDA'12 mln $ 48 Senior debt 40% 104 Net debt mln $ 20 Subordinated notes 20% 52 Noncontroling interest mln $ 15 Convertible notes 10% 26 Total 100% 261 Valuation multiples EV/EBITDA on entry x 7 Total investments EV/EBITDA on exit x 7 Pre-money valuation Enterprise value mln $ 336 Entry mult x EBITDA’12-Net debt-NI Equity value mln $ 301 Transaction issues Growth capital investment mln $ 50 Current shareholders stake for sale % 70% Pre-money equity valuation + growth Post-money valuation capital Enterprise value mln $ 386 Equity value mln $ 351 Total investments mln $ 261 Stake for sale x Equity pre-money Cash out mln $ 211 valuation + growth capital Cash in mln $ 50
  • 41.
    LBO deal case.Debt & equity parameters I. Senior debt Term years 8 Interest rate % 8% Principal amount mln $ 104 Repayment annuity payments II. Subordinated notes Term years 8 Cash interest rate % 10% PIK interest % 4% Principal amount mln $ 52 Conversion warrant - III. Convertible notes Term before conversion years min (10; new investment round) Conversion price 10 years 1,5 x entry valuation new round 0,8 x new investor valuation Interest rate % 8% Principal amount mln $ 26 IV. Common equity Dividend payout ratio % 10% Par value mln $ 78
  • 42.
    LBO deal case.Debt schedules A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 I. Senior debt Annuity payments 9 18 18 18 18 18 18 18 Outstading amount, b-o-p 0 0 99 89 78 66 53 40 25 Principal repayment 0 5 10 11 12 13 14 15 16 Interest payment 0 4 8 7 6 5 4 3 2 Outstanding amount, e-o-p 0 99 89 78 66 53 40 25 8 II. Subordinated notes Outstanding amount, b-o-p 0 0 52 54 56 59 61 64 66 PIK interest 0 0 2 2 2 2 2 3 3 Outstanding amount, e-o-p 0 52 54 56 59 61 64 66 69 Cash interest payments 0 3 5 6 6 6 6 6 7 III. Convertible notes Outstanding amount, b-o-p 0 0 26 26 26 26 26 26 26 Outstanding amount, e-o-p 0 26 26 26 26 26 26 26 26 Interest payments 0 1 2 2 2 2 2 2 2 Total interests 0 8 17 17 16 16 15 14 13 Cash interest payments 0 8 15 15 14 13 13 12 11 P&L
  • 43.
    LBO deal case.P&L forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 Sales 400 392 392 412 453 498 508 518 529 COGS -232 -231 -231 -235 -240 -264 -269 -275 -280 Gross profit 168 161 161 177 213 234 239 244 248 Gross margin 42% 41% 41% 43% 47% 47% 47% 47% 47% EBITDA 48 43 43 54 77 85 86 88 90 EBITDA margin 12% 11% 11% 13% 17% 17% 17% 17% 17% D&A -5 -5 -7 -7 -7 -7 -7 -7 -7 EBIT 43 38 36 46 70 77 79 81 83 EBIT margin 11% 10% 9% 11% 15% 16% 16% 16% 16% Interest payments 0 -8 -17 -17 -16 -16 -15 -14 -13 EBT 43 30 18 29 53 62 64 67 69 Net income 34 24 15 23 43 49 51 53 55 Net income margin 9% 6% 4% 6% 9% 10% 10% 10% 10% Dividends on common equity 0 -2 -1 -2 -4 -5 -5 -5 -6 BS
  • 44.
