Private Equity Strategies by Ascanio Rossini Outline
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Private Equity Strategies By Ascanio Rossini Outline 1. What is Private Equity (PE) and what distinguishes it from other asset classes? i. Definition ii. Key Features iii. Fund Structure 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 1. WHAT IS PRIVATE EQUITY (PE) AND WHAT DISTINGUISHES IT FROM OTHER ASSET CLASSES? 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, LBO, 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. iii. Key Features High Risk – Potentially Investments promise above-average real adjusted returns to compensate for the High Return many risks committed capital is subject to. Performance Driven Performance is the consequence of a strong alignment of interests between i) Incentive System 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 Active Value Creation and actively supporting management to improve company outlook. Confined Investment Investment power is confined to the fund manager (GP), once the capital is Power committed investors have no say in the investment process. Flexibility as a Strategic Extreme flexibility and creativity allows funds to harness emerging opportunities Value and capitalize on new markets and varied strategies. iv. Fund Structure Typical Structure of a PE partnership i.e. Pension funds, Insurance Companies, HNWi, Sovereign Wealth funds, Family Offices, endowments, FoF. Limited Partner LP Limited Partner LP Limited Partner LP General Partner GP A B … C GP Ownership Fund Ownership Fund Management Co-investment Private Equity Fund Portfolio Company 1 Portfolio Company 2 … Portfolio Company 3 2. PRIVATE EQUITY STRATEGIES 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 will 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. Source: Cumming, Johan 2009 Revenues 1. Early Stage 2. Expansion Stage 3. Maturity Stage 4. Decline Stage Time Strategy Classification cont’d Early Stage Expansion Maturity Decline Venture Capital Growth Capital Buyouts Turnarounds • Investments in early • Investments in fast • Natural slowdown in • Firm experiences stage activities growing companies growth, peak in terms difficulties and targeting young with realized profits of financial stability, declining revenues. companies often with that need money to good cash flows and • Investments are made a tech component and grow. little investment req. with a view to re- high potential for • Capital usually goes to • Investment at this stage establishing prosperity. growth. increasing PC, internal look for ‘management • VC invests in target restructuring buy-outs’, where new startups before their (market/product owners can create true revenue potential development) or goes opportunities for has been validated. to financing an growth or even turn acquisition. around companies Venture Capital Growth Capital Buyouts Distressed Debt/Turnarounds • Seed Capital • Replacement Capital • MBO • ‘Distressed-to-Control’ • Start-up Capital • Bridge financing • LBO • ‘Loan-to-Own’ • Venture Growth Capital • PIPE • Mezzanine • Rescue Financing • Angel Investors • RD 1. Early Stage Strategy What is it? Pros Cons • Specialized minority • Highest potential for • Commercial equity investments in above-average returns. uncertainty, betting on young, small • Usually initial capital potential. companies. commitment is small • Cash flow unreliability, Venture Capital • High-risk/high-return (i.e. seed and startup) sometime may not due to potential that although some tech even be profitable has not yet been developments may businesses. validated. require large amounts. • Tend to be small size Seed Capital funds Start-up funds • Generally involves a • High in growth investments accounting VG Capital funds new technology, promoting economic for a relatively small Pre-IPO concept, business development and job portion of the equity model. creation. (10-20-30%). • Large say in management and business operations. 2. Expansion Strategy What is it? Pros Cons • Minority equity • Relatively ‘safer’ w.t.p • Requires extensive investments in quickly VC since companies work in system’s growing, relatively have already development, heavy established companies demonstrated their recruitment of to help support further ‘pull’ and are mature management team, growth. enough. investment in • • Growth Capital or Companies that These deals tend to production, build up of generate revenues and require less money advertising etc. Growth Financing operating profits but than buyout deals. without sufficient • Popular in emerging capital to pursue markets where Growth Capital Funds transformational businesses don’t changes. always have access to • Capital goes to expand, capital from banks or restructure operations, from capital markets. enter new markets or finance a major acquisition W/O a change of control of the company 3. Maturity Strategy What is it? Pros Cons • Provide capital to mature • LBOs involves debt • Leverage is beneficial companies with stable which is often non- since it limits revenues and some recourse to financial committed capital, but further growth or sponsor and has no if buy-out and exit efficiency potential. claim on other goes wrong the loss is • Buyout funds hold the investments managed amplified by the Buyout; majority of the company’s by the fund. leverage. AUMs. • The investor itself only • Large operations • LBO: Most of them needs to provide a involving very large Leveraged Buyout LBOs acquire large stakes via fraction of the capital firms that can take on Management Buyout MBOs Management Buy-in MBIs borrowed funds! for the acquisition. big debts, preferably at Leveraging the investment • The returns to the cheap interest. with up to 60-90% debt investor will be financing. 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. 4. Decline Strategy What is it? Pros Cons • A type of financing to • Distressed financial • Risk of not being able companies that are situation may favor the to reverse the experiencing financial stress PE fund, in that it can financial distress. that may range from acquire it with very Distressed Debt and declining revenues to an low multiples cheap Turnaround unsound capital structure or equity creating a good an industry threat. investment • Control-oriented approach: opportunity (assuming PE firm acquires debt that it can then exit). Control-oriented Approach securities of the company to Turnaround Approach 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. 3. EXIT EVENTS 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 3. CONCLUDING REMARKS.