Exploring Private Equity
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Justin Shuman's document provides an overview of private equity markets and transactions. It includes an introduction to Shuman's background and contact information. The document then covers private equity definitions and the value chain between investors, funds, and portfolio companies. It also outlines typical private equity deal processes, including sourcing deals, valuation, due diligence, and financing. Recommended reading materials on private equity, valuation, and mergers and acquisitions are listed at the end.
Exploring Private Equity
- 1. Exploring Private Equity October 29, 2013 1
- 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