    LBO deal case.BS entries A 1 mln $ 2012 Adjustments 2013 I. Non current assets PP&E 100 Capex from new investment proceeds 145 Intangibles 10 10 Goodwill 0 Pre money equity valuation – Initial shareholders equity 201 Total non current assets 110 356 II. Current assets Cash 80 3 Inventories 25 25 Reveivables 20 20 Total current assets 125 47 Total assets 235 404 III. Long term liabilities Existing loan facility 100 Debt repayment from cumulative cash and operating cash flow of 2013 0 Senior debt 0 Principal amount – repayment of principal in 2013 99 Subordinated notes 0 Value of the notes issued in 2013 52 Convertible notes 0 Value of the notes issued in 2013 26 Total long term liabilities 100 178 IV. Current liabilities Current portion of long term debt 0 0 Payables 20 20 Total current liabilities 20 20 V. Equity Shareholders equity 100 Pre-money equity*(1-cash out stake)+equity contribution by PE+NI-dividends 191 Noncontrolling interest 15 15 Total equity 115 206 Total equity & liabilities 235 403
  • 45.
    LBO deal case.BS forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 I. Non current assets PP&E 100 145 145 145 145 145 145 145 145 Intangibles 10 10 10 10 10 10 10 10 10 Goodwill 0 201 201 201 201 201 201 201 201 Total non current assets 110 356 356 356 356 356 356 356 356 II. Current assets Cash 80 3 8 19 46 77 111 146 181 Inventories 25 25 25 25 26 28 29 30 30 Reveivables 20 20 20 21 23 25 25 26 26 Total current assets 125 47 52 65 94 130 165 201 238 Total assets 235 404 409 421 451 487 522 558 594 III. Long term liabilities Existing loan facility 100 0 0 0 0 0 0 0 0 Senior debt 0 99 89 78 66 53 40 25 8 Subordinated notes 0 52 54 56 59 61 64 66 69 Convertible notes 0 26 26 26 26 26 26 26 26 Total long term liabilities 100 178 170 161 151 141 129 117 103 IV. Current liabilities Current portion of long term debt 0 0 0 0 0 0 0 0 0 Payables 20 20 20 20 21 23 23 24 24 Total current liabilities 20 20 20 20 21 23 23 24 24 V. Equity Shareholders equity 100 191 204 225 263 308 354 402 452 Noncontrolling interest 15 15 15 15 15 15 15 15 15 Total equity 115 206 219 240 278 323 369 417 467 Total equity & liabilities 235 403 408 421 450 486 521 557 594
  • 46.
    LBO deal case.CF forecast A 1 2 3 4 5 6 7 8 mln $ 2012 2013 2014 2015 2016 2017 2018 2019 2020 Operating cash flow Net income 34 24 15 23 43 49 51 53 55 PIK interest 0 0 2 2 2 2 2 3 3 D&A 5 5 7 7 7 7 7 7 7 Changes in receivables 0 0 0 -1 -2 -2 0 -1 -1 Changes in inventories 0 0 0 0 -1 -3 -1 -1 -1 Changes in payables 0 0 0 0 0 2 0 0 0 Cash flow from operations 39 30 24 32 50 56 60 62 65 Investment cash flow Capex -5 -50 -7 -7 -7 -7 -7 -7 -7 Cash flow from investments -5 -50 -7 -7 -7 -7 -7 -7 -7 Financing cash flow Existing debt 0 -100 0 0 0 0 0 0 0 Senior debt 0 99 -10 -11 -12 -13 -14 -15 -16 Subordinated notes 0 52 0 0 0 0 0 0 0 Convertible notes 0 26 0 0 0 0 0 0 0 Common equity contribution 0 78 0 0 0 0 0 0 0 Common equity repayment 0 -211 0 0 0 0 0 0 0 Dividends 0 -2 -1 -2 -4 -5 -5 -5 -6 Cash flow from financing 0 -57 -12 -13 -16 -18 -19 -20 -22 Total cash flow 34 -78 5 11 27 31 34 35 36
  • 47.
