Private Equity
Private Equity
Private Equity
PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Universit Bocconi and SDA Bocconi
Content
1. What Is Private Equity and Venture Capital?
2.
3.
4.
5.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
Preliminary Definitions
The definition of Private Equity (PE) is based on two aspects, each related to the
two man characteristics of the PE relation:
PE is a source of financing: It is an alternative to other sources of
liquidity, (such as a loan or an initial public offering (IPO)) for the
company receiving the financing.
PE is an investment made by a financial institution: Private Equity
Investor (PEI) in the equity of a non-listed company (i.e. not a public
company).
Throughout the course, the definition of PE will be used in its broad meaning, which
also includes Venture Capital.
Venture Capital is a very specific case of PE. It is the investment in the very early
stages of a companys life.
3
Debt
Assets
es
shar
Equity
Private
Equity
Investor
cash
PRICING
LIQUIDITY
MONITORING
Public
Private
Content
1.
4.
5.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
Private Equity and Venture Capital: Today and Tomorrow Interview with
Fabio Sattin
1. Certification Benefit
2. Network Benefit
3. Knowledge Benefit
4. Financial Benefit
8
10
11
EQUITY
RATING
Other
Partners
Angels
Private
Equity
Banking
System
Trade
Credit
Financial
Markets
Development
Startup
Early Growth
Mature Age
To do
something
complex
Expansion
Crisis or
decline
It goes back
to them
Maybe for an
IPO
They
disappear
13
Content
1.
2.
5.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
Private Equity and Venture Capital: Today and Tomorrow Interview with
Fabio Sattin
15
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
16
18
19
Content
1.
2.
3.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
21
Seed Financing
The Seed Financing is the most complex and riskiest activity among the PE
investment.
It is the investment of an idea or of an research and development (R&D) project, it is
in fact very industry-oriented: it usually deals with the biomedical, IT, and the
pharmaceutical industries / sectors. Under seed financing, the uncertainty of the
project is high because the investor has to trust the idea of the entrepreneur. This is
why the managerial role of the investor is very limited.
There are two levels of risk:
1. The capability for the idea to generate on output
2. If there is an output: does this output have a marketability?
22
Seed Financing
Because this phase is very risky, there are three golden rules an investor needs to
know:
1. 100/10/1 RULE
The investor has to screen one hundred projects, finance ten of them and be lucky (and
able) enough to find the one successful one.
The activity is risky that you must invest on much more that one project. The investor
needs to invest a huge amount of money. The psychological threshold is one billion .
By the time the investors find the winning project they will have lost much of their
beginning investment.
Because this investment occurs before the company is founded, the investors have to
protect themselves in case the person owning the projects idea suddenly can no longer
preform his or her job.
The solution to this risk is in the Incubator Strategy, an ad hoc infrastructure in which
the inventor can work without worrying about his or her ideas being stolen.
23
Seed Financing
3. SIZE OF THE MARKET
The investors usually invest in the markets they know the best.
Despite this, in some cases, the idea may be a good one without a market willing to buy
it.
Such is the case in which the investors look for venture philanthropy, set up by nonprofit institutions with the investors themselves.
24
Startup Financing
The Startup Financing is the financing of a new company starting its own initial
operations.
The entrepreneurs and the founders need of cash derives from the necessity to buy
the necessary equipment to start (e.g. equipment, inventory, building, etc.) the
business. In this kind of financing the risk is still very high, leading to a high level of
protection for the investor.
The level of risk depends on the fact that the PEI is betting on a business plan.
Because the investor is neither a non-profit organization nor a High Net Worth
Individual (HNWI), there are several ways in which this can occur.
1. PUT OPTION
This tool is used to sell back to the entrepreneur the shares the investor bought. This
tool is quite dangerous: it assumes that if the business plan does not work, the founder
will still have money to pay off the PE. For this reason, the put option may be used
together with a second tool
25
Startup Financing
2. COLLATERAL
This is a pledge for the investor over some valuable assets of the newly founded
company and this is usually used together with the put option.
Another way to reduce the risk the business plan is not accurate and reliable is to grant
the inventor some stock options. In this way the entrepreneur will also enjoy the
profitability of the company.
The PEI needs to find the right combination between not losing all its investment (such
is the case when the PE owns 95% of the equity) and not having any say in the
management of the business (such is the case when the PEI owns 2% of the equity)
For instance, for the investor the right balance would be owning 48% of the company.
In such case the PEI would have the right to
lead the company but the founder is the
owner of the company.
26
28
Content
1.
2.
3.
4.
5. Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
8.
The PE Clusters
In clip 4 the venture capital has been presented. In the following Clips (5, 6, and 7), we will see
the other clusters belonging to the PE family which are made for the phases of expansion,
mature age, and crisis.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
30
Expansion Financing
The expansion financing takes place in the fastest phase of growth of a firm to consolidate
its position in the market.
The investment is only used to sustain the (reducing) gap existing between the cash flow
and money needed.
In this phase, the level of risk is moderate (and it mostly depends on the business) because
the trend of development of the business is well known.
In this cluster the stake held by the PE is not usually very high.
The expansion financing deals are about the growth of a company.
Expansion Financing
Internal Growth
We say that a company grows via internal growth when it plans to grow by itself.
This means that investments in fixed assets and in working capital will be made.
The role of the PEI: the investor needs to provide money to the venture backed company in order
to buy and/or sustain the procurement of working capital and to purchase new assets.
Because this kind of deal is not difficult for a PEI, the offer is very wide and there is a very
high number of investors providing this financing.
This kind of financing can be an alternative to a loan.
Why should a company choose PE over a bank?
Because the need for extra money comes with other
needs which can be accomplished with one of the
four benefits seen in Clip 2.
There may be the need for the PE network or the
need to build a good reputation.
32
Expansion Financing
External Growth
We say that a company grows via external growth when it plans to grow by acquiring another
company (i.e. carry on an M&A) in order to enhance the level of sales and exploit the synergies
coming from this operation. This path is much more complicated than the internal growth and it
may be undertaken by an adult company in order to enter a new market.
The role of the PEI: the investor has to sustain the M&A and in this case, they not only have to
provide the venture-backed company with the money necessary, but they also have to:
a.
b.
c.
d.
e.
f.
Hands on approach
33
Expansion Financing
External Growth
The injection of money can be done in two ways:
1. The PEI invests in the venture-backed company, from which it gets shares and the
company has to get enough money to carry on the M&A. If the process is successful
the venture-backed company and the target will merge.
Venture-Backed
Company
Debt
TARGET COMPANY
Assets
Equity
Equity
PEI
34
Expansion Financing
External Growth
The PROs
The venture-backed company will merge with the target and the company will
benefit from the synergies.
The CONs
The venture-backed company is going to give the investor a portion of the synergies
created.
In order to address this drawback, there is another way to do and M&A using PE.
35
Expansion Financing
External Growth
2. The second way in which this M&A can be done is as follows:
The PEI builds a Special Purpose Vehicle (SPV). The SPV is an empty box built
only for the purpose of a specific extraordinary operation. This company does not
have any assets nor liabilities and equity before the operation takes place.
The PEI and the venture-backed company collect money from the banking system
and put the cash collected in the SPV.
In this way, they will have enough capital to buy another company.
This option can be used in two cases:
a. When the venture-backed company has got a huge financial need and it does not want
to further increase the amount of debt.
b. The company wants to keep the SPV as a separate entity, this happens when the
company does not want the PEI to share the gain deriving from the M&A process.
36
Expansion Financing
External Growth
Venture-Backed
Company
SPV
cash
cash
Debt
Equity
Assets
PEI
Equity
cash
cash
BANKING SYSTEM
37
Expansion Financing
External Growth
In this way, the PE will not benefit from the synergies created.
On the other hand:
This second option is more expensive than the first one;
The PEI has a minor incentive in creating synergies (this may entail that lower
synergies will be created)
The company has to obtain financing from banks to invest in the SPV:
38
Content
1.
2.
3.
4.
5.
Expansion Financing
6. Replacement Financing
7.
Vulture Financing
8.
PE Clusters
Replacement Financing occurs when a company is beyond the phase of fast growth
and is in the mature age stage.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
40
Replacement Financing
Replacement financing takes place in the mature age of a company and the
role of the PEI is that of replacing an existing shareholder.
A company needs replacement financing when it wants to face strategic decisions
linked either to governance, status, or corporate finance decisions.
The level of risk is moderate and linked to the quality of the strategic process that
has to be put in place.
There are three kinds of operations belonging to this cluster:
1. Leverage Buyout (LBO)
2. Private Investment in Public Equity (PIPE)
3. Corporate Governance (CG) Deals
These deals do not derive
from the arise of need of
money of a company.
41
Leverage Buyout
LBO is very commonly used, especially in the Anglo-Saxon world, where they
account for 45%.
The role of an investor is not only to finance the company but to identify the target
company that the venture-backed company has to buy at 100%.
This operation takes place in the following steps:
1. When the PEI identifies the potential target, the PEI itself creates an SPV (for the
SPV definition, see clip 5) of which it becomes the full owner (i.e. 100%
shareholder).
2. The PEI collects money up and highly leverages the SPV up to a ratio of 90% debt
and 10% equity.
3. The SPV receives a huge amount of cash through which it is able to purchase the
target company.
42
Leverage Buyout
4. The SPV buys the target company either through a negotiation process or
through a hostile process and trough an IPO on the stock exchange. The
aggressiveness of the operation depends on the level of debt used by the
PE to buy the target company.
