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Exploring Private Equity
October 29, 2013

1
Introduction
Justin Shuman
– Education:
 Drexel University (B.S., Business Administration)
 Cornell University (M.B.A., Concentration in Investment Banking)

– Professional Experience:
 Woodlawn Partners – Senior Associate (Current)
 Harris Williams & Co. – Associate (2011 – 2013)
 DuPont Capital Management – Analyst (2007 – 2009)

Contact Information
E-mail: justin@woodlawnpartners.com

2
PE Market Overview

PE Transaction

Recommended Reading

Private equity definition and overview of the industry
ecosystem including funds, investors, and portfolio
companies
Step-by-step walk through a hypothetical private equity
transaction including sourcing, valuation, and
confirmatory diligence topics

Recommended reference materials for learning more
about valuation, investment banking, and private equity

3
Private Equity Value Chain
PE Market Overview

PE Transaction

Recommended Reading

Value Chain
 Investors commit capital to funds, fund-of-funds, or directly invest in
assets
 Funds deploy capital into assets on behalf of their investors (LPs or
Fund-of-Funds)
 Investments receive capital from LPs, Funds, and Fund-of-Funds
INVESTORS (“LPs”)
Pension Funds
Endowments
Foundations
Bank Holding Companies
High-Net-Worth Individuals
Insurance Companies
Investment Banks
Corporations
Other…

FUNDS
Invests in PE Funds

INVESTMENTS

PE Fund

Venture
Growth Equity

Fund of Funds

PE Fund

Buyouts
Mezzanine

PE Fund
Direct Investments

Special Situations
Real Assets

4
A Short Vocabulary Lesson…
PE Market Overview

PE Transaction

Recommended Reading

Limited Partnership Agreement (“LPA”): the agreement that binds LPs to GPs and defines investment
strategy as well as all other rules for fund governance
Commitment: LP investment in a private equity fund
Capital Call: issued by the GP before the closing of a transaction. A capital call requests capital from LPs to
fund investment

Investment Period: normally 5 years from the fund being “turned on” (i.e. fees commencing and the first
capital call). After 5 years the GP may not draw down capital for new investments (“use it or lose it”)
Fund Life: usually 10 years
Fund Extension: highly negotiated but often 2 year increments to provide more time for the GP to manage
and exit existing investments in the fund.
Deal-by-Deal: economic calculation that determines carried interest on a deal-by-deal basis (easier to get to
the carry early)
Back-Ended: economic calculation that determines carried interest on a total fund basis (more difficult to get
to the carry early)
Hurdle Rate: the IRR hurdle which a GP must earn for LPs before it can begin to take 20% of the profits
IRR: internal rate of return is the discount rate that will bring a series of cash flows to an NPV of 0

Return on Invested Capital (“ROIC”): realized capital / invested capital
EBITDA Multiple: purchase price / EBITDA
5
Fundraising Climate
PE Market Overview

PE Transaction

Recommended Reading

Significant amounts of private equity raised before the downturn created buying power
– Moving further into an investment period heightens pressure to invest
– Assuming a five-year investment horizon, $141 billion of private equity’s $348 billion of dry powder will need to
be invested over the next two to three years

Given the capital overhang, fundraising has proven challenging since 2008
– With 805 funds currently in the market, time from initiation to final close is proving longer than 2005 – 2008.
– Fundraising in 2012 fell to the lowest level seen in more than a decade, but the amount of capital raised increased 13%
from 2011 as larger funds found the most success
U.S. Private Equity Fundraising

Capital Overhang of U.S. PE Investors by Vintage Year
For the Years Ended December 31, 2007 – 2012
($ in billions)

300

$180

250
$481

$500
$433

$428

$373

$120

$400
$348

$100
$300
$80
$60

$200

$40
$100

Cumulative Overhang

Overhang by Year

$501

No. of Funds Raised

$160
$140

275

$600

229

228

221

200
150

118

113

2009

2010

128

110

100
50

$20
$0
2007
Cumulative Overhang
$500M - $1B

Source: Pitchbook.

