2. What is Private Equity?
• Private equity is capital that is not noted on a public
exchange.
• Private equity is composed of funds and investors that
directly invest in private companies, or that engage in
buyouts of public companies, resulting in the
delisting of public equity.
• Institutional and retail investors provide the capital
for private equity, and the capital can be utilized to
fund new technology, make acquisitions, expand
working capital, and to bolster and solidify a balance
sheet.
4. Business Life Cycle
• Launch: A company begins its operations by launching new
products or services. During the launch phase, sales are low,
but slowly increasing, initial startup costs are high, with losses
in this phase and negative cash flows.
• Growth: Companies experience rapid sales growth with
profits beyond break-even point and positive cash flows.
• Shake-out: Sales continue to increase, but at a slower rate,
usually due to either approaching market saturation or the
entry of competitors with profits starting to decrease.
• Maturity: Sales slowly decrease. Profit margins get thinner
with stagnant cash flows. Many businesses extend their
business life cycle during this phase by reinventing themselves
and investing in new technologies and emerging markets.
• Decline: Sales, profit, and cash flow all decline.
6. PE – Four Different Forms of
Investment
• Venture capital – equity investments in less
mature non-public companies to fund the
launch, early development, or expansion of
business.
• Growth capital – minority equity investments
in mature companies for expansion,
restructuring of operations, financing an
acquisition or entering a new market, without a
change of control of the company.
7. PE – Four Different Forms of Investment
• Mezzanine capital – investment in subordinated debt or
preferred stock of a company without taking voting control
of the company.
• The gap in funding between senior debt and equity is
common for the following reasons:
1) accounts receivable, inventories and fixed assets are
being discounted at greater rates than in the past for fear
that their values will not be realized in the future;
2) many balance sheets now contain significant intangible
assets,
3) as a result of defaults and regulatory pressure, banks have
placed ceilings on the amount of total debt a company can
obtain.
8. PE – Four Different Forms of Investment
• While additional liquidity can be obtained from equity
investors, equity is the most expensive source of capital.
Further, equity capital, by its nature, dilutes existing
shareholders.
• As a result, mezzanine debt can be an attractive
alternative way to obtain much needed capital.
10. PE – Four Different Forms of Investment
• Leveraged buyout (LBO) – purchase of all or most of a company
or a business unit by using equity from a small group of investors in
combination with a significant amount of debt. LBO targets are
mature companies generating strong operating cash flows.
• Ex. In 2007, Blackstone Group bought Hilton Hotels for $26 billion
through LBO. Blackstone put up $5.7 billion in cash (and $0.8 bn
later)and financed $20.5 billion in debt from a group of 26 big
banks, hedge funds, and real estate debt investors. Before the
financial crisis of 2009, Hilton had issues with declining cash flows
and revenues. Hilton later refinanced at lower interest rates and
improved operations.
• BS bought back some debt at deep discount and by issuing shares.
Hilton again became public in Dec 2013 with second IPO of $2.3
bn. With 76 percent of the equity, Blackstone’s stake in Hilton was
worth at least $15 bn. That is a profit, on paper at least, of more than
$8.5 billion.
12. Private equity-AUM
• Private equity continued to drive global
growth in private markets. Fundraising
rebounded across regions, and global totals fell
just short of the pre-pandemic peak established
in 2019. AUM reached an all-time high of $6.3
trillion, driven primarily by asset appreciation
within portfolios. With a pooled IRR of 27
percent in 2021, private equity (PE) was once
again the highest-performing private markets
asset class
13. Some PE/VC Terminology
General partner (GP):
An entity that raises capital from limited partners for a fund
and determines which assets the fund should invest in.
Limited partner (LP):
An entity that commits capital to a general partner’s fund.
Limited Partnership
A legal entity composed of a general partner and various
limited partners. The GP manages the investments and is
liable for the actions of the partnership while the LPs are
generally protected from legal actions and any losses
beyond their original investment. The GP receives a
management fee and a percentage of profits (Carried
interest), while the LPs receive income and capital gains.