5. The PE fully owns the target company.
After the acquisition, the PE will sell the target to anther company.
43
Leverage Buyout
The target company usually has:
Relevant Cash Flow
Low D/E ratio
Assets that can be easily be sold on the market
SPV
BANKS
TARGET COMPANY
Debt
Cash
Debt
Assets
Equity
100%
Equity
PEI
44
45
46
Content
1.
2.
3.
4.
5.
Expansion Financing
6.
Replacement Financing
7. Vulture Financing
8.
PE Clusters
This is the final clip related to PE clusters.
The final stage of the life cycle of the company will be presented: Vulture (or
distressed) financing.
Venture Capital
Mature Age
Expansion
Early Growth
Startup
Development
Startup
Financing
Seed Financing
Time = 0:
Birth of the
company
Replacement
Financing
Expansion
Financing
Early Growth
Financing
Crisis or
decline
Vulture
Financing
Time
48
Vulture Financing
Vulture financing takes place in the final stage of a companys life cycle,
when it enters its decline phase or, worse, a crisis.
Money is used to sustain the financial gap generated from the decline of growth. The
financial aid coming from the PEI is used to launch a survival plan.
Due to the life stage, this activity is very risky, even though the level of risk also
depends on the sector of the venture-backed company. For this reason, the PEI fully
understand the field in which the company operates.
49
Vulture Financing
There are two deals included in this definition:
1. Restructuring financing (or turnaround)
2. Distressed financing
The separation of the vulture financing in two different kinds of deals derive from
two different ways to differently regulate the deals.
50
Restructuring financing
Distressed financing
Restructuring Financing
In restructuring financing, the company is facing a crisis, but is still alive.
The need of financing derives from the settlements of debts with banks and with
suppliers. At the same time, money can be used to re-launch the business, therefore
in some cases money can be used to buy further assets or invested to redesign the
business plan.
The company needs the strategic support from the PEI
These strategic needs make the PEI not only a financer for the troubled company but
also an advisor.
51
Restructuring financing
Distressed financing
Restructuring Financing
Because the risk is very high due to the strategic nature of the role of PE, the
investor is a majority shareholder: there is a very strong hands-on approach and
this needs a majority stake in the equity of the company.
For the high difficulty of the deal and due to the elevated riskiness of these
projects, it is very difficult to find a PEI investing in such deal, it is more of an
investment banking activity.
52
Restructuring financing
Distressed financing
Distressed Financing
Contrarily to replacement financing, distressed financing is a very common deal
for PEI and it occurs when the company is dead.
This may look a bit contradictory to the other clusters of PE in which the main goal
of a PE deal is to finance a company finding itself in the need of money.
The aim of PE is not in fact to merely finance the company, rather to buy the
relevant (and valuable) assets of the company.
In this case, an investor is going to buy:
Patents
Brands
Contracts
Equipment
53
Restructuring financing
Distressed financing
Distressed Financing
Why would a PEI want to buy the assets of a defaulted company?
1. In some cases, the PE may be a trader of assets. This means that the investment is
made only to sell such assets to a third buyer.
2. In other cases, the PEI buys the assets because it inserts them in other venture-backed
companies in its portfolio.
The assets are bought before a court, and the negotiation process can be tough between
the court and the investor. As a matter of fact, it is a desire of the court to maximize the
liquidity of a company when it goes bankrupt, so that it can pay off its debts.
Sometimes the court implements the poison pill. This means that the PEI is going to buy
a valuable asset mandatorily together with another less valuable assets or together with a
debt of the company.
These deals work differently according to the different countries. In the US, these deals
work very well: there is a chapter in the United States Bankruptcy Code dedicated to the
distressed financing (Chapter 11) (find out more about Chapter 11 at this link).
54
Content
1.
2.
3.
4.
5.
Expansion Financing
6.
Replacement Financing
7.
Vulture Financing
Q&A
Today, what is state of the art in private equity and venture capital all around the
world?
Today PE is an engine for the economic growth, especially for Europe and Italy.
As for Europe, one of the main hurdles is made up of the big role the banking system plays
(huge difference with respect to the US).
In Europe, There is the need to create a new financial intermediary, not bankingrelated, which should possess specific knowledge on companies and their development
and this is why PE can be (and is) so important in Europe.
Nowadays we can see an increasing interest in private debt, again standing as a signal that
PE in Europe plays a fundamental role.
Q&A
According to you, are Europe and the US are two different worlds concerning private
equity?
There is a European way to play PE which is very different from the American one.
I recall that years ago the, then Italian Ambassador, a big PE player in the US, once said
that Europe is a completely different market.
Why is that? Europe (excluding the UK) can be taken as one very big country with many
family businesses and PE can help them to develop this changes the approach a PE has
when investing in a family business.
We can say that PE has adapted also to invest in each specific country. Basing on my
experience in the US, I can tell that in continental Europe, PE players support
generational change: again, a different way to do PE.
Q&A
What are the key trends in the market for private equity and venture capital?
After the financial crisis, today PE is definitely changing like many other industries.
In the first place there is a problem at the fundraising level, which has become more
difficult and PE firms had to come up with new strategies to do fundraising, like club
deals, co-investments, SPACs.
The second problem is the fees structure. The fact that the fees are calculated on the
committed capital is under a review process by many funds.
Again, I see many sovereign funds investing in PE.
On the deal-side, in Europe SMEs are the main target for PE investments ( 45 bio
invested each year).
In the future, I think that the investments may have a different structure.
Q&A
The industry is changing: new strategies are coming up, in the US we see majority
investments, whereas we see minority investments in Europe. How do you see the
market in terms of strategic choices of the biggest players in the market, as the
company of yours?
One of the most important aspects is the fact that in Europe most deals are not very
large. In addition, minority investments will still make the majority of the deals.
For these reasons, PE firms are boosting their industrial skills in order to enhance their
industrial know how PE is not a replacement for the managers, they are active owners,
not active managers.
Having said that, it is necessary for the PE investors to have a solid knowledge of the
company and of the sector in order to help companies to develop their strategies.
This must be done without overlapping the role of the management team.
MODULE 2
PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Universit Bocconi and SDA Bocconi
Content
3.
4.
5.
6.
7.
8.
9.
10. New Solutions: SPACs, Private Debt Funds, Venture Philanthropy, and Crowd Funding
Introduction
In the previous module we have seen:
When a company needs the intervention of PE
The deals a PEI can undertake to provide the financial aid a company needs
We need to explore the world of the investors.
In this module we will discover:
Who can be a PEI
How an investor works
How the regulation works for PE
The remuneration of PE
The Formats
Regardless where the deal occurs, there are two formats, each having its regulation
and players:
1.The European Union format: This format is regulated by a Directive of the
European Union.
2.The Anglo-Saxon format: This format is regulated by US and UK laws.
Using one of the two formats does not
necessarily mean that the deal occurs in the
area of the format.
The European format has been adapted and is now used in, Brazil, and Russia, and
others; whereas the Anglo-Saxon format is also used in India and Australia.
2. Closed-End Funds
3. Investment Firms
Regulated by both:
- the financial services directive
- the new AIFM (Alternative Investment
Fund Managers) directive
The Formats
The taxonomy of the formats must be clear and must be applied as follows:
Local players (i.e. the perimeter of the investment is within the country of origin of
the PEI itself: a US PEI investing in the US only is a local player) must apply the legal
framework of the country of origin of the investor.
Global players (i.e. the perimeter of the investment is outside the country of origin of
the PEI itself) can opt for one format or the other one according to the needs of their
portfolio.
Content
1.
4.
5.
6.
7.
8.
9.
10. New Solutions: SPACs, Private Debt Funds, Venture Philanthropy, and Crowd Funding
2. Closed-End Funds
3. Investment Firms
Regulated by both:
- the financial services directive
- the new AIFM (Alternative Investment
Fund Managers) directive
Banks
Closed-End Funds
Investment Firms
Closed-End Funds
An investment made through closed-end funds consider a two-level system involving two
different institutions:
Asset Management Company (AMC)
Closed-End Fund
The AMC is a financial institution.
It can host many funds at the same time (they can be both closed and open-end) and it can
manage financial services as defined by the Financial Services Act (i.e., personal management
of savings, dealing, brokerage, advisory).
The closed-end fund is a separate entity that invests money for a pool of investors.
AMC
When referring to closed-end funds,
there are three players to consider:
Closed-End Fund
Investors
11
Banks
Closed-End Funds
Investment Firms
12
Banks
Closed-End Funds
Investment Firms
Closed-end
Funds
Investors
Banks
Closed-End Funds
Investment Firms
Investors put money in the funds and from the moment when
they do that, they automatically lose any right to have a
tailor-made investment. Their investment will be managed by
the AMC together with the other money belonging to the fund.
When they invest, they receive a certificate with the value
they invested in the fund.
Typically investors are:
- High net worth individuals
- Banks
- Insurance companies
- Pension funds
- Corporations
- Governments
14
Banks
Closed-End Funds
Investment Firms
Management rules
15
Banks
Closed-End funds
Investment Firms
16
Content
1.
2.
5.
6.
7.
8.
9.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
In the previous clip, closed-end funds were presented, together with the relative
regulatory frameworks and the players they interact with over their life (i.e. the investors
and the AMC).
The goal of this clip is to understand how those funds work.
All the rules concerning the functioning of a closed-end fund are stated in the set of rules
called internal code of activity (see module2, clip2), approved by the authority.