2008
2009
Under $100M
$1B - $5B

2010
2011
$100M - $250M
$5B +

$0
2012
$250M - $500M

0
2005

2006

2007

2008

2011

2012

Source: Pitchbook.

6
Private Equity Deal Activity
PE Market Overview

PE Transaction

Recommended Reading

172 exits took place in 4Q 2012, and the record 6,538 portfolio companies still held will drive
future activity
Private equity deal flow has been partially supplemented by the record $64.1 billion in dividend
recapitalizations in 2012, 58% higher than the previous record of $40.5 billion for the full year
2010
Total Private Equity Deal Flow

PE Deals by Industry
For the Years Ended December 31, 2011 – 2012

For the Quarters 1Q07– 4Q12

5%
$300

7%

900
800

6%

$250

8%

$200

600
500

$150
400
$100

300

Transaction Volume

9%
14%

33%

12%
13%

21%

13%

200

20%

$50
100
$0

0

1Q07
2Q07
3Q07
4Q07
1Q08
2Q08
3Q08
4Q08
1Q09
2Q09
3Q09
4Q09
1Q10
2Q10
3Q10
4Q10
1Q11
2Q11
3Q11
4Q11
1Q12
2Q12
3Q12
4Q12

Value of Deals

700

34%

4%

Total Capital Invested
Source: Pitchbook.

Deal Count

Business Products & Services

Consumer Products & Services

Healthcare

Information Technology

Financial Services

Energy

Materials and Resources
Source: Pitchbook.

7
Private Equity Deal Size
PE Market Overview

PE Transaction

Recommended Reading

Middle market M&A transactions (<$500MM) accounted for 91% of private equity deal volume in
2012 as investors exhibited a preference toward smaller deals
49% of private equity capital was allocated to deals below $500 million in 2012, the second
highest total since 2005
Since credit market conditions are positive, the proportion of large deals should grow in 2013
Percentage of PE Transactions (Count) by Size

Percentage of PE Investment by Deal Size
For Years Ended Dec. 31, 2005 – 2012

For Years Ended Dec. 31, 2005 – 2012
100%

100%

90%

90%

80%

80%

70%

70%

60%

60%

50%

50%

40%

40%

30%

30%

20%

20%

10%

10%

0%

0%
2005

2006

0-24M

Source: Pitchbook.

2007

25M-99M

2008
100M-499M

2009

2010

500M-999M

2011
1B-2.5B

2012
2.5B+

2005
0-24M

2006

2007

25M-99M

2008
100M-499M

2009

2010

500M-999M

2011

1B-2.5B

2012
2.5B+

Source: Pitchbook.

8
Deal Time-Line
PE Market Overview

PE Transaction

Recommended Reading

3
1

2

Source Lead

Speak
with
Owner

1 – 2 Weeks

4

Create
Valuation &
Returns
Model

1 Week

Conduct
Due
Indication
Negotiate
Diligence
of Interest Letter of Intent / Arrange
(“IOI”)
(“LOI”)
Financing

1 Week

2 - 4 Weeks

12 – 16 Weeks

Negotiate
Purchase
Agreement

Close
Transaction

1 – 2 Weeks

TRANSACTIONS TAKE ANYWHERE FROM 5 MONTHS TO 6 MONTHS OR MORE TO CLOSE
9
Sourcing

1
PE Market Overview

PE Transaction

Recommended Reading

Traditional Intermediaries
– Investment Banks
– Business Brokers

Proprietary Sources
–
–
–
–

Accountants
Lawyers
Business Owners
Trade Associations

PROPRIETARY DEAL FLOW NORMALLY EQUALS BETTER/CHEAPER PURCHASE PRICES
10
Valuation & Return Analysis