    LBO deal case.Exit valuation 1 2 3 4 5 6 7 8 mln $ 2013 2014 2015 2016 2017 2018 2019 2020 EBITDA 43 43 54 77 85 86 88 90 Exit multiple x7 Enterprise value at exit 302 302 375 539 593 605 617 629 Net debt Initial loan facility 0 0 0 0 0 0 0 0 Senior debt -99 -89 -78 -66 -53 -40 -25 -8 Subordinated notes -52 -54 -56 -59 -61 -64 -66 -69 Convertible notes -26 -26 -26 -26 -26 -26 -26 -26 Total debt -178 -170 -161 -151 -141 -129 -117 -103 Cash 3 8 19 46 77 111 146 181 Total net debt -175 -162 -142 -106 -64 -18 29 78 Equity value at exit 127 140 233 433 529 586 645 707 PE fund stake in equity 70% 70% 70% 70% 70% 70% 70% 70% Conversion of convertible notes Equity value after conversion 166 259 459 555 612 672 733 Share of a converter 19% 12% 7% 6% 5% 5% 4% Share of a PE fund after conversion 57% 88% 93% 94% 95% 95% 96% PE fund stake value 94 227 427 523 580 639 701
  • 48.
    LBO deal case.Returns calculation Exit year 2014 2015 2016 2017 2018 2019 2020 2013 -78 -78 -78 -78 -78 -78 -78 2014 96 1 1 1 1 1 1 2015 0 229 2 2 2 2 2 2016 0 0 431 4 4 4 4 2017 0 0 0 527 5 5 5 2018 0 0 0 0 585 5 5 2019 0 0 0 0 0 645 5 2020 0 0 0 0 0 0 706 IRR 22% 72% 78% 63% 51% 44% 39% Cash-on-cash 1,2 2,9 5,6 6,8 7,6 8,5 9,3 Alternative scenario: fully equity financed buyout Exit year 2014 2015 2016 2017 2018 2019 2020 2013 -261 -261 -261 -261 -261 -261 -261 2014 238 3 3 3 3 3 3 2015 0 444 4 4 4 4 4 2016 0 0 658 6 6 6 6 2017 0 0 0 765 6 6 6 2018 0 0 0 0 834 6 6 2019 0 0 0 0 0 903 6 2020 0 0 0 0 0 0 974 IRR -9% 31% 37% 32% 27% 24% 22% Cash-on-cash 0,9 1,7 2,5 3,0 3,3 3,6 3,9
  • 49.
    Exit strategies. Returnson exit Alternative Valuation Valuation scenario: fully equity financed buyout PE fund equity PE fund equity PE fund equity Convertible Convertible notes notes Subordinated Subordinated PE fund equity notes notes Senior Senior Debt Debt 2013 2017 Time 2013 2017 Time 49
  • 50.
  • 51.
    Due diligence types Due diligence Due Diligence types • Typically takes 4-5 weeks Commercial • Can be organized through VDR (Vendor Data Room) • Serves as a basis for Operational negotiations on warranties, indemnities • Possible adjustment to Financial and EBITDA and purchase price may be negotiated based on tax due diligence results Legal Environmental 51
  • 52.
    Due diligence consultants Commercial Financial and tax Legal Large deals Mid-size deals Generalists Mid-size deals Mid-to-small deals Law firms Mid-to-small deals Also doing transaction documentation 52
  • 53.
  • 54.
    A typical exampleof deal structuring in Russia Shareholder A Shareholder B Shareholder C 100% 100% 100% BVICo BVICo BVICo 30% 30% 40% Shareholders’ Agreement Cyprus HoldCo Buyer SPV Sale and Purchase Agreement Joint 50% 50% Venture Cyprus SPV 100% Russian LLC/CJSC Source: Goltsblat, Salans 54
  • 55.
    Why English lawis used in Russian transactions? Use of legal concepts not available Key merits of English law under Russian law or untested in Russian courts. For example: • Flexible • representations, warranties, • Adaptable indemnities • Commercial • put and call options • Freedom of contract • drag and tag along • Predictable • conditions precedent • Reputable judiciary • restrictive and negative covenants • Common law and precedents • retention and escrow accounts • deadlock mechanisms • English law is widely used in international transactions (often in conjunction with local laws) across a variety of jurisdictions, including on many deals in the Middle East, Africa, Singapore, Hong Kong, China, India, Russia and the CIS • English law is a common law system, based on a combination of legislation and case precedent. This makes English law flexible, adaptable and practical • The laws and rules themselves are less prescriptive when interpreting the intentions and actions of the parties and instead the courts will interpret what the parties have written in the contract • English courts have a strong reputation for reaching fair, balanced and unbiased judgments and rulings Source: Goltsblat, Salans 55
  • 56.