18
Banks
Closed-End Funds
Investment Firms
Banks
Closed-End Funds
Investment Firms
Time
Time
Time
Time
-1.5
0
3
N 0.5
N+3
Fundraising
N 0.5
Getting to time N
N+3
Extra time
20
Banks
Closed-End funds
Investment Firms
Closed-End Fund
Fundraising
-1.5
Fundraising
Before launching any activity, the AMC needs the approval by the
authority, where the approval depends on three criteria:
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Draw Down Period
3
22
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Getting to Time N
3
N 0.5
Getting to Time N
At time 3, the investors have to have entirely injected all the money equivalent to
their tickets. So, after the three years, the AMC keeps on investing until the end of
the fund. In fact, some investing activity can have already taken place before Time 3
but, not using the entire amount.
The length of the fund can be defined by the AMC, as long as it is shorter than 30
years. Usually, 90% of the funds have a maturity of 10 years. As a matter of fact, for
an AMC, 10 years is a maturity long enough to make two investments:
1. Year 0 - 3: first investment
2. Year 3 - 5: exit from the first investment
3. Year 5 - 7: second investment
4. Year 7 - 10: exit from the second investment
23
Banks
Closed-End Funds
Investment Firms
Closed-End Fund
Extra Time
N
N+3
Extra Time
After the end of the closed-end fund there is the possibility to use
up to three year of extra time.
As was presented in the first week, PE tends to have low liquidity,
and as such sometimes an AMC does not have the whole liquidity it
would need to pay off the investors right away.
When the fund finally comes to an end, the AMC valuates the fund
and spreads this value among all the investors coherently with the
amount of tickets bought by each investor in the beginning of the
fund.
24
Content
1.
2.
3.
6.
7.
8.
9.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
Banks
Closed-End Funds
Investment Firms
26
Banks
Closed-End Funds
Investment Firms
27
Banks
Closed-End Funds
Investment Firms
1. Management Fees
Management fees correspond to the amount of money an AMC receives every year
from closed-end funds.
Closed-end funds are the vehicles generating:
Revenues, in the form of capital gains
Dividends coming from the companies in which the investment is made
Losses, in case the deal is not successful
The management fees is a fixed percentage of money calculated on the value of the
closed-end fund in the beginning of the fund itself.
For instance, in the case of a closed-end fund being worth 100 million bearing
management fees at 2%, every year the AMC receives 2 million from the fund.
28
Banks
Closed-End Funds
Investment Firms
1. Management Fees
The management fees must be precisely calculated for they have to cover:
Operating costs
Remuneration of the advisor helping the AMC in the consulting activity
Remuneration of the technical committee
The percentage of the management fees is in fact computed with the capital
budgeting approach. That means that it is computed replying to the question: Is the
amount enough to properly cover all expenses?
The reply is in fact not in the percentage per se, rather it stands in the absolute value
of these fees.
29
Banks
Closed-End Funds
Investment Firms
1. Management Fees
In case an AMC belongs to a bank, all the above-listed costs will be easily covered.
On the contrary, if the AMC is an independent entity, covering all the above-listed
expenses can be very tough.
For instance, in venture capital, AMCs are owned by professionals and not by financial
institutions, because they need a workforce who can fully be devoted to the venturebacked company.
30
Banks
Closed-End Funds
Investment Firms
2. Carried Interest
The second source of remuneration for the AMC is made up of the carried interest.
Maximizing the carried interest is the
ultimate goal and desire of an AMC.
31
Banks
Closed-End Funds
Investment Firms
2. Carried Interest
CARRIED INTEREST = % x (Final IRR Hurdle IRR)
The carried interest is the spread between the final IRR and a hurdle (a.k.a. threshold) IRR
multiplied by a fixed percentage.
Usually, the fixed percentage ranges between 25-30%; the hurdle rate ranges between 7-8%.
This means that, at the end of the fund, the AMC will receive a carried interest if and only
if the final IRR is larger than 7-8%..
The carried interest formula is also called the waterfall mechanism.
This mechanism can be used either with or without catch-up, where the choice to calculate
IRR one way or the other is up to the AMC and must be agreed in the Internal Code of
Activity.
Without catch-up: The carried interest is computed on the difference between the final
IRR and the hurdle rate.
With catch-up: The carried interest is directly computed on the final IRR.
32
Content
1.
2.
3.
4.
7.
8.
9.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
PE Players in Europe
As anticipated in clip 1 of this module, PE in Europe is a financial activity regulated
within the financial systems legal framework and there are players players that can
be a PE investor in Europe:
1. Banks
2. Closed-end funds
3. Investment firms
In this clip, the attention is focused on the other two players of the European format.
34
Banks
Closed-End Funds
Investment Firms
However banks can hold equities of AMCs, insurance companies, and non financial
firms.
35
Banks
Closed-End Funds
Investment Firms
36
Banks
Closed-End Funds
Investment Firms
37
Banks
Closed-End Funds
Investment Firms
38
Banks
Closed-End Funds
Investment Firms
39
Banks
Closed-End Funds
Investment Firms
Private
Equity
Investments
Debt
Cash
Equity
A-Shareholders
B-Shareholders
Collected through
Debt and Equity
40
Banks
Closed-End Funds
Investment Firms
41
Banks
Closed-End Funds
Investment Firms
42
Content
1.
2.
3.
4.
5.
8.
9.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
44
PE Players in the US
The US financial market is driven by common law and great importance is covered
both by the local courts work and by the federal courts work.
Some federal acts have created a general framework for the financial system. This
framework is not based on financial institutions but on relevant financial activities.
The pillars are represented by:
Discipline on stock exchange and securities
Corporate governance rules
Discipline for insurance and pension funds
General rules for banks
45
VCF
SBIC
Banks
Corporate Venture
Business Angels
PE Players in the US
In the US system, there is evidence of:
1.
2.
3.
4.
5.
46
VCF
SBIC
Banks
Corporate Venture
Business Angels
47
VCF
SBIC
Banks
Corporate Venture
Business Angels
Debt
Assets
Equity
Limited
Partners
General
Partners
The Limited Partners (LPs) must own 99% of the equity of the LP, whereas the
General Partners (GPs) must own 1% of it. This is set by US law.
48
VCF
SBIC
Banks
Corporate Venture
Business Angels
49
VCF
SBIC
Banks
Corporate Venture
Business Angels
50
VCF
SBIC
Banks
Corporate Venture
Business Angels
51
VCF
SBIC
Banks
Corporate Venture
Business Angels
LLP
Debt
Debt
Cash
Equity
1%
Assets
General
Partners (100%)
Equity
99%
Limited Partners
Investment 1
Investment 2
Investment n
52
VCF
SBIC
Banks
Corporate Venture
Business Angels
53
Content
1.
2.
3.
4.
5.
6.
9.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
VCF
SBIC
Banks
Corporate Venture
Business Angels
55
SBIC
VCF
Banks
Corporate Venture
Business Angels
SBIC
SBICs were created through the Small Business Investment Company Act of 1958.
They are considered the beginning of the PE development in the US because they
were created to stimulate the VC market.
It is a legal entity, in which one of the two shareholders must be a US Public Admin,
while the other shareholder can be any kind of shareholder (it is usually a bank,
corporation, or individual).
Debt
Assets
Shareholder 1
(50%)
Equity
Shareholder 2
(50%)
Sharing stands
for a joint
venture
56
VCF
SBIC
Banks
Corporate Venture
Business Angels
57
VCF
SBIC
Banks
Corporate Venture
Business Angels
58
VCF
SBIC
Banks
Corporate Venture
Business Angels
Other US Players
Banks
Also in the US, banks can invest in PE although like in Europe they have many
constraints, therefore it is very rare that they directly invest in PE. They usually act
as either GPs or LPs in VCFs.
Corporate Ventures
They are not proper legal entities, rather they are a division or a department of a
corporation which wants to invest in venture capital. The only aim of the CV is to run
seed and start-up financing.
The investment is done to promote R&D, outputs, patents and unlike in VCFs, the aim
is not to generate IRR but to enhance the value for the corporation.
59
VCF
SBIC
Banks
Corporate Venture
Business Angels
Other US Players
Business Angels
They are PE investors without any professional skills. Example of such could be
foundations, universities, and individuals.
They can also be high net worth individuals, charities, and foundations, and in this
case can benefit of the QSBS rule (Qualified Small Business Stock). This means that if
they invest in PE and, at the end of the investment, the capital gain is immediately
invested in another private company under the form of PE, taxes are not paid. This
is a huge incentive for PE investments.
They are mostly active in venture capital, mostly with seed and start-up financings.
60
Content
1.
2.
3.
4.
5.
6.
7.
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
62
VCF
VCT
Banks
Business Angeles
Local PPP
PE Players in the UK
In the UK system, there is evidence of:
1.
2.
3.
4.
5.
63
VCF
VCT
Banks
Business Angeles
Local PPP
64
VCF
VCT
Banks
Business Angeles
Local PPP
65
VCF
VCT
Banks
Business Angeles
Local PPP
66
VCF
VCT
Banks
Business Angeles
Local PPP
cash
Cash
Investors (99%)
Equity
Management
Company (1%)
Investment 1
Management Company
(Trustee)
Investment 2
Investment n
67
VCF
VCT
Banks
Business Angeles
Local PPP
A trust can invest in listed securities, but at least 70% of the cash collected among
the retail investors must be used to invest in non-listed companies.
In the end, fiscal incentive are granted to the investors.
68
VCF
VCT
Banks
Business Angeles
Local PPP
69
Content
1.
2.