2
PE Market Overview

PE Transaction

Recommended Reading

DCF
– Use management’s assumptions (revenue growth, profit margins, etc.) to back
into what equity value is worth

LBO
– Similar to a DCF analysis, but a LBO shows an investor how much it can pay in
order to achieve its target equity return
– Can simulate return scenarios under various capital structures

Public Comparables
– Evaluate what EBITDA multiples similar businesses trade at in today’s market

Precedent Transactions
– Review what similar private businesses were acquired for within the last 12-24
months

TRIANGULATE IN ON FAIR PRICE THAT MEETS UNDERWRITING RETURN TARGETS
11
Due Diligence

3
PE Market Overview

PE Transaction

Recommended Reading

Accounting
– Vet accounting practices and controls
– “Quality of earnings” report normally done to validate that
operating results are conservative

Business
– Evaluate product/service offering to validate financial model
– Analyze competitive landscape
– Review key employees

Environmental / Legal
– Scrutinize potential environmental and legal liabilities that could
impact a transaction
FIND AND UNDERSTAND EVERY RISK ASSOCIATED WITH THE ACQUISITION
12
Transaction Financing

4

Equity
– Fund: capital call draws down equity from LPs in pro-rata fashion at close
– Management: existing management usually “rolls” equity
– Co-investors: LPs that directly invest in the equity outside of the fund

Debt
– Senior Debt: secured by assets
– Subordinated Debt: unsecured, second lien on assets
– Mezzanine Debt: fills the gap between equity and debt
 14%-16%, PIK, warrants, no amortization (principal payments) until maturity

CAPITAL STRUCTURES & FINANCING FLEX DURING DILIGENCE AS RISK IS UNDERSTOOD
13
PE Market Overview

PE Transaction

Recommended Reading

Books
 “Applied Mergers & Acquisitions” – Robert F. Bruner
 “Investment Banking: Valuation, Leverage Buyouts, and Mergers &
Acquisitions” – Joshua Rosenbaum and Joshua Pearl
 “Competition Demystified” – Bruce C. Greenwald & Judd Kahn
 “Understanding Michael Porter” – Joan Magretta

Websites








www.prequin.com
www.pehub.com
www.pitchbook.com
www.thedeal.com
www.dealbook.com
www.altassets.com
www.bloggingbuyouts.com

