Introduction to Private Equity: Venture, Growth, LBO & Turn-Around Capital, Second Edition

393 Pages·2013·9.85 MB·English

by  Cyril Demaria(auth.)

Introduction to Private Equity
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Introduction to Private Equity
Venture, Growth, LBO & Turn-Around Capital
SECONDEDITION
Cyril Demaria
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Demaria,Cyril.
Introductiontoprivateequity:venture,growth,LBO&turn-aroundcapital/CyrilDemaria.–Secondedition.
1onlineresource.
Includesbibliographicalreferencesandindex.
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ISBN978-1-118-57189-7(ebk)–ISBN978-1-118-57190-3(ebk)–ISBN978-1-118-57191-0(ebk)–
ISBN978-1-118-57192-7(hbk) 1.Privateequity. I.Title.
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ISBN978-1-118-57192-7(hbk)ISBN978-1-118-57189-7(ebk)ISBN978-1-118-70052-5(ebk)
ISBN978-1-118-57190-3(ebk)ISBN978-1-118-57191-0(ebk)
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Contents
ForewordtotheSecondEdition xi
Acknowledgements xiii
AbouttheAuthor xv
Introduction 1
0.1 AMovingTarget 1
0.2 AConsubstantialLackofInformation 2
0.3 BenignNeglect,MalignConsequences 5
0.4 KnowingtheDeviltoCircumventit 6
PARTI WHATISPRIVATEEQUITY? 9
1 PrivateEquityasanEconomicDriver:AnHistoricalPerspective 11
1.1 PoolingIntereststoIdentifyandExploitSourcesofWealth 12
1.1.1 Identify,ControlandExploitResources 13
1.1.2 LeveragePublicPoliciesandaFavourableBusinessEnvironment 15
1.2 ChampioningEntrepreneurship 17
1.2.1 NoPrivateEquitywithoutEntrepreneurs 17
1.2.2 ConvertVenturesintoBusinessSuccesses 20
1.2.3 EntrepreneurshipandPrivateEquityFormaSpecificEcosystem 22
1.3 Conclusion:AnAttemptatDefinition 24
1.3.1 ANegotiatedInvestmentinEquityorQuasi-Equity 24
1.3.2 AFixedMaximumTerm 25
1.3.3 ImplyingSpecificRisks 25
1.3.4 WithHighExpectedReturns 25
1.3.5 UndertakenonBehalfofQualifiedInvestors 25
1.3.6 ToSupportEntrepreneurs 25
2 ModernPrivateEquity–AFrenchInvention? 33
2.1 USA:TheFoundryofModernPrivateEquity 34
2.1.1 TheStrictSeparationofPublicPoliciesandPublicFinancing 34
viii Contents
2.1.2 TheSeparationofPublicEndeavoursandPrivateEfforts;the
SubsequentSupportoftheFormerfortheLatter 35
2.1.3 GovernmentalInput:SBA,DARPAandERISA 35
2.1.4 Universities,DefenceandDisruptiveInnovation 36
2.1.5 Challenges 37
2.2 Europe:AdaptingaSuccessfulModelorCreatingitsOwn? 39
2.2.1 GovernmentalInput:LegalChanges,TaxRebates,Infrastructures
andPan-EUMarket 40
2.2.2 NationalChampions,InformationTechnologiesandIncremental
Innovation 43
2.2.3 Challenges 47
2.3 Conclusion:EmergingMarkets,BuildingCastlesonSand? 57
PARTII THEPRIVATEEQUITYECOSYSTEM 71
3 PrivateEquity:ABusinessSystemPerspective 73
3.1 WeAreAllInvestorsinPrivateEquity 73
3.1.1 SourcesofCapital 73
3.1.2 PrivateEquityInvestmentRationale 79
3.2 OrganisationandGovernanceofPrivateEquityFunds 91
3.2.1 PrivateEquityFundManagersareFinancialIntermediaries 91
3.2.2 IncentivesandFees 93
3.2.3 ConflictsofInterest 95
3.2.4 Power,ChecksandBalances 98
3.3 MeasuringPerformance,ManagingRisksandOptimisingReturns 99
3.3.1 MeasuringPerformanceinanUncertainContext 99
3.3.2 ManagingRisksandOptimisingReturns 103
3.4 PitfallsandChallenges 110
3.5 Conclusion 113
4 TheUniverseofInvestment 117
4.1 VentureCapital:FinancingCompanyCreation 122
4.1.1 VentureCapitalInvestmentTargets 122
4.1.2 ActorsandStructures 130
4.1.3 OperationalActivities 142
4.1.4 Challenges 144
4.1.5 Limits 152
4.2 GrowthCapital:FinancingCompanies’Expansion 152
4.2.1 GrowthCapitalInvestmentTargets 152
4.2.2 ActorsandStructures 152
4.2.3 OperationalActivities 154
4.2.4 Challenges 154
4.2.5 Limits 155
4.3 LeveragedBuy-Out:FinancingCompanies’Transmissions 155
4.3.1 LBOInvestmentTargets 156
Contents ix
4.3.2 Actors 158
4.3.3 OperationalActivities 160
4.3.4 ChallengesandLimits 165
4.4 OtherInterventionsinPrivateEquity 177
4.4.1 FundsofFunds 178
4.4.2 TargetingtheStockExchange 183
4.4.3 SpecialSituations:Turn-AroundCapitalandDistressedDebt 186
4.4.4 Quasi-EquityInstruments(Mezzanine)andSecondLienDebt 198
4.4.5 MerchantBanking,InvestmentBankingandPrivateEquityHouse
Intervention 212
4.4.6 SecondaryMarket 214
4.4.7 RealEstate,InfrastructureandExoticAssets 218
4.5 Conclusion 221
4.5.1 PrivateEquityisaFinancingSolutionDesignedforaSpecificNeed 221
4.5.2 VentureandGrowthCapital 221
4.5.3 LeveragedBuy-Out 221
5 TheProcessofInvestment:AMatterofTrustandMutualInterest 225
5.1 Step1:PreliminaryAnalysis 225
5.2 Step2:Valuation 226
5.3 Step3:Negotiating 227
5.4 Step4:Structuring 228
5.5 Step5:ComplementaryDueDiligence 229