3.
4.
5.
6.
7.
8.
Taxation within PE
After having seen the key elements of the different vehicles through which an
investor can invest in PE, it is time to understand how the taxation works for these
investments.
To see how taxation works within PE, provided that taxation differs in every country,
two are the perspectives:
Players involved into taxation in PE
Areas of impact on taxation
Not every combination player-area of impact is relevant from the fiscal point of
view. We will focus only on those combinations which are.
71
Taxation within PE
Vehicles
Taxation on capital Relevant to increase
gains NAV and IRR
Taxation on Relevant to increase
dividends NAV and IRR
Investors
Relevant for personal
taxation profile (final net
IRR)
Venture-backed
Company
Not relevant
Not relevant
Not relevant
Not relevant
Incentive to R&D
Not relevant
investment
Not relevant
Comparative
incentive D vs. E
Not relevant
Incentive to startup
Not relevant
72
In this case, the tax burden derives from a mix of the fact that an investor is either a
domestic or a foreign investor (with respect to the vehicle) and if the investor is a
legal entity or a private individual. You will have 4 different combinations as
reported in the matrix below, whose content will differ by country.
Domestic
Foreign
Private
individual
Legal
Entity
74
Taxation on Dividends
For the taxation on capital gains, there are two
relevant players: the vehicles and the investors.
Taxation on Dividends
In this case, the rules that are applied to investors and to vehicles concerning the
taxation on dividends are the same as in the case of capital gains.
Although, one very important difference between this case and the previous one
stands in the fact that dividends are not the primary goal of the PE activity, the
generation of capital gain is.
75
76
77
Content
1.
2.
3.
4.
5.
6.
7.
8.
9.
10
10
New Trends in PE
Innovation in the instruments and mechanisms of financing is very important in PE.
As a matter of fact, the market signals and trends stimulate new solutions in the way
of doing PE.
Nowadays, there is the definition of 4 new solutions:
1) Private Debt funds
2) Crowd Funding
3) Venture Philanthropy
4) Special Purpose Acquisition Companies (SPACs)
79
10
80
10
2. Crowd Funding
Crowd funding has become very important and widespread nowadays. It is a brand
new and digital way of collecting money.
Different players can launch their own financial needs and make a call on the
internet to collect money through their platform.
PE and VC can be done through crowd funding: for companies who are in the very
early stages of their life, they launch a call on the market to raise money.
Because this is a very recent approach, we can not say with certainty whether this
tool works or not for startups.
81
10
3. Venture Philanthropy
When PE vehicles invest only in businesses generating a string social impact, this is
called Venture Philanthropy.
In these cases, the mechanisms are the same as in the other forms of PE except for
the fact that both investors and the management company accept to get a lower
level off profits in terms of capital gains, carried interest, and management fees.
82
10
4. SPACs
SPACs were born around ten years ago in the US and the idea was so successful that
they started to operate in Europe 3-4 years ago.
They basically are an empty shell a form of an SPV.
20% of the SPV vehicle is held by the promoter, the company is listed in the Stock
Exchange so that they can collect the other 80% of the equity.
The SPAC can collect money only to do one investment: to buy another company.
If the SPAC succeeds, it will merge with the target company, otherwise the investors
will get their money back as this is a one-shot vehicle.
83
Content
1.
2.
3.
4.
5.
6.
7.
8.
9.
11
10. New Solutions: SPAC, Private Debt Fund, Venture Philanthropy, and Crowd Funding
11
Introduction
This exercise aims at understanding, in practice, how the calculation of carried
interest and of management fees work for a closed-end fund managed by an AMC.
The exercise will be done following these steps:
1) Presentation of the inputs
2) Investment: presentation on the cash flows deriving from the investment and in
the divestment phases
3) Computation of the IRR
In doing the exercise, we have to remember the formula used in module2 clip4 to
calculate the Carried interest:
85
11
Inputs
INPUT
Management Fee
2%
Hurdle Rate
8%
Carried Interest
30%
400
2%
OUTPUT
Committed Capital
Capital at the End
400
?
86
11
Investment
To apply the carried interest formula and to compute the remuneration of the managers, we need
to calculate the development of the investment of the closed-end fund.
Investment period
Divestment period
extra
Draw-downs
Years
(+)
Draw-downs
100
200
100
400
(-)
Investment
80
190
130
180
310
360
100
200
50
1600
(+)
Divestment
40
200
320
370
100
250
500
600
700
3080
(-)
Management
fee
88
12
14
16
28
30
32
24
66
508
1100
1792
Cash
10
11
Total
2% x 400
Maturity
87
11
STEPS
Fund Global IRR
348%
340%
Carried Interest
102%
408
1384
c) Carried Interest:
Net Global IRR * Carried Interest
88
11
348%
340%
Carried Interest
102%
408
1384
11
16.2%
8.2%
Carried Interest
2.45%
c) Carried Interest:
Net Yearly IRR * Carried Interest
122.2335
1669.766
11
Final Considerations
Note that in both cases we have used the formulas without catch up.
This means that the carried interest is calculated on the difference between the
final IRR and the hurdle rate.
It is possible, on the contrary, to calculate the same results also with catch up and
this means that the carried interest is calculated not on the difference but on the
IRR of the fund.
91
MODULE 3
PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Universit Bocconi and SDA Bocconi
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
6. Managing and Monitoring: Covenants Usage
7. Exiting
8. Private Equity Advice for Entrepreneurs Interview with Fabio Sattin
Introduction
In the previous week we saw:
The different formats in which an investor can invest in PE
The different regulations and fiscal frameworks for the players involved in the
PE activity
This week is concentrated on the management of private equity and venture capital
funds.
After an overview of the managerial process of an investor we will, in detail, see the
four different steps of this process.
For this reason, it is important to understand the different aspects of the Managerial
Process of private equity.
Fundraising
Investment activity
Managing and Monitoring
Exiting
For each phase there is also a different contribution coming from the management
themselves, the advisory and the board of directors.
Fundraising
This first activity of fundraising is included in the managerial process even if this activity
starts before the vehicle is launched.
The fund-raising activity is devoted to promote the business idea of the new vehicle of
equity in order to find money.
It is in fact a very preliminary activity (Note: remember that in Closed-End Funds this
activity occurs before time 0?) occurring before the actual starting of the investment. In
the case of the Closed-End Funds this takes 1.5 years, whereas for VCF this phase takes 1
year.
If managers are able to collect the whole investment and they are able in this way to get
to time 0, the legal entity starts its activities and then the other three activities
(investment, managing and monitoring, and exiting) start.
Investing
Investing is the mission of the equity investment vehicle to create value for the
investor through the scouting, the screening, the choice, the managing and the
exiting of ventures.
From when they decide to invest, managers have two problems: on the one hand,
they have to valuate the company in which they invest; and on the other hand, when
managers and GPs decide to invest they have to negotiate the mechanisms
supporting their management of the company. If the decision of the investment is
made, the managerial process enters another phase: The management and
monitoring phase.
Exiting
Exiting concerns the decision to sell the equity owned in the portfolio in order to
have a gain. This single decision has to be planned with a broad portfolio vision.
For this to happen, the PE has to identify another shareholder to which they sell
their stake of the company. Because the liquidity is very low, finding a counterpart is
not easy.
This is the most important phase, because it is only with the exiting that the PE is
able to exit the investment and generate a capital gain (i.e. an IRR for the PE
investor).
10
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
6. Managing and Monitoring: Covenants Usage
7. Exiting
8. Private Equity Advice for Entrepreneurs Interview with Fabio Sattin
Introduction
This clip focuses on one specific step of the managerial process: The fundraising
phase.
This phase occurs before time 0, since it is the phase in which the PE firm has to
gather the investors that want to invest in the funds.
This is a very hard phase for the PE. The managers have to convince the investors of
their idea: as a matter of fact, the investors will remain in that project for a very
long time (think of a Closed-end fund whose length is ten years).
12
Fundraising Steps
In the fundraising phase the management company has to sell the proposal launched
to the market.
The proposal is basically a business idea that leads to the creation of a vehicle to
invest in private equity to produce value that will be spread among the promotersmanagers and the investors.
Fundraising is a selling game in which reputation, mutual trust, and love for risk are
the pillars.
As a matter of fact, the success of the fundraising phase depends on the reputation
of the management company: The better it is, the easier this phase becomes.
13
Fundraising Steps II
The typical fundraising activity steps are as follows:
1.
2.
3.
4.
Of course, depending on the country and on legal framework, these activities can be
partially or totally driven by law.
14
Job Selling
Raising Debt
Closing
15
Job Selling
Raising Debt
Closing
16
Job Selling
Raising Debt
Closing
17
Job Selling
Raising Debt
Closing
2. Job Selling
Job selling is the phase in which the managers have to convince the investors not
only to give an opinion about the idea, but also to invest in that idea. This is
actualized by the letter of commitment with which the investors declare how they
want to participate in the fund.
This phase often occurs via one-to-one meetings between the promoters and the
potential counterparts (may it be an insurance company, a bank or a high net worth
individual). In some other cases, this phase may be organized in a kind of meeting,
in which more than one investor is involved.
18
Job Selling
Raising Debt
Closing
3. Debt Raising
This phase only occurs if the fund is based either in the UK or in the US.
Debt raising is job selling too, but with a different perspective in which the goal is to
sell a project to a community of financers.
Debt raising is strongly related to the reputation both of the promoter and of the
investors (good signaling effect). In fact this step is difficult for each counterpart
(the investors and the banks) because no one wants to make the first move.