14

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Exploring Private Equity

  • 2. Introduction Justin Shuman – Education:  Drexel University (B.S., Business Administration)  Cornell University (M.B.A., Concentration in Investment Banking) – Professional Experience:  Woodlawn Partners – Senior Associate (Current)  Harris Williams & Co. – Associate (2011 – 2013)  DuPont Capital Management – Analyst (2007 – 2009) Contact Information E-mail: justin@woodlawnpartners.com 2
  • 3. PE Market Overview PE Transaction Recommended Reading Private equity definition and overview of the industry ecosystem including funds, investors, and portfolio companies Step-by-step walk through a hypothetical private equity transaction including sourcing, valuation, and confirmatory diligence topics Recommended reference materials for learning more about valuation, investment banking, and private equity 3
  • 4. Private Equity Value Chain PE Market Overview PE Transaction Recommended Reading Value Chain  Investors commit capital to funds, fund-of-funds, or directly invest in assets  Funds deploy capital into assets on behalf of their investors (LPs or Fund-of-Funds)  Investments receive capital from LPs, Funds, and Fund-of-Funds INVESTORS (“LPs”) Pension Funds Endowments Foundations Bank Holding Companies High-Net-Worth Individuals Insurance Companies Investment Banks Corporations Other… FUNDS Invests in PE Funds INVESTMENTS PE Fund Venture Growth Equity Fund of Funds PE Fund Buyouts Mezzanine PE Fund Direct Investments Special Situations Real Assets 4
  • 5. A Short Vocabulary Lesson… PE Market Overview PE Transaction Recommended Reading Limited Partnership Agreement (“LPA”): the agreement that binds LPs to GPs and defines investment strategy as well as all other rules for fund governance Commitment: LP investment in a private equity fund Capital Call: issued by the GP before the closing of a transaction. A capital call requests capital from LPs to fund investment Investment Period: normally 5 years from the fund being “turned on” (i.e. fees commencing and the first capital call). After 5 years the GP may not draw down capital for new investments (“use it or lose it”) Fund Life: usually 10 years Fund Extension: highly negotiated but often 2 year increments to provide more time for the GP to manage and exit existing investments in the fund. Deal-by-Deal: economic calculation that determines carried interest on a deal-by-deal basis (easier to get to the carry early) Back-Ended: economic calculation that determines carried interest on a total fund basis (more difficult to get to the carry early) Hurdle Rate: the IRR hurdle which a GP must earn for LPs before it can begin to take 20% of the profits IRR: internal rate of return is the discount rate that will bring a series of cash flows to an NPV of 0 Return on Invested Capital (“ROIC”): realized capital / invested capital EBITDA Multiple: purchase price / EBITDA 5
  • 6. Fundraising Climate PE Market Overview PE Transaction Recommended Reading Significant amounts of private equity raised before the downturn created buying power – Moving further into an investment period heightens pressure to invest – Assuming a five-year investment horizon, $141 billion of private equity’s $348 billion of dry powder will need to be invested over the next two to three years Given the capital overhang, fundraising has proven challenging since 2008 – With 805 funds currently in the market, time from initiation to final close is proving longer than 2005 – 2008. – Fundraising in 2012 fell to the lowest level seen in more than a decade, but the amount of capital raised increased 13% from 2011 as larger funds found the most success U.S. Private Equity Fundraising Capital Overhang of U.S. PE Investors by Vintage Year For the Years Ended December 31, 2007 – 2012 ($ in billions) 300 $180 250 $481 $500 $433 $428 $373 $120 $400 $348 $100 $300 $80 $60 $200 $40 $100 Cumulative Overhang Overhang by Year $501 No. of Funds Raised $160 $140 275 $600 229 228 221 200 150 118 113 2009 2010 128 110 100 50 $20 $0 2007 Cumulative Overhang $500M - $1B Source: Pitchbook. 2008 2009 Under $100M $1B - $5B 2010 2011 $100M - $250M $5B + $0 2012 $250M - $500M 0 2005 2006 2007 2008 2011 2012 Source: Pitchbook. 6