14. Some PE/VC Terminology
Portfolio company:
A company that has received an investment from a venture
capital or private equity firm.
Lead investor:
The investor that makes the largest investment in a venture
capital round. As the primary financier of the round, the
lead investor determines the valuation of the company.
Investment bank:
A financial institution that serves as an agent or underwriter
for security issuances. Some investment banks also act as
brokers/dealers and provide advisory services for mergers,
acquisitions, restructurings and other transactions.
15. Some PE/VC Terminology
Accelerator:
A program startups can apply to that provides funds and
mentorship to help companies grow, usually in exchange for
equity. Most accelerators focus on helping early-stage
companies.
Incubator:
An organization that gives early-stage companies office space,
resources, advice and networking opportunities (usually in
exchange for equity).
Stage
The period in a VC’s life at which investment is made. Stage is
one of the two main ways of classifying and distinguishing
Venture transactions (the other being by sector) and is divided
into seed, early, mid and late.
16. Some PE/VC Terminology
Venture capital:
A type of private equity investing that focuses on startups and
early-stage companies with long-term, high-growth potential.
Vintage year:
When a fund closes and starts investing.
Angel:
A high-net-worth individual who makes direct investments
into early-stage companies.
Bootstrap
To bootstrap a company means to develop it without the
assistance of professional Venture Capital. Instead, the
founders make do with their own assets, capital from angel
investors and any cash flows which they can generate from the
company’s own business activities or assets.
17. Some PE/VC Terminology
Unicorn
A VC-backed company with a valuation of $1B or more.
A round
Successive rounds of funding for a Venture company are given
successive letters, like A,B etc. New VC investors can be
introduced in each round. An A round is usually defined as the
first round but it may be preceded by one or more angel
rounds or by a seed round.
Anti Dilution
Provisions commonly found in the funding agreements
governing rounds of investment in Venture companies under
which the shareholdings of certain shareholders (typically
early-stage investors and entrepreneurs) cannot fall below a
specified percentage of the whole.
18. Some PE/VC Terminology
Fund
The investment vehicle, often a limited partnership, to
which the limited partners commit capital.
Syndicate
A group of investors that agree to participate in a round of
funding for a company.
Dry Powder
Unused capital which is, as yet, still available for drawdown
and investment.
Go shop
A contractually agreed period during which the owner of a
business can solicit offers for its sale at a price in excess of
that already agreed with a vendor, in default of which the
sale to the vendor will proceed. Should the owner be
successful in soliciting a higher offer, then a walkaway fee
will usually be payable.
19. Fund of Funds
• A private equity fund of funds consolidates investments
from many individual and institutional investors to
make investments in a number of different private
equity funds.
• This enables investors to access certain private equity
fund managers that they otherwise may not be able to
invest with, diversifies their private equity investment
portfolio, and augments their due diligence process in
an effort to invest in high-quality funds that have a high
probability of achieving their investment objectives.
• Private equity funds of funds represent about 15% of
committed capital in the private equity market.
20. Secondary Markets for Private Equity
• A secondary market has developed for private equity
as banks and other financial institutions attempt to
sell their PE investments to reduce the volatility of
earnings and rebalance portfolios.
• In addition, individuals and institutional investors are
also sellers of LP interests in PE funds.
• Secondary market sales fall into one of two
categories: a) the seller transfers a LP interest in an
existing partnership that continues its existence
undisturbed by the transfer, b) the seller transfers a
portfolio of PE investments in operating companies.
21. Secondary Markets for Private Equity
• Sellers of PE investments sell both their investments
in a fund and their remaining unfunded commitments
to the fund.
• Buyers of secondary interests include large pooled
investment funds and institutional investors,
including hedge funds.
• In addition, the private equity fund that originally
invested in a company will sometimes purchase
secondary market offerings.