    Typical deal documentsfor PE transactions NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 56
  • 57.
    NDA NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 57
  • 58.
    NDA Commonissues addressed • Parties • The definition of information to be held confidential • The exclusions from what must be kept confidential • The disclosure period - information not disclosed during the disclosure period (e.g., one year after the date of the NDA) is not deemed confidential • The term (time period) of the confidentiality • Obligations of the recipient regarding the confidential information • Insider trading (in case of public company) • The law and jurisdiction governing the parties However, it is hard to prove breach of an agreement and quantify losses, so typically NDA is just a formality… 58
  • 59.
    LOI/ MOU NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 59
  • 60.
    LOI/ MOU Common issues addressed • Parties • Consideration - price for the assets and business to be purchased • Term Sheet • Timing for Term Sheet signing and transaction completion • Public announcements restrictions • Non-binding nature of the document Differences between LOI/MOU • LOI outlines the intent of one party toward another with regard to an agreement, and may only be signed by the party expressing intent • MOU must be signed by all parties to be a valid outline of an agreement 60
  • 61.
    Term Sheet NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 61
  • 62.
    Term Sheet Common issues addressed • Parties • Total price consideration, formula for calculation, adjustments • Debt and working capital • Payment tranches • Transaction calendar and deal closing date • Short list of conditions precedent, representations and warranties, existence of certain indemnities • Exclusivity • Break-up fee • Subject to due diligence • Confidentiality • Governing law 62
  • 63.
    SHA/SPA NDA - non-disclosure agreement, is a legal contract that outlines confidential information that the parties wish to share with one another for NDA certain purposes, but wish to restrict access to or by third parties. NDA protects confidential nonpublic business information LOI/MOU - letter of intent/ memorandum of understanding is a document outlining an agreement between two or more parties before the LOI/ MOU agreement is finalized, written in letter form and focuses on the parties' intentions. Non-binding. TS - term sheet is a bullet-point document outlining the material terms and TS conditions of a potential deal. After execution TS guides legal counsels in preparation of a final agreement (SPA, SHA). Non-binding. SHA - shareholders’ agreement is an agreement among a company’s SHA shareholders describing how the company should be operated and the shareholders' rights and obligations. Binding. SPA - share purchase agreement is a legal contract which outlines terms SPA and conditions for acquiring a company's shares Binding. 63
  • 64.
    Deal structuring entailsnegotiations SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 64
  • 65.
    SPA related dealstructuring SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 65
  • 66.
    Representations, warranties andindemnities Representations • Representations are statements by one party (usually the seller) which induce another party (usually the purchaser) to enter into a contract • If the statement relied on is untrue or incorrect and the position misrepresented, the other party may be entitled to terminate or rescind the contract and/or claim damages Warranties • Warranties are terms of a contract which, if breached, will entitle the innocent party to claim damages • The contractual measure of damages aim to put the innocent party in the position it would have been in had the breach not occurred • Used in order to provide reassurance from the seller on factual matters or future promises concerning the status of the target company and its business, assets, liabilities and financial position Possible warranties (but not limited to): • Accuracy of financial information • Employment arrangements • Ownership of assets • Recent material changes to the business • Nature and extent of contracts • Intellectual property, appropriate licences • Absence of any disputes • Share structure and ownership of the target Source: Goltsblat, Salans 66
  • 67.