  • 7. Private Equity Deal Activity PE Market Overview PE Transaction Recommended Reading 172 exits took place in 4Q 2012, and the record 6,538 portfolio companies still held will drive future activity Private equity deal flow has been partially supplemented by the record $64.1 billion in dividend recapitalizations in 2012, 58% higher than the previous record of $40.5 billion for the full year 2010 Total Private Equity Deal Flow PE Deals by Industry For the Years Ended December 31, 2011 – 2012 For the Quarters 1Q07– 4Q12 5% $300 7% 900 800 6% $250 8% $200 600 500 $150 400 $100 300 Transaction Volume 9% 14% 33% 12% 13% 21% 13% 200 20% $50 100 $0 0 1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 Value of Deals 700 34% 4% Total Capital Invested Source: Pitchbook. Deal Count Business Products & Services Consumer Products & Services Healthcare Information Technology Financial Services Energy Materials and Resources Source: Pitchbook. 7
  • 8. Private Equity Deal Size PE Market Overview PE Transaction Recommended Reading Middle market M&A transactions (<$500MM) accounted for 91% of private equity deal volume in 2012 as investors exhibited a preference toward smaller deals 49% of private equity capital was allocated to deals below $500 million in 2012, the second highest total since 2005 Since credit market conditions are positive, the proportion of large deals should grow in 2013 Percentage of PE Transactions (Count) by Size Percentage of PE Investment by Deal Size For Years Ended Dec. 31, 2005 – 2012 For Years Ended Dec. 31, 2005 – 2012 100% 100% 90% 90% 80% 80% 70% 70% 60% 60% 50% 50% 40% 40% 30% 30% 20% 20% 10% 10% 0% 0% 2005 2006 0-24M Source: Pitchbook. 2007 25M-99M 2008 100M-499M 2009 2010 500M-999M 2011 1B-2.5B 2012 2.5B+ 2005 0-24M 2006 2007 25M-99M 2008 100M-499M 2009 2010 500M-999M 2011 1B-2.5B 2012 2.5B+ Source: Pitchbook. 8
  • 9. Deal Time-Line PE Market Overview PE Transaction Recommended Reading 3 1 2 Source Lead Speak with Owner 1 – 2 Weeks 4 Create Valuation & Returns Model 1 Week Conduct Due Indication Negotiate Diligence of Interest Letter of Intent / Arrange (“IOI”) (“LOI”) Financing 1 Week 2 - 4 Weeks 12 – 16 Weeks Negotiate Purchase Agreement Close Transaction 1 – 2 Weeks TRANSACTIONS TAKE ANYWHERE FROM 5 MONTHS TO 6 MONTHS OR MORE TO CLOSE 9
  • 10. Sourcing 1 PE Market Overview PE Transaction Recommended Reading Traditional Intermediaries – Investment Banks – Business Brokers Proprietary Sources – – – – Accountants Lawyers Business Owners Trade Associations PROPRIETARY DEAL FLOW NORMALLY EQUALS BETTER/CHEAPER PURCHASE PRICES 10
  • 11. Valuation & Return Analysis 2 PE Market Overview PE Transaction Recommended Reading DCF – Use management’s assumptions (revenue growth, profit margins, etc.) to back into what equity value is worth LBO – Similar to a DCF analysis, but a LBO shows an investor how much it can pay in order to achieve its target equity return – Can simulate return scenarios under various capital structures Public Comparables – Evaluate what EBITDA multiples similar businesses trade at in today’s market Precedent Transactions – Review what similar private businesses were acquired for within the last 12-24 months TRIANGULATE IN ON FAIR PRICE THAT MEETS UNDERWRITING RETURN TARGETS 11
  • 12. Due Diligence 3 PE Market Overview PE Transaction Recommended Reading Accounting – Vet accounting practices and controls – “Quality of earnings” report normally done to validate that operating results are conservative Business – Evaluate product/service offering to validate financial model – Analyze competitive landscape – Review key employees Environmental / Legal – Scrutinize potential environmental and legal liabilities that could impact a transaction FIND AND UNDERSTAND EVERY RISK ASSOCIATED WITH THE ACQUISITION 12
  • 13. Transaction Financing 4 Equity – Fund: capital call draws down equity from LPs in pro-rata fashion at close – Management: existing management usually “rolls” equity – Co-investors: LPs that directly invest in the equity outside of the fund Debt – Senior Debt: secured by assets – Subordinated Debt: unsecured, second lien on assets – Mezzanine Debt: fills the gap between equity and debt  14%-16%, PIK, warrants, no amortization (principal payments) until maturity CAPITAL STRUCTURES & FINANCING FLEX DURING DILIGENCE AS RISK IS UNDERSTOOD 13
  • 14. PE Market Overview PE Transaction Recommended Reading Books  “Applied Mergers & Acquisitions” – Robert F. Bruner  “Investment Banking: Valuation, Leverage Buyouts, and Mergers & Acquisitions” – Joshua Rosenbaum and Joshua Pearl  “Competition Demystified” – Bruce C. Greenwald & Judd Kahn  “Understanding Michael Porter” – Joan Magretta Websites        www.prequin.com www.pehub.com www.pitchbook.com www.thedeal.com www.dealbook.com www.altassets.com www.bloggingbuyouts.com 14