19
Job Selling
Raising Debt
Closing
4. Closing
After all the steps are concluded, whether the fund is located in the Englishspeaking countries or in Europe, the closing phase starts.
The closing phase can be meant in two ways:
A successful closing occurs when the PE firm is able to collect all the money
necessary to begin the PE activity and this was possible thanks both to the
reputation and to the purpose of the initiative
A pure closing occurs when the PE firm is not able to collect the whole money
in the fundraising phase. Such is the case when the managers do not have a very
robust network.
20
Content
1. The Managerial Process for Equity Funds
2. Fundraising
Introduction
This clip and the following focuses on another step of the managerial process: The
investing phase.
After the money has been collected by the PE firm, the phase of investing activity
can start.
The investing activity is the core of private equity business and it is the main way to
develop the business idea for the managers on the investors behalf.
22
Investing
Investing is a very broad definition, in which we can distinguish two different
important moments:
1. Decision-Making: the activity of valuation and selection in which the PE has to
assess whether the investing activity makes sense.
2. Deal-Making: the activity of negotiation of the contracts by which the PE firm
can invest and actively participate in the company. These contracts include, for
instance, the calculation of the shares the investor has to buy, the corporate
governance rules
23
Decision Making
Deal Making
Decision Making
Decision making is the capability to understand the market and to pick up the right
opportunities.
This activity is made up of different steps:
Origination
Screening
Valuation and due diligence
Rating assignment
Negotiation
Decision to invest
The decision making process involves all of the players: the management company,
the technical committee, and an advisory company. This path is sequential and the
PE needs a green light in every step to move on to the next step.
24
Decision Making
Deal Making
Origination
In this phase the PE must decide the destination of the money collected.
It is based on two different drivers: some part of the origination is spontaneous, as
you are a PE investor and the whole system knows that you have collected so much
money and that you are looking for a company in which to invest. This is why, the PE
firm has to screen a considerable amount of incoming proposal.
On the other hand, origination is based on a proactive activity. This means that the
managers have to scout the market and find the most suitable solution. This can be
done through the other players (the technical committee and the advisory board)
who can also help and scout the market.
25
Decision Making
Deal Making
Screening
After the origination step, the screening step starts. In this phase about 90% of the
dossiers collected in the origination step will be eliminated (note: remember the
100/10/1 rule in startups?).
The screening is driven by the managers together with the technical committee. The
output of the screening is a very small number of dossiers which the PE firm can
further investigate and study deeply.
26
Decision Making
Deal Making
27
Decision Making
Deal Making
Rating Assignment
In this phase the PE rates and grades the dossiers of the different companies. This is
fundamental to assess the level of risk and is important to understand if (and how)
the PE firm has to collect funds through debt.
For instance, assessing the level of riskiness and of indebtedness during an LBO in
which an SPV has to be financed using debt is of primary importance. If the level of
risk is too high after the rating assessment the deal can not be taken further.
28
Decision Making
Deal Making
Negotiation
Negotiation is not based on the deal design, but it is the negotiation with the
entrepreneur to calculate the numbers of shares a PE owns and the stake to which
they correspond in terms of equity. In this phase the PE understands if there is room
for an external shareholder.
29
Decision Making
Deal Making
Decision to Invest
The managers (the GPs or the directors in an AMC in Europe) have to convince the
whole Board of the PE firm if it is worth to invest in that specific company.
30
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
Introduction
This clip deals with the second part of the investing phase: Deal making.
In the first part of the investing phase, the managers of the PE firm decided to
invest after the green light of the Board of the AMC or by the GPs.
This second part concerns the deal making activity related to the financial and legal
issues related to the investment in the venture-backed company.
32
Deal Making
Deal making means setting up the contracts between the investors and the company
in which they find the right balance between the need of money of the company and
the expectation of IRR and capital gain for the PE investors.
33
Targeting
Liability Profile
Engagement
Deal Making
Vehicle
Targeting
Amount of Shares
Contract
Designing &
Techniques of
Financing
Liability
Profile
Syndication
Strategy
Debt Issuance
Categories of
Shares
Engagement
Paying Policy
Governance Rules
34
Targeting
Liability Profile
Engagement
Targeting
Targeting is based on two decisions that must be negotiated
with the company.
1. The vehicle in which the PE firm invests
2. The percentage of shares the PE gets
1. The Vehicle
This is the valuation of either a direct investment or in an indirect investment (with
the SPV).
The rationales of a direct investment may be among others: the business is totally
interesting for the investor; the control is complete; the commitment between
investor and company is high and exclusive.
The rationales of a SPV creation may be among others: the investor pays only the
relevant assets; the investment is tailor-made on the business plan. Remember that
this entails the use of leverage, therefore the PE firm has to convince the banking
system too.
35
Targeting
Liability Profile
Engagement
Targeting
2. The Amount of Shares
This negotiation follows the decision taken in the previous
step (i.e. the PE firm decided the vehicle through which it
will make its investment).
This step concerns the decision of the percentage of shares the PE has to buy and
the role it will have within the company equity. There are some key points to be
addressed:
Majority versus minority
Relative and absolute size of investment
Capital requirement impact
Voting rights and effective influence within the board of directors
36
Targeting
Liability Profile
Engagement
Liability Profile
The liability profile, as the name itself suggests, involves
the decision concerning the liability side of the company.
Again, there are two decisions a PE firm needs to make
First choice: The Syndication Strategy
It concerns the decision to find other equity investors with whom build a syndicate
to invest together. At first sight, this decision may sound unfair due to the huge
amount of time the PE firm dedicated to the screening and to get to the final
decision.
Actually, this may be helpful to multiply the investment power and in this way, they
could share the risk borne otherwise only by the PE firm.
37
Targeting
Liability Profile
Engagement
Liability Profile
Second choice: Debt Issuance
It concerns the decision to combine equity investment
(with or without SPV, syndicated or not) with the usage of
leverage, this entails a very hands-on approach towards the
venture-backed company.
This decision is related to the debts of the venture-backed company whether they be
issued with bonds or obtained through loans and mortgages. In the latter case, this
means that the PE firm will have to negotiate with the banking system.
38
Targeting
Liability Profile
Engagement
Engagement
The third pillar of deal making concerns the engagement: in
this moment the PE firm has to set up the rules by which a
PE can govern the venture-backed company. This pillar is
made up of three activities.
Categories of Shares
It concerns the choice of the shares the PE has to buy in order to guarantee the best
way to develop the investment and the following managing phase. Typical choices
concerns:
Common shares
Shares with limited or increased rights
Shares with embedded option: for instance a share with a put option allowing the
PE to sell the shares under some particular circumstances
Tracking stocks
This decision has to be coordinated with the different classes of debt in case of
leverage.
39
Targeting
Liability Profile
Engagement
Engagement
Paying Policy
This concerns the questions a PE firm needs to address
related to the fact that a PEI is buying another companys
shares.
The most important questions that need to be answered in this step are:
Does the PEI need to buy new shares or can it buy also pre-existing shares?
Whats the expectation of the entrepreneur? (to gain money or to have support)
Whats the relationship between the PEI and the existing shareholders?
Targeting
Liability Profile
Engagement
Engagement
Governance Rules
It is the negotiation of the functioning of the board to
ensure the capability of the PE to interact the company in
the best way as possible.
Some among the most discussed issues in this activity are:
Numbers of directors
Can the PEI sitting on the board of directors
The scheduling of the board meetings
41
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
Introduction
This clip deals with the third part of the managerial process: Managing and
monitoring.
The PE company is one of the shareholders and at this moment the investor has a
conjoint aim: they want to enhance the value of the company as much as possible
and at the same time they want to find another buyer in order to exit and get their
capital gain.
43
44
45
46
47
Active participation in the life of the company with the provision of the proper corporate
governance. Creation of value means to support decisions, introduce professional expertise,
and impose a severe discipline. There is only one case in which this action is not necessary:
when the exit occurs through a put option with a bank.
Development of all the required processes to monitor and measure value inside the company
and between the company and the investor (in terms of accountability, auditing, IT
systems).
Recruitment
Management
The management team could be not adequate in terms of skills. The investors support is
crucial to choose, from the marketplace, the right people to hire; this is particularly true
both for start ups and for SMEs.
Relationship
Management
Both current and strategic activities can benefit from the network of the investor
(customers, suppliers, governmental lobbying, ).
Mentoring
The PE has to be completely and fully available for the entrepreneur 24/7. the entrepreneur
expects the PEIs support to make decisions at any moment. This activity concerns soft
assistance in terms both of technical and personal support to the management and to the
entrepreneur (or shareholders).
48
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
Introduction
This clip deals with the other side of managing and monitoring.
Besides the creation of value, the PEI has to deal with the protection of such value:
the second moment of the managing and monitoring activity.
These actions are taken in order to protect the divergence of opinions between the
entrepreneur and the PEI and the risk of struggle that may derive from it.
These are rules for the VCB and the PEI to live together in a temporary (albeit very
important) marriage.
50
51
52
A covenant between the investor and existing shareholders that forbids both existing
shareholders and PEIs from selling for a certain period.
Permitted
Transfer
This is a kind of more sophisticated lock up. It is an agreement between the investor and
existing shareholders that prohibits both existing shareholders and PEIs from selling without the
approval of the other.
Staging
Technique
The injection of capital occurs in installments, with a financial target to be met before the next
installment takes place. This agreement helps ensure that the money is not squandered on
unprofitable prospects.
