By: Ana Cosniceru and Salma Abdellaoui IPO is a term embedded in the finance lexicon that frequently appears when deliberating the business world in general. Conversations about private equity are no exception; the acronym will surely be alluded to as well. But what is it exactly? This term refers to the "Initial Public Offering" or … Continue reading IPO process for Private Equity
Category: Fundamentals of Private Equity
By Gianluca Sonda Introduction Angel investing is a micro-finance practice which involves affluent individuals providing capital for business start-ups typically in exchange for convertible debt or ownership equity. The term “angel” was actually coined during the 70s describing the investors who financed the Broadway shows and other theatre productions back in the day. Angel investors … Continue reading Windfalls, Pitfalls and Angels
The Buy-and-Build (B&B) method has experienced burgeoning popularity over the last decade which continues into the present. From 20% in 2000, the share of PE deals with add-on acquisitions trended toward 53% in 2012.
Before the 70s, common stock was the only instrument available to GPs in PE and VC when investing in portfolio companies. This rigid capital structure limited minority investors by subordinating them and offering intermediate returns only in the form of dividends or share repurchases. Subsequently, the industry transformed...
Back in the '80s, some ambitious entrepreneurs designed a miniature model of the typical private equity fund. Forget about pools of cream-of-the-crop professionals: search funds are a businessperson’s stepping stones to achieving their pipe dream position as a CEO. Although it sounds like a solo trip to success, these operating managers are backed by capital from a group of advising investors.
“Everyone has access to information. We just know how to analyze it better.” This is the mantra of Billions protagonist Bobby Axelrod, a fictional hedge fund manager who’s ethically compromised fund breeds alpha like a wolf pack. Putting aside any insider trading and market manipulation though, is this also the mentality of the PE funds that acquire current portfolio companies from other PE funds?
With reputations and capital at stake, Private Equity and Venture Capital firms endeavor to make the best possible investment decisions. However, complete information is often impossible to obtain or takes too long to acquire resulting in opportunity costs from deferring investment. Given these structural challenges, how can decision making processes be structured to optimize outcomes?
Investors allocate capital with Private Equity Firms in order generate a high rate of return on their invested capital. However, when there are several investors and a separate manager, how much of the profits from investments are investors entitled to? PE firms address this issue by constructing unique and specific payout schemes, called distribution waterfalls, to attract and signal to various types of investors and to accumulate committed capital to enter investments. This article outlines the fee structuring of PE firms and explores the types of distribution waterfalls.
In the early 1980s there was a dramatic increase in private equity activity in the US when pension funds began to invest heavily in them following the clarification of the “prudent man” rule, declaring private equity a sufficiently safe investment. When the 90s tech frenzy came along, pension funds needed the extraordinary returns offered by VC firms to keep pension plans solvent as baby-boomers aged. However, due to structural problems, pension funds were fundamentally unattractive to VC firms as LPs, so they were going to need help to break in.
Financial sponsors tend to create value in LBO transactions in three different ways: operational improvements, debt expansion and multiple expansion.
No period in history better demonstrates the need for portfolio diversification than the late 90s Tech Bubble and the March 2000 crash. In the public markets and at the height of the bubble, speculators were in such a frenzy to get a hold of technology stocks that any newly listed stock with the word “tech” or “.com” in their name could shoot up over 100% in one day. Many of these companies had yet to properly develop their products and their financial health was often very uncertain, yet they commanded prices at very high price to earnings multiples. In private markets there was also a strong appetite among VC firms to invest in the technology sector and bring the burgeoning amount of tech startups to public markets in IPO exits.
The grim reality of venture capitalism is that most startups fail. Even with an innovative idea, a motivated team can easily fail to make a product or service that customers can find value in. Yet the romanticised stories of young and creative entrepreneurs building radically successful businesses from scratch persists.
he aim of this article is to briefly describe a principal transaction document for a Private Equity deal: the Sale and Purchase Contract. This is an extremely complex topic to which many articles would be needed to give a full understanding to the reader so rather the intention is to provide a brief introduction to an aspect which is irregularly discussed.
The complexity of LBO transactions determines the necessity of multiple players, each one of which carries out a specific role. The main players of an LBO transaction are financial sponsors, investment banks, banks, institutional lenders and target management.
Financial sponsors tend to create value in LBO transactions in three different ways: Operational improvements, Debt and Multiple Expansion. The first two forms assume improvements of the target financial and operational performance. The last value creation option refers to the sponsor features instead of the target. Indeed, it does not modify the financial and operational performance of the target and comes from sponsors’ broader knowledge and expertise. The literature tends to focus on the first to ways since future valuations are too uncertain. Indeed, even sponsors' financial models tend to concentrate on value enhancement coming from developments in the target operations and a better capital structure.
The conventional LBO transaction includes several steps, starting with "The Sourcing" and continuing with "The Screening". During the Screening, financial sponsors make research on potential targets trying to understand the one that deserves the investment. The goal is to find the ideal candidate.
Starting from last year, capital allocation schemes that are hybrids of direct investment and limited partnership, namely “Shadow Capital”, have become increasingly appealing among participants of the Private Equity industry. This way of investing allows the Limited Partners to employ their resources benefiting from the expertise and experience of PE funds and to gain a direct foothold in the private firms’ capital. Most notably, Shadow Capital accounted for 25.6% of total capital committed in PE investments in 2015, surging from the 17.5% average it accounted for in the period 2009-2014 (see table below).