    Representations, warranties andindemnities Indemnities • Indemnity is a promise to reimburse the buyer in respect of a particular type of liability, should it arise • Easier to establish than a warranty claim as there is no need to calculate loss • Used where there is a known or potential, clearly identifiable liability, the risk of which is to be borne by the party giving the indemnity, such as unpaid tax, a potential environmental claim, or a specific issue arising from due diligence • Warranties may be given on an indemnity basis Tax deed • Tax dead is a document containing tax indemnities • If there are any unexpected tax problems associated with the target, the buyer will expect that the price is reduced by an amount equal to the consequential tax liability (buyer’s protection) • The tax deed also contains lengthy provisions limiting the ability of the buyer to bring claims under the tax deed (seller’s protection) Indemnity security • Retention, escrow accounts • Pledge over assets • Parent guarantee Source: Goltsblat, Salans 67
  • 68.
    Purchase price/ consideration Purchase price mechanisms • Completion accounts mechanism may be included, whereby an audit of the target company and its business is conducted and the purchase price is adjusted. • The completion accounts process includes accounting assumptions and valuation methodology or formula for price calculation. • Contracts will sometimes also include deferred consideration payments at agreed stages after completion • Escrow accounts can be used, while money is deposited with a third party, who holds it ‘in escrow’ for the parties and only releases it in accordance with the terms of the escrow contract • These can sometimes be linked to earn-out provisions, which compare future economic performance against agreed targets (such as revenue or profits) and then adjust the deferred payments according to whether or not these targets are met. • Price can be adjusted both sides according to ratchet scheme Source: Goltsblat, Salans 68
  • 69.
    Conditions precedent Conditions precedent • Conditions precedent (CPs) are clauses which provide that certain parts of the contract will only come into force if and when agreed conditions are met • There is no obligation to complete the transaction until the CPs are met. If SPA is signed the buyer has no obligation to pay until the CPs are met • The contract will typically include provisions dealing with the legal obligations of the parties pending satisfaction of all the conditions and the efforts to which they must go in order to achieve satisfaction of the CPs themselves Possible CPs (but not limited to): • Obtaining anti-monopoly approval • Bank consent • Change of control • Approvals from key customers and suppliers to assign contracts • Investment Committee approval • Absence of any material adverse change in the financial condition of the target Termination rights • Material adverse change • Material breach of warranty Source: Goltsblat, Salans 69
  • 70.
    Restrictive covenants • Restrictive covenants are contractual promises, preventing the seller of the business from competing with the business sold (non-compete), together with non-poaching undertakings in relation to key staff, suppliers and customers (non-solicit). • They must be restricted in time and scope to be effective and enforceable Source: Goltsblat, Salans 70
  • 71.
    SHA related dealstructuring SPA I win structuring I win You win You lose = DEAL I lose I lose SHA You lose You win structuring 71
  • 72.
    Put and calloptions Put option Right to put its shares on Party B • The right, not an obligation Party A Party B • Put and call options should Obligation to pay $ contain price of execution, to Party A terms and possible triggers. 50% • Put price may be linked to IRR shareholding 50% shareholding or cash-on-cash multiple of the (subject to ‘put’ right) Company investor • May be used to give an exit strategy or as an enforcement Call option mechanism on default under Right to call for shares from Party A shareholders’ agreements Party A Party B • Redemption shares are often used as a ‘soft’ put option, but Obligation to transfer shares to party B, in can be redeemed only from net exchange for $ profit 50% payment 50% shareholding shareholding • Call and put often used in (subject to ‘call’ right) Company parallel, limiting downside as well as upside Source: Goltsblat, Salans 72
  • 73.
    Covenants and vetorights Covenants • A covenant is an agreement or promise to do (positive covenant) or refrain from doing something (negative covenant), binding on the party who gives it Possible positive covenants: Possible negative covenants: • Provide financial information on request • Not to issue new shares • Inform about break of warranty • Not to dispose any material assets • Maintain Debt/EBITDA below 3x Veto rights • A veto right is the right of a party to withhold its approval to a proposed course of action or decision that requires its consent Possible veto rights on: • Issuing or selling shares • Making capital expenditures over $X • Taking loans over $X • Terminating employment with key employees Source: Goltsblat, Salans 73
  • 74.