Stock Option
Plan
An option given to the management of the venture backed company to buy stocks at a favorable
stock price. The provision generates commitment to create value.
Callable and
Puttable
Securities
The issuing of securities in which the PEI has the right to sell the stocks to the existing
shareholders (puttable) and the existing shareholders have the right to buy the stocks from the
PEI (callable). In both cases, the option scheme can be: American or European (i.e., without or
with a specific data to exercise the right) and single or combined (i.e., only callable or puttable,
or callable and puttable together).
53
A contractual obligation used to protect the minority private equity investor. In case the majority
shareholders sells the stake, then the PEI has the right to follow the transaction and sell its
minority stake on the same conditions and to the same buyer that is buying the majority stake.
Drag-Along
Rights
A contractual obligation used to protect a majority PEI. With this agreement, in case the PEI sells
the stake it has the right to ask the shareholders to sell their stake at the same conditions and to
the same buyer. It is a mechanism to maximize the price of the sold shares: the PEI has the
possibility to sell 100% of the company without owning it and when you can sell the whole
company, you have a higher contractual power.
Right of
First Refusal
A provision by which the PEI can avoid the shareholders selling their stake to undesired
shareholders. In this case, the PEI has to buy the stake of the selling shareholders at the same
conditions offered by the potential buyer.
Exit Ratchet
A provision by which the remaining shareholder has the right to obtain a percentage of the
capital gain deriving from the sale of the shares. This applies both to the PEI and to the
entrepreneur.
54
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
6. Managing and Monitoring: Covenants Usage
7. Exiting
8. Private Equity Advice for Entrepreneurs Interview with Fabio Sattin
Introduction
In this clip we will deal with the last step of the managerial process of PE: Exiting.
This is the moment in which the PEI understands if (and how much) value has been
created by the VBC.
Exiting is the most difficult step for a PEI, because there exists both a pricing and a
liquidity issue.
56
Exiting
The exiting activity concerns the decision to sell the stake in order to gain the value
created through the investment and the managing & monitoring of the venture.
Exiting strategies have to be contextualized according to the portfolio strategy of
the PEI. There is in fact a double perspective where the IRR of the investment has to
be coordinated with goals and constraints coming from the whole portfolio.
57
Exiting II
Exiting has to be coordinated with:
The specific rules and covenants of the investment
The timing opportunity driven by the companys business
The timing opportunity driven by the financial market
The capital requirement and pricing constraints
The track record of exiting in the portfolio of the PE firm
Equity investments are made up of different clusters (i.e., seed, start up, expansion,
replacement, vulture) but theory and market trends show there is no correlation
between: the stage of investment, the holding period and the exit way strategy.
This suggests that each case has to be analyzed per se
58
Exiting III
The typical exiting strategies are the following:
1. Trade sale
2. Buy back
3. IPO or sale post IPO
4. Sale to other private equity investors
5. Write off
Even if in many investments the agreement for the exiting is clearly defined ex ante,
only the development of the investment itself can tell the right choice of an exiting
strategy.
59
1. Trade Sale
Trade sale is the exiting in which the private equity investor sells its stake to another
corporation or to another entrepreneur.
This exiting strategy is based on the industrial relation between the private equity
investor, the buyer, and the venture backed company.
The purpose of a trade sale is generally an acquisition to develop a strategic business
plan from the buyer and for that reason trade sale can be developed through
different solutions.
Anyway, this option is not very widespread because usually entrepreneurs do not
want to share their company or their ideas with another company or worse, with
another entrepreneur.
They are common in two cases: in LBO and when the PE_ holds the drag along right
and they sometimes can occur in PIPEs.
60
2. Buy Back
Buy back is the exiting in which the private equity investor sells its stake to an
existing shareholder or to a buyer chosen by the existing shareholders themselves.
Buy back is a trade sale in which the buyer is not a new corporation coming from the
market. It occurs when the shareholders who dont want to leave the company call
for the equity investor to sustain the business.
One of the most used covenants in these cases is the puttable shares (the PE has the
possibility to sell the shares back to the entrepreneur).
This option to exit gives for granted the fact that the entrepreneur has got
liquidity enough to buy the shares, otherwise a negotiation starts between the
entrepreneur and the PE.
61
3. IPO
This way out is the best option a PEI could ever dream of. In this way a PEI can
maximize the capital gain; and this occurs only in 1% of the cases. Through an IPO,
the private equity investor sales its stake in the stock exchange.
That means that an IPO is the condition by which a PEI launches the sale but the
mere sale can either occur during or after the IPO itself. In both cases, the private
equity investor is strongly involved in the IPO process, acting either as a global
advisor or as a manager. The different role depends on the nature of the private
equity investor.
An IPO is very difficult, though, because the company must be ready for it, the
business of the company has to be attractive to be accepted and the entrepreneur
has to be prepared to work and deal with retail investors. IPO launches follow the
so-called bubbles. For instance, going back to early 2000s many IPOs took place.
62
The sale to another private equity investor is the exiting in which the private equity
investor sells its stake to another private equity investor.
This exiting strategy is common in the American market and is based on strong
relationship between the private equity investor and the community of private
equity investors.
Although this kind of exit is not that easy due to the fact that different PE investors
have different goals: the first one wants to maximize the capital gain, whereas the
second one wants to buy the participation at the lowest possible price (in order to
maximize in the future the capital gain).
The purpose of this sale is to sell the stake to an investor which operates in the
following stage of investment (i.e., from seed to start up, from start up to
expansion, etc) so that the VBC is walked through its life cycle.
63
5. Write O
Write off is the exiting in which the private equity investor cancels the value of the
stake in its portfolio; it is the worst nightmare of a PEI.
This happens when the company defaults and this may occur in start up and seed
financing because the business plan may be too aggressive.
A write off does not necessarily mean an IRR -100% because the PEI may try to sell
some valuable assets in order to recover from the loss.
Write off process can be driven by a private agreement or by law (i.e. failure
process).
64
Content
1. The Managerial Process for Equity Funds
2. Fundraising
3. Investing: The Decision Making Phase
4. Investing: The Deal Making Phase
5. Managing and Monitoring: Supporting the Company
6. Managing and Monitoring: Covenants Usage
7. Exiting
Q&A
Lets focus on PE in continental Europe where the minority investments are very
popular and are a means to make the company grow. This means that the
entrepreneur and the investor have to work together.
What are the suggestions for an entrepreneur who has to work with a PE investor?
The chemistry and the personal relation between the PE and the entrepreneur is
fundamental to make the partnership successful.
Suggestions? In the first place, the basic decision: the entrepreneur has to understand
that he/she needs a partner, not just a cash injection. The entrepreneur has to be open to
share his/her decisions and to be transparent about the problems. In addition, an
entrepreneur has to select the right PE firm for the specific needs. Besides the PE firm,
the entrepreneur has to pick the right person for this person will be actively involved in
the ordinary life of the company.
In the end, the entrepreneur has to understand the decision-making process of the
partner (either local or international). Depending on the needs, a local partner may be
more suitable than an international one, or the other way around. Also, the business
model is an aspect the entrepreneur needs to understand (some PE may be more keen on
IPO, rather than trade sale).
Throughout the deal, the entrepreneur has to remember that the PE is an investor that
does not just provide money.
Q&A
Sometimes there may be an overlap between management and when a PE invests in
a company.
How do you think it is possible to work together and successfully within this
interaction?
This is a very crucial aspect, especially for Europe. When an entrepreneur opens the equity
to a PE investor, the entrepreneur needs to remember that the company will still be
managed by the management team. If an entrepreneur is not ready to distinguish her role
and the managers role, this means this in not the right time to open to PE.
The entrepreneur has to bear in mind that if he/she decides to open to PE, she will have to
accept the decisions taken by the PE.
Again, the entrepreneur has to be able to delegate the decisions to the management,
keeping under control the overall process.
It is very important from both sides to be very clear and maybe to write down what the
managers can or can not do, what the entrepreneur can or can not do.
Q&A
You said before that PE is like a marriage and we know that the IPO may be among
the most wanted desires at the end of the marriage. How is it possible to regulate
the marriage and the shared desire of an IPO?
Normally there is a pre-IPO deal. The picture of a PE investor investing as a minority
shareholder for 3-4 years leading a company to be listed is the ideal picture.
If this is the case, the parties need to regulate it from the beginning of the deal, including
it in the terms and conditions.
Also, it should be stated that all shareholders and the management team must take every
decision with that final purpose borne in mind. Also, in the contract it should be defined
when the IPO is supposed to take place and who is selling and who is not and whether there
will be a capital increase.
For instance, in my personal experience, we have rules since our first IPO with Natuzzi in
1993. When there is an IPO, we sell 2/3 of the stake on the day of the IPO and the
remaining third of the stake after one year and this is made clear since day one.
According to me, having rules is the best way to avoid misunderstandings.
MODULE 4
PRIVATE EQUITY
AND VENTURE
CAPITAL
By Professor Stefano Caselli
Universit Bocconi and SDA Bocconi
Content
1. Company Valuation Fundamentals
2.
3.
4.
5.
6.
7.
8.
9.
Introduction
This week deals with the issue and concrete application of company valuation.
This clip provides you with an overview of the fundamentals of company valuation,
while in subsequent clips some specific valuation models will be focused on and their
application to PE.
Company Valuation
Company valuation is the assessment of companys value.
Concerning PE, company valuation is a fundamental step since the PEI needs to know
the value of the company in which it is investing to decide to buy either newly
issued shares or already existing.
