2. Outline
1. What is Private Equity (PE) and what distinguishes it from other asset classes?
i. Definition
ii. Key Features
2. Private Equity Strategies
i. Strategy Classification
1. Early Stage: Venture Capital
2. Expansion Stage: Growth Capital
3. Maturity Stage: Buyout (LBO, MBO)
4. Decline Stage: Distressed Debt/Turnaround
3. Exit Events
4. Concluding Remarks
3. 1. WHAT IS PRIVATE EQUITY (PE) AND WHAT DISTINGUISHES IT
FROM OTHER ASSET CLASSES?
4. i. Definition
Private Equity (PE) is an asset class falling under the alternative investments spectrum commonly involving…
1. Investments in equity securities and debt of companies NOT quoted on a public exchange (Baker, Filibeck,
Kymaz 2015)
2. Takes the form of a PE fund: a collection of investors – retail and institutional – that pool funds to invest in
ownership of a company with the aim of improving its financial performance in view of capital gains upon an
exit event (sale transaction)
3. PE funds tend to specialize in strategies that differ primarily on the basis of the stage of development (life-
cycle) of the company they invest in (i.e. Venture Capital ‘Funds’, LBO (Buyout) Funds, Growth Capital,
Mezzanine…)
4. A transformational, active investment strategy calling for highly specialized skills by the investment
manager whose only aim is to create VALUE, without hesitating to align the management of the targeted
company with that objective
5. iii. Key Features
High Risk – Potentially
High Return
Performance Driven
Incentive System
Active Value Creation
Confined Investment
Power
Flexibility as a Strategic
Value
Investments promise above-average real adjusted returns to compensate for the
many risks committed capital is subject to
Performance is the consequence of a strong alignment of interests between i)
fund managers (GPs), ii) management teams of the portfolio companies, iii) the
investors in the fund (LPs)
PE must create value by providing resources to firms, being responsible owners
and actively supporting management to improve company outlook
Investment power is confined to the fund manager (GP), once the capital is
committed investors have no say in the investment process
Extreme flexibility and creativity allows funds to harness emerging opportunities
and capitalize on new markets and varied strategies
6. iii. Key Features (cont’d)
General Partner GP
Limited Partner LP
A
Limited Partner LP
B
Limited Partner LP
C…
Private Equity Fund
Fund Ownership
GP Ownership
Fund Management
Portfolio Company 1 Portfolio Company 2 Portfolio Company 3…
Co-investment
Typical Fund Structure of a PE partnership (i.e. USA) and why it matters
i.e. Pension funds, Insurance Companies, HNWi, Sovereign Wealth funds, Family Offices, endowments, FoF.
7. iii. Key Features (cont’d)
Fee Structure and why it matters
Management Fee Performance Fee Other Fees
• Fixed fee that fund
managers receive from
LPs
• 1.5% - 3%, usually 2%
of total capital
commitment
• Payed regardless of
whether the manager
achieves nothing or
loses a bundle
• Variable Fee,
distributed according
to ‘Distribution
Waterfall’
• GPs set carried
interest based on
specific Hurdle Rates
(IRRs) divided in
‘Buckets’
• Example:
Hr=8%, CI= 10% / 90%
Hr=11%, CI=20% / 80%
Hr=15%, CI=25% / 75%
• Other Variable Fees
that may include,
• Monitoring fees
• Agreed IRR objectives
• Typically low,
0.5% -1.5%
9. i. Strategy Classification
PE has developed an incredibly wide array of specialized funds with investment strategies characterized according to:
• Stages of Investment (Company Life-Cycle)
• Geographic focus
• Sector and Size of Investments
• Strategic approach
We analyze and compare investment strategies on the basis of the Stages of Investments, with reference to the stage
in the development life-cycle of a company.
12. i. Strategy Classification (cont’d)
Early Stage
Venture Capital
Expansion
Growth Capital
Maturity
Buyouts
Decline
Turnarounds
• Investments in early
stage activities
targeting young
companies often with
a tech component and
high potential for
growth
• VC invests in target
startups before their
true revenue potential
has been validated
• Investments in fast
growing companies
with realized profits
that need money to
grow
• Capital usually goes to
increasing PC, internal
restructuring
(market/product
development) or goes
to financing an
acquisition
Venture Capital
• Seed Capital
• Start-up Capital
• Venture Growth Capital
• Angel Investors
Growth Capital
• Replacement Capital
• Bridge financing
• PIPE
• RD
• Natural slowdown in
growth, peak in terms
of financial stability,
good cash flows and
little investment req
• Investment at this stage
look for ‘management
buy-outs’, where new
owners can create
opportunities for
growth or even turn
around companies
Buyouts
• MBO
• LBO
• Mezzanine
• Firm experiences
difficulties and
declining revenues.