    Drag along andtag along Drag along • A drag along right allows a shareholder of a company to force the remaining Buyer shareholders to accept an offer from a third party to purchase the whole company. • The other shareholders are then ‘dragged along’ and forced to sell their shares at the same time and price. • Used to give liquidity and an exit route on an assumption that most buyers will Party A Party B want to acquire 100% of the company shareholding • The offer may also need to match or 3. Party B is exceed a minimum agreed price or shareholding forced to accept minimum time period before the drag and sell its along right can be triggered shares Company • The other shareholder may be given a right to match the offer and buy the shares itself (Right of first refusal) Source: Goltsblat, Salans 74
  • 75.
    Drag along andtag along Tag along • Tag along provision is a corresponding right that entitles shareholder to Buyer participate in a sale by the other 1. Party A shareholders at the same time and at decides the same price per share. to sell its shares • The minority shareholder then ‘tags along’ with the majority shareholder’s sale. • Can state that, if the tag along procedures are not followed by the Party A Party B purchaser, then its attempt to buy any of the shares is not valid and will not be shareholding 2. Party B registered shareholding can force the buyer to buy its shares as well Company Source: Goltsblat, Salans 75
  • 76.
    Good leaver/ Badleaver provisions • Leaver provisions are contractual Possible provisions mechanisms covering employees Good Intermediate Bad who are also shareholders in a Leaver Leaver Leaver company Death Serious/ Resignation • When an employee leaves the permanent prior to company, he is required to transfer illness an agreed his shares back to the company of spouse minimum period • Typically used for the shares granted Serious/ Resignation Dismissal for to managers as a motivation scheme permanent after an gross • Good leavers tend to receive market illness agreed misconduct value for their shares, whereas the minimum price paid to bad leavers tends to be period heavily discounted Retirement at Dismissal on Dismissal for retirement grounds of fraud age poor or dishonesty performance Redundancy Breach of restrictive covenants Source: Goltsblat, Salans 76
  • 77.
    Other SHA tools Upside sharing Deadlock mechanism Anti-dilution Preferred shares/Liquidity preference Corporate governance rights 77
  • 78.
  • 79.
    Corporate governance issues Management Structuring Board of compensation and Directors incentives programs Corporate governance Monitoring CEO replacement Influence on strategy
  • 80.
    Board of Directors Structuring Board of Directors Board size Board composition Board committees  Key point while deal  3 categories:  Two main committees: structuring (as well as entrepreneurs (founders), compensation and audit board composition) investors, independent  Compensation committee  Smaller boards – more directors area: salaries, stock option effective in decision  PE investor does not have for top managers (chaired making a majority of board seats by independent director,  Typical PE-backed as a rule excludes CEO) company Board – 5-7  Balanced composition: 2  Audit committee area: members (half of a size of managers, 2 investors, 1 – compliance with legal a public company Board) independent director (the requirements on financial  Monthly frequency of swing vote) reporting (members with Board meeting is common  Composition changes accounting expertise for early-stage companies subject to company independent from performance management)
  • 81.
    Companies monitoring andvalue creation I. Monitoring process High frequency of interaction with Medium to high frequency of Low frequency of interaction with management. Level: analyst + interaction with management. management. Level: VP/director + Level: analyst/associate + Weekly operational reports Monthly reporting packs BoD, committees presence, general reporting forms review Start-ups Profitable growing Mature company Maturity of a businesses business II. Value creation Negotiations Fund team – in- Fund raising: Synergy with external house other funds among consultants, consultants for a assets as a portfolio bankers, legal company pledge companies and government authorities
  • 82.
    Management incentive tools General incentive scheme Bonus scheme Management share in IRR additional payment min max 0% 15% 0% 16% 20% 0% 21% 25% 0% 26% 30% 0% 30% 35% 0% 35% 40% 30% 40% 50% 50% 50% 100% 70% Example Bonus & IRR calculation Enterprise value $mln 423 Equity value $mln 422 Fund share $mln 396 IRR (Fund) % 57% min IRR % 35% Additional gain to the Management $mln 114 real IRR (Fund) % 39%
  • 83.