Company Valuation
The process of company valuation is the core of the investing phase.
We will use corporate finance theory to do that.
However, what is peculiar about PE is that equity has to be calculated in two
different moments:
Time 0: The moment in which the PEI decides to invest and in which the PEI
buys the shares of the private company
Current
Liabilities
Fixed Assets
NFP
Financial
Investments
Other
Liabilities
Intangible
Assets
Equity
6
Equity Value
The general equation to calculate the equity value for an n-maturity perspective of
investment is:
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
Enterprise Value
Where:
TV is the terminal value at time n
SA are surplus (non-operating) assets
M represents the equity held by minority shareholders
NFP is the net financial position
SA, M and NFP refer (if they exist) to the time in which the valuation is made
8
Multiples
At the same time, the multiples method is also very widespread. This takes into
consideration the company together with its peers.
For this reason, this method is used together with the DCF to develop a fine tuned
valuation.
The most used multiples are:
EV/EBITDA
EV/EBIT
EV/S
Multiples
EV/EBITDA
Enterprise value/EBITDA gives a strong advice about How many times do you have to
multiply the EBITDA to buy the company? It is based on the capability of the firm to
produce gross margin.
EV/EBIT
Enterprise value/EBIT gives a strong advice about How many times do I have to multiply
the EBIT to buy the company? It is based on the capability of the firm to produce
operating profit.
EV/S
Enterprise value/sales gives a strong advice about How many times do I have to multiply
the sales to buy the company? It is based on the capability of the firm to produce sales.
10
Content
1.
4.
5.
6.
7.
8.
9.
Introduction
After an overview of the DCF, in this clip we will individually analyze all the parts of
the formula used to calculate the equity value, bearing in mind that the DCF is based
on the generation of cash flow.
Equity =
t=1
CFt
+ TVn + (SA M NFP)
(1 + WACC)t
Enterprise Value
12
Cash Flow
WACC
TV
NFP, M, SA
DCF
The items composing DCF are the following:
Cash Flow
WACC
kd
ke
TV
NFP
Minorities (M)
13
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
PROFIT AND LOSS (OR INCOME) STATEMENT
+ Sales and other operating revenues
- Operating costs (including R&D)
= EBITDA
Gross margin
-Depreciation
= EBIT
+ Other income
Operating profit
Typically financial and not operating income
- Interest expenses
= EBT
- Income taxes
= NET INCOME OR LOSS
14
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
CASH FLOW
EBIT
- Income taxes
+ Depreciation
- Increase in net working capital
- capital expenditure
CAPEX
= CASH FLOW
This is the most widespread way to calculate the Free CF for the firm (i.e. the cash flow
available for financers and shareholders without considering a new debt issuance and the old
debt repayment).
Some authors call it also unlevered cash flow or cash flow for the firm to highlight the fact
that it does not provide any information about the capital structure.
15
Cash Flow
WACC
TV
NFP, M, SA
WACC
The concept of cost of capital refers to:
That together are necessary to calculate the weighted average cost of capital (WACC).
16
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Debt
The cost of debt:
id* = id (1 t)
Where:
id stands for the average weighted cost of capital calculated either by dividing the
interest expenses by the financial liabilities or by taking into consideration every single
rate referring to different financings.
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The cost of equity capital is calculated through the Capital Asset Pricing Model (CAPM)
formula:
ie = rf + (rm rf)
Where:
rf stands for the risk free rate (the rate of return yielded by a risk-free investment
coherent in terms of maturity with the investment itself)
rm = rf + risk premium (i.e. the exceeding return investors expect from the market,
measured with historical series, with respect to a risk-free investment)
stands for the degree of correlation between the investment and the market
18
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The coefficient of a stock is a regression of returns of the stock against the returns on a
market index.
When a company is not listed, it is necessary to compute the beta using the data of the
comparable companies. Here follows the steps:
1) Identification of the beta of a comparable (one or more)
2) Deleveraging of the beta with comparable companies data
3) Re-leveraging of the beta using the target company data
Unlever means to exclude the effect of capital structure while relever means to recalculate the beta coefficient using the capital structure of the firm
19
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
The procedure to unlever is:
u = / [1+(1 t)(D/E)]
Where D and E are the market value of debt and equity of the chosen comparable
companies.
And the procedure to relever is:
* = u x [1+(1 t)(D/E)*]
* = target company data
20
Cash Flow
WACC
TV
NFP, M, SA
WACC:
The Cost of Equity
Once equity and debt cost of capital have been computed, the WACC is:
21
Cash Flow
WACC
TV
NFP, M, SA
Terminal Value
The terminal value (TV) is a crucial item necessary to calculate the equity value. The
formula is as follows:
TVn=
CFn x (1 + g)
(WACC g)
(1 + WACC)n
Where g represents the perpetual growth rate by which the company is supposed to grow
every year.
22
Cash Flow
WACC
TV
NFP, M, SA
Surplus Assets,
Minorities, and NFP
In the end, as seen in the previous clip, we need to deduct (if they exist):
Surplus Assets
Minorities equity
23
Content
1.
2.
5.
6.
7.
8.
9.
Introduction
Through this exercise we will see the application of the equity value through the DCF.
This set of slide presents the solution for the Old Winery case.
Through this case a company valuation within PE is treated through a time horizon of
four years.
This means that the stream of CF has to be calculated over the whole investment
period.
25
Sales
Operating Costs
EBITDA
Depreciation
EBIT
Other Income
Interest Expenses
EBT
Taxes
NET INCOME
2015
2016
2017
2018
49,860
39,379
52,756
40,910
56,698
43,782
61,721
45,714
10,481
11,846
12,916
16,007
1,768
2,305
2,305
2,388
8,713
9,541
10,611
13,619
300
36
36
36
8,413
9,505
10,575
13,583
1,648
4,074
4,378
5,710
6,765
5,431
6,197
7,873
26
Inputs
Inputs to compute the Cash Flow Statement (/000): Data presented in the Business plan
2015
2016
2017
2018
1,768
2,305
2,305
2,388
(+)
Depreciation
(-)
(-)
9,788
4,500
500
500
(-)
Capex
(-)
3,000
3,975
1,322
500
Mondavi (US)
Beringer (US)
Southcorp(AUS)
Bodegas (SP)
Campari (ITA)
Antinori (ITA)
Beta
EV/Sales
EV/EBITDA
D/E
0.73
0.94
1.02
0.89
1.23
Not listed
6.2
5.5
8.5
8.5
6.7
4.9
26
22.9
24.9
26.7
24
26.9
9.45
5.25
8.25
8.35
7.35
7.85
27
Inputs
0.25%
g rate /g)
Surplus Assets (SA)
12,000
-
Minorities (M)
Net Financial Position (NFP)
10,000
The aim of the PE in this case is to compute the equity value through the formula:
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
28
Cash Flow
WACC
TV
NFP, M, SA
Cash Flow
Starting with the EBIT, we compute the CF for the
period taken into consideration:
2015
2016
2017
2018
8,713
9,541
10,611
13,619
1,648
4,074
4,378
5,710
1,768
2,305
2,305
2,388
(+)
EBIT
(-)
Income Taxes
(+)
Depreciation
(-)
9,788
4,500
500
500
(-)
Capex
3,000
3,975
1,322
500
3,955
703
6,716
9,297
CASH FLOW
29
Cash Flow
WACC
TV
NFP, M, SA
WACC
Following the steps in the WACC calculation, we need to compute:
a. Cost of debt net of tax
id* = id (1 t)
b. unlevered
u = / [1+(1 t)(D/E)]
c. relevered
* = u [1+(1 t)(D/E)*]
d. Cost of equity
ie = rf + (rm rf)
e. WACC
30
Cash Flow
WACC
TV
NFP, M, SA
WACC
a.
id* = id (1 t)
b.
2.4%
Corporate tax
35%
1.56%
beta unlevered
0.159337
beta relevered
0.32116
unlevered
u = / [1+(1 t)(D/E)]
c.
cost of debt
relevered
* = u [1+(1 t)(D/E)*]
31
Cash Flow
WACC
TV
NFP, M, SA
WACC
d.
Cost of Equity
ie = rf + (rm rf)
e.
1.25%
7.75%
beta
0.962
final beta
0.32116
3.34%
WACC
2.25%
WACC
32
Cash Flow
WACC
TV
NFP, M, SA
Terminal Value
Computation of the terminal value (TV), using the following formula:
TVn=
CFn x (1 + g)
(WACC g)
(1 +
WACC)n
9,297 x (1 + 0.25%)
(2.25% 0.25%)
(1 +
2.25%)4
= 425,482.50
33
Cash Flow
WACC
TV
NFP, M, SA
Surplus Assets,
Minorities, and NFP
Expected Holding Period (n)
g rate (g)
Surplus Assets (SA)
Minorities (M)
Net Financial Position (NFP)
4
0.25%
12,000
10,000
34
Equity Value
n
Equity =
t=1
CFt
+ TVn + (SA M NFP)
t
(1 + WACC)
35
Content
1.
2.
3.
6.
7.
8.
9.
Introduction
In PE deals as said in the previous clips, there is a double valuation issue regarding
equity.
As a matter of fact the PEI wants the equity value to be as low as possible in the
beginning of the investment while the value has to be as large as possible by the end
of the investment.
37
Inputs
The exercise that follows is based on the assumption that the liquidity is not an issue
for the exit from this investment.
In this company, the business plan is solid and the assumptions are very reliable.
Such is the case for investments made in expansion financing.
