What s Special About Private Equity? October 11, 2016

Transcription

1 What s Special About Private Equity? October 11, 2016

2 What is Private Equity? Private equity is the common term for equity investments into non-listed companies, made in order to help such companies develop and grow under stable conditions.

3 Types of Private Equity Firms Dedicated Funds: Private equity firms with a dedicated fund, with the majority of the fund s capital coming from institutional investors and individuals who are accredited investors. Fundless Sponsors: Private equity firms that raise capital from investors on a per-deal basis. Family Offices: Private equity firm with an extremely limited number of investors.

4 Trends in Private Equity

5 Investment Duration

6 Current Inventory

7 PE Fundraising Note however, that early reports suggest a mild decline in fundraising in the third quarter.

8 Targets

9 Trends in PE Exits

10 Multiple of EBITDA

11 Use of Equity Increasing

12 Time to close Transactions

13 Private Equity Deal Considerations Working Capital and Indemnification Certainty of Funding Management Buy In Monitoring and Transaction Fees

14 Working Capital Working capital adjustments serve as a