• Investments are made
with a view to re-
establishing prosperity
Distressed Debt/Turnarounds
• ‘Distressed-to-Control’
• ‘Loan-to-Own’
• Rescue Financing
13. 1. Early Stage
Strategy What is it? Pros Cons
Venture Capital
Seed Capital funds
Start-up funds
VG Capital funds
Pre-IPO
• Specialized minority
equity investments in
young, small
companies
• High-risk/high-return
due to potential that
has not yet been
validated
• Generally involves a
new technology,
concept, business
model
• Large say in
management and
business operations
• Highest potential for
above-average returns
• Usually initial capital
commitment is small
(i.e. seed and startup)
although some tech
developments may
require large amounts
• High in growth
promoting economic
development and job
creation
• Commercial
uncertainty, betting on
potential
• Cash flow unreliability,
sometime may not
even be profitable
businesses
• Tend to be small size
investments accounting
for a relatively small
portion of the equity
(10-20-30%)
14. 2. Expansion
Strategy What is it? Pros Cons
Growth Capital or
Growth Financing
Growth Capital Funds
• Minority equity
investments in quickly
growing, relatively
established companies
to help support further
growth
• Companies that
generate revenues and
operating profits but
without sufficient
capital to pursue
transformational
changes
• Capital goes to expand,
restructure operations,
enter new markets or
finance a major
acquisition W/O a
change of control of
the company
• Relatively ‘safer’ w.t.p
VC since companies
have already
demonstrated their
‘pull’ and are mature
enough
• These deals tend to
require less money
than buyout deals
• Popular in emerging
markets where
businesses don’t
always have access to
capital from banks or
from capital markets
• Requires extensive
work in system’s
development, heavy
recruitment of
management team,
investment in
production, build up of
advertising etc
15. Strategy What is it? Pros Cons
Buyout;
Leveraged Buyout LBOs
Management Buyout MBOs
Management Buy-in MBIs
• Provide capital to mature
companies with stable
revenues and some
further growth or
efficiency potential
• Buyout funds hold the
majority of the company’s
AUMs
• LBO: Most of them
acquire large stakes via
borrowed funds!
Leveraging the investment
with up to 60-90% debt
financing
• LBOs involves debt
which is often non-
recourse to financial
sponsor and has no
claim on other
investments managed
by the fund
• The investor itself only
needs to provide a
fraction of the capital
for the acquisition
• The returns to the
investor will be
enhanced as long as
the ROA exceeds the
cost of debt
• Lenders can insure
themselves against
default by syndicating
the loan by buying CDS
of CDOs
• Leverage is beneficial
since it limits
committed capital, but
if buy-out and exit
goes wrong the loss is
amplified by the
leverage
• Large operations
involving very large
firms that can take on
big debts, preferably at
cheap interest
3. Maturity
16. 4. Decline
Strategy What is it? Pros Cons
Distressed Debt and
Turnaround
Control-oriented Approach
Turnaround Approach
• A type of financing to
companies that are
experiencing financial stress
that may range from
declining revenues to an
unsound capital structure or
an industry threat
• Control-oriented approach:
PE firm acquires debt
securities of the company to
have control over
restructuring or bankruptcy
procedures
• Turnaround approach: the
PE fund will attempt
restructuring by investing
new equity and take control
of the company
• Distressed financial
situation may favor the
PE fund, in that it can
acquire it with very
low multiples cheap
equity creating a good
investment
opportunity (assuming
that it can then exit)
• Risk of not being able
to reverse the
financial distress
18. Wide held perception is that successful PE investments are normally exited through flotation on the stock
markets, IPOs but in reality these only account for 16% of European buyout exits (EVCA: 2012)
The most common exit route for buyout and capital financing are TRADE SALES:
In a trade sale, private equity investors sell off all of their shares held in a company to a trade buyer.
i.e. a third party often operating in the same industry as a company itself. This method is preferred by
the investor because it provides a complete and immediate exit from the investment
Other exit events include:
• Secondary Buyout
• Sale to Management
• Leverage recapitalization