5.6 Step6:Transaction 229
5.7 Step7:MonitoringandExit 230
5.8 Conclusion 230
PARTIII PRIVATEEQUITYINTEENAGETIME:TRENDSETTING,FADS
ANDRESPONSIBILITIES 233
6 PrivateEquityEvolution:TrendsorBuzzes? 235
6.1 IsPrivateEquityGoingMainstream? 235
6.2 IsPrivateEquity(Still)CreatingValue? 239
6.3 PrivateEquity:BetweenBubblesandCrashes 242
6.4 Conclusion 247
6.4.1 ThereisNoSuchThingas‘CapitalOverhang’ 247
6.4.2 ElementsofAnalysis 248
6.4.3 From‘CapitalOverhang’to‘DryPowder’ 250
7 PrivateEquityandEthics:ACultureClash 255
7.1 Greed 255
7.2 Destruction 261
7.3 Philanthropy 266
7.4 Transparency 268
7.5 Self-RegulationorImposedRegulation? 269
7.6 Conclusion 271
x Contents
8 GeneralConclusion–PrivateEquityTodayandTomorrow 275
8.1 FewerGeneralPartners,butnotNecessarilyBetterOnes 275
8.2 CoreTarget:ManagetheVolatilityofPerformance 276
8.3 TheOnlyValidLeitmotiv:Long-TermThinking 278
8.4 TheImpactofFairMarketValue 280
8.5 ALong-TermTrend:TheAttractivenessofPrivateEquity 281
8.6 PrivateEquity:FutureVictimofitsOwnSuccess? 290
8.7 TheImpactofaBetterKnowledgeofPrivateEquity 294
8.7.1 UnderstandingtheRiskandManagingtheJ-Curve 294
8.7.2 InnovatingthroughStructuring 296
8.7.3 TheTemptationofCo-Investments 297
8.7.4 ChangeorDie:ThePressureonGeneralPartners 298
8.7.5 Regulation:Damocles’SwordLoomingoverPrivateEquity 299
Template1(Fund) 303
ArchitectureofthePrivatePlacementMemorandumofaPrivateEquityFund 303
Template2(Fund) 305
StructureofaLimitedPartnershipAgreement 305
Template3(Fund) 309
DueDiligenceChecklist 309
Template4(Fund) 313
QuarterlyReportTemplate 313
Template5(Company) 317
Non-DisclosureAgreement 317
Template6(Company) 321
BusinessPlan 321
Template7(Company) 327
Term-Sheet 327
BusinessCase:KrotonEducacionalSA–APrivateEquityOperationCanHide
AnotherOne 333
Exhibits 349
Glossary 361
Bibliography 375
Index 383
Foreword to the Second Edition
Private equity can be described as ‘investments in private companies in privately negotiated
transactions’.Thismeansthatprivateequityisanassetclassthatisnormallyopaque,illiquid
andveryoftendifficulttoanalyse.
However,privateequityinvestingoffersmanyadvantagescomparedtoinvestinginpublic
and liquid asset classes. The underlying companies can be acquired in a transaction that
does not have to be publicly announced or explained, many times also using an inefficient
process leading to an attractive investment. Privately owned companies can be developed
without public scrutiny for long-term success. Public companies normally have quarterly
reportingrequirementsandarethereforeonlytargetingshort-termbenefits.Thefundmanagers
who are active in private equity normally have much more information at hand when they
make investment decisions compared to investing in public companies. The incentives to
managementcanbefullyalignedwiththeinvestors,andthefundmanagerscanhavetighter
control of the companies and can develop them aggressively without having to worry about
howeverydecisionisunderstoodbythepublicmarkets.Throughprivateequityinvestments,
investorscanalsopossiblyinvestinindustriesornicheswheretherearenopubliccompanies.
Privateequityisaverycomplexassetclass.Privateequityinvestingismoreofanartthan
otherinvestmentsthatcanbeanalysedandcomparedquantitatively.Privateequityisanasset
classwheremanagerselectionplaysthehighestroleofallassetclasses.Normally,thereare
not several private equity managers who are in the same state of development of their own
activities. Some have decades of experience and some have worked as part of a team for a
longtime.Somehavemadeseveralinvestmentsinthesameindustryandsomehaverealized
abigportionoftheirinvestments.Thismeansthatanalysingprivateequityinvestmentsand
fundmanagersrequiresbroadskillsandalongexperience.
Privateequityisnotasprivateasitusedtobe.Becauseofallthelargeleveragedbuy-outs
thatoccurredattheendof1980’sandthemega-leveragedbuy-outsduring2006–08,private
equitytransactionshavebeenwidelyreportedandfollowed.Privateequityisalong-termasset
classandinvestorswillrealizethefinalreturnlongaftertheyhavemadethedecisiontoinvest.
Despite all of the mentioned difficulties and hurdles, Cyril Demaria has been able to
writeaninterestingandextremelywell-formulatedbookaboutprivateequity.Cyrilhasseen
and experienced private equity from many angles and in different roles. Cyril has been an
investordirectlyinvolvedinstart-upcompanies andalsoinmoredeveloped andestablished
businesses.Cyrilhasalsobeenadvisorandinvestortoprivateequityfunds.Mostimportantly,
Cyril has been writing about the private equity industry in many papers and magazines for