38
Inputs
The issue can be addressed by following these steps:
1. Calculating equity at time 0
2. Calculating equity at time n
In this case another business plan would be needed, which a PEI does not have in
this case. So the next step is to calculate the IRR with the numbers available at
the moment of valuation.
39
?
3
?
4
4,500
30%
40
Holding Period
2015
2016
2017
2018
2019
2020
Sales
Operating costs
EBITDA
Depreciation
EBIT
Other income
Interest expenses
EBT
35,000
31,000
4,000
1,500
2,500
120
2,380
39,000
33,000
6,000
1,500
4,500
100
4,400
43,000
37,000
6,000
1,500
4,500
100
4,400
45,000
39,000
6,000
2,000
4,000
75
3,925
50,000
43,000
7,000
2,000
5,000
75
4,925
54,000
46,500
7,500
2,000
5,500
-
75
5,425
816
1,483
1,483
1,308
1,641
1,808
1,564
2,917
2,917
2,617
3,284
Taxes
NET INCOME
3,617
4,500
1,000
5,000
4,000
1,000
1,000
4,000
1,200
1,000
3,500
1,200
5,000
3,500
1,200
1,000
3,000
1,200
1,000
CASH FLOW
(EBITDA Taxes NFP)
-6,316
-483
-483
-3,808
859
1,692
41
HOLDING PERIOD
EBITDA MULTIPLES
1
2
3
4
5
6
-6.67%
-3.39%
-2.27%
-1.71%
-1.37%
-1.14%
33.33%
15.47%
10.06%
7.46%
5.92%
4.91%
73.33%
31.66%
20.12%
14.74%
11.63%
9.60%
113.33%
46.06%
28.73%
20.86%
16.36%
13.46%
153.33%
59.16%
36.32%
26.16%
20.43%
16.76%
193.33%
71.27%
43.15%
30.87%
24.01%
19.64%
43
Content
1.
2.
3.
4.
7.
8.
9.
Introduction
The venture capital method (VCM) focuses on the relation among the expected IRR,
the growth of the firm and the percentage of shares the PEI has to buy in order to
become an active owner of the venture-backed company.
This approach can be used (and it is typically used):
For deals where the phase of price setting is fundamental
For seed and startup deals in where it is difficult to determine the percentage of
investment for the equity investor.
45
Step 1
Step 2
Step 3
Step 4
Step 5
The
The
The
The
The
46
Step 1
Step 2
Step 3
Step 4
Step 5
Inputs
Data Inputs
4,500,000
45%
5
3,500,000
12
100,000,000
47
Step 1
Step 2
Step 3
Step 4
Step 5
48
Step 1
Step 2
Step 3
Step 4
Step 5
Step 2: TV Calculation
This activity concerns the setting of the expected holding period and the calculation
of the terminal value.
The P/E ratio can also be a starting point to calculate the TV, in addition to the DCF
method seen in the previous clips.
49
Step 1
Step 2
Step 3
Step 4
Step 5
% PE shares =
28,843,803.28
Future Value of the Investment
=
= 68.68%
42,000,000
TV
50
Step 1
Step 2
Step 3
Step 4
Step 5
Number of shares =
Number of shares =
100,000,000 x 68.68%
(1 68.68%)
= 219,214.20
51
Step 1
Step 2
Step 3
Step 4
Step 5
4,500,000
219,214.20
= 20.53
52
Content
1.
2.
3.
4.
5.
8.
9.
Introduction
In this clip some hints and tips will be presented that startuppers should keep in mind
before launching their own business.
As a matter of fact, nowadays this is a very good moment to launch (well-built) start
up in Europe too.
54
Favorable Conditions
1) The first condition that may allow you to launch your own startup is the huge
amount of liquidity available in Europe together with the fact that interest rates
are lower these conditions make an investor keen on investing in new
projects.
2) Nowadays there is a widespread interest in alternative investments which PE and
VC belong to.
3) On top of that, especially in Europe, there is a need for growth to enhance the
GDP
55
56
57
Final Recommendations
If you want to launch your own start up, remember that investors could be very
different being:
Business angels
High Net Worth Individuals
Incubators
Etc. ...
In any case, you have to remember that you have to select the most suitable one
for your project and needs.
58
Content
1.
2.
3.
4.
5.
6.
9.
Q&A
What are the key trends in the M&A market today?
In 2014 we observed a positive trend of the M&A market, which continues through 2015, it
is driven by acquisition financing and the liquidity availability of PE funds and corporations.
Generally speaking, we can say we are very optimistic for the M&A market and we will for
the next 6-7 months.
As for the Italian market, it is dominated by foreign investors, both strategic investors and
PE investors Quality assets seem to be what the investors are more interested in.
In addition, multiples speak for themselves, the EBITDA margin multiple was 9: a record
over the last 15-20 years. I do not think that this is an Italian market bubble, again
acquisition financing is very good and there is still room for mid-size acquisition financing
projects, but this will depend on debt capital market, stock market and on the Grexit,
which may affect these markets in the next 3-4 months (note: the interview was taken in
early July 2015).
As for the Italian domestic market, we still see a lack of strategic domestic investments,
Italian investors are very cautious within Italian boundaries. This is a reason why PE is very
important in Italy.
Q&A
PE is one of the main drivers of the M&A market. How do you see the relationship
between PE and M&A today?
PE has a very important share in the worldwide M&A market, in Europe as well
as in the US and this share is going to increase especially in those industries
where corporate strategic barriers are low.
I think that worldwide PE plays a very important role. As for Italy, this is even
bigger for two reasons: in the first place the IPO market is very weak and PE
could replace this IPO market, in addition to that PE can be extremely
important to support domestic groups in consolidation processes.
Q&A
M&A is relevant and complex at the same time. In your opinion, what are the key
issues for a company to manage M&A?
Looking at the buy-side, the due diligence has to be extremely accurate,
especially when it comes to the value of the potential synergies and to what
happens in the post-acquisition process.
Looking at the sell-side, there are some opportunities in the IPO and M&A
market and sometimes sellers concentrate on fundamentals and forget to take
into consideration that the market can be very volatile.
There is an M&A cycle, largely depending on the stock market and the liquidity
availability. Therefore, sometimes the right window opens and closes very
quickly. You should catch the right window!
Content
1.
2.
3.
4.
5.
6.
7.
Q&A
An IPO is one of the exit mechanisms for private equity and venture capital. How do
you see the relationship between PE and stock exchange and what are the key issues
for an SME that jumps into the stock exchange?
PE is crucial to capital markets, also they are important to spread an equity
culture. PE stands right before the IPO.
There is now an always strong relationship between us and the PE community,
not only on a local level.
In the past, up to 40% of IPOs derived from PE. In these years, half of the
capital raised from the London Stock Exchange comes from VBCs.
Q&A
What is Borsa Italiana (the Italian Stock Exchange) doing for SMEs and why SMEs are
usually so reluctant to go public?
In Southern Europe there is a huge number of SMEs, not very close to the
capital markets. It is mainly for them that PE plays a bigger role.
The SMEs usually have a bigger perception of the distance between them and
the stock exchange. This is more of a psychological problem rather than a
technical one. Hence, we are creating markets that can be tailor-made for
smaller companies, and we are trying to engage with companies at an earlystage of life.
This is why three years ago we launched ELITE, which has proved to be very
successful. It is not a market but a business support program for SMEs in which
we train and coach companies and their managers.
Q&A
Can you say something more about ELITE that is becoming an exceptional format to
sustain SMEs towards the capital market? What is the challenge for Borsa Italiana
(Italian Stock Exchange)?
ELITE turned out to be a magical solution, not only for Italian SMEs. It is a
quite recent understanding that let us know why companies would not go public.
It is all about creating the right environment. We provide an early-stage
training, together with top business schools, such as Bocconi University; then we
move to a phase in which companies are pushed towards change. We ask them to
explore new areas, such as business areas or their governance mode.
Eventually we present them to our investors. This program does not necessarily
lead to the stock exchange rather to consider all possible options that can
accelerate growth.
Content
1.
2.
3.
4.
5.
6.
7.
8.
Q&A
Restructuring and "special situations" are part of the relevant business for private
equity. How do you see today the relationship between PE and these areas?
PE can help companies throughout their life cycle. PE can turn ideas into
businesses and can support expansion as well. PE funds can also help in their
restructuring and turnaround phases.
In todays world, even if a company has a very sound business plan, it can be
strongly hit by sudden events which change the value of the company.
This is why PE funds that invest in change are more than welcome!
Without such players in the markets these companies overwhelmed by change
would go bankrupt and we would lose their so-called going concern value.
Q&A
What are the key issues for a PE investor that has to manage restructuring and
special situations?
The most important thing is to have the right mindset. The PE has to look at
all those unsuccessful cases and point out those few companies which have a
chance.
This is an important skill for a PE investing in turnaround and restructuring.
Q&A
In your experience and in your opinion, what are the key trends in the market for
restructuring and special situations within the PE world?
In the last few years there is an increasing attention of banks towards
distressed debt. For this, they created dedicated teams and they totally
changed their attitude.
Beforehand, they had a very passive attitude: they were more focused on
legal technicalities. Now, they really want to understand the business and
how they can create value in a company. This is a totally brand new mindset.
On the other hand, banks are quite new to this approach and to this way of
doing business. Therefore, I see a clear trend towards a partnership between
banks and PE funds to work together and help distressed companies.
PE can put in money and help banks in spotting the right companies in which
to invest. This could help not only distressed companies but all of the
economy after a domino effect.