22. Private Investment in Public Equities (PIPE)
• Many PE firms are making private investments in
public equities (PIPEs). These are minority
investments in 5 to 30% of the stock of a publicly
traded company and the investments are made
without using debt financing.
• The return potential of these investments depends on
the actions of the management of the company, who
are not controlled by the PE fund.
• Ex. - Blackstone’s acquisition of a 4.5% equity stake
in Deutsche Telekom for $3.3 billion, KKR’s
purchase of a $700 million convertible bond from
Sun Microsystems.
23. PE Club Transactions
• When the size of a potential acquisition by a private
equity firm exceeds around 10 to 15% of the capital
in a fund, the possibility of a “club transaction” is
considered.
• In a club deal, two to five different private equity
firms coordinate to co-invest in a target company.
• The benefits include spreading economic risk,
sharing expertise, pooling of relationships with
financing sources, reduction of costs per firm, and
reduction in competition.
• The challenges include increasing exposure to a
single large transaction for limited partners who have
capital invested in more than one of Club
Transactions.
24. Private Equity vs Hedge Funds
• The investment strategies of PE firms differ to those of
hedge funds.
• Typically, PE investment is geared towards long-hold,
multiple-year investment strategies in illiquid assets
(whole companies, large-scale real estate projects, or
other tangibles not easily converted to cash) where they
have more control and influence over operations or
asset management to influence their long-term returns.
• Hedge funds usually focus on short or medium term
liquid securities which are more quickly convertible to
cash, and they do not have direct control over the
business or asset in which they are investing.
25. Private Equity vs Hedge Funds
• Both PE firms and hedge funds often
specialize in specific types of investments and
transactions. PE specialization is usually in
specific industry sector asset management
while hedge fund specialization is in industry
sector risk capital management.
• Finally, PE firms only take long positions, for
short positions is not possible in this asset
class.
26. Portfolio Company Capitalization
• Debt (50–70% of overall cap structure)
- Senior bank debt, two types: Revolving credit
facility, which can be paid down and reborrowed
as needed and Term debt (senior and
subordinated)
- Junior debt, two types: High-yield (typically
public markets) and Mezzanine (subordinated
notes, typically sold to banks, institutions, and
hedge funds)
• Equity (30–50% of overall cap structure)
- Preferred stock
- Common stock
27. Some Large PE Firms
PE Firm Year of Establishment AUM (2017) in $ billion
The Blackstone Group 1985 434
Kohlberg Kravis Roberts 1976 148
The Carlyle Group 1987 201
TPG Capital 1992 75
Warburg Pincus 1966 40
Advent International 1984 31
Apollo Global Management 1990 248
CVC Capital Partners 1981 70
Bain Capital 1984 75
Apax Partners 1969 51
28. History of Venture Capital
• VC in US developed in the late 19th. and early 20th. Century.
• When Alexander Graham Bell needed money in 1874 to
complete his experiments on telephone, Boston Attorney,
Hubbard and Salem leather merchant, Sanders helped out
and later put up the capital to start Bell Telephone Co. in
Boston.
• The first modern VC was formed in 1946 when MIT
President Karl Compton and others set up American
Research and Development (ARD) to finance commercial
applications of technologies. ARD is the “father of venture
capital”.
• With its support developed High Voltage Engineering
Company (X-Ray, 1947), Digital Equipment Company
(computers, now with HP, 1957) and others.
29. History of LBO
• The first LBO transaction was completed in 1955, using a
publicly traded holding company as an investment vehicle
to borrow money and then acquire a portfolio of
investments in corporate assets.
• This activity gained momentum during the 1960s when
Warren Buffet (through Berkshire Hathaway) and Nelson
Peltz (through Triarc) made leveraged investments.
• During the 1970s a group of bankers at Bear Stearns,
including Jerome Kohlberg and Henry Kravis, completed a
number of leveraged investments, but in 1976 these
bankers left Bear Stearns to organize their own firm, which
was called Kohlberg Kravis & Roberts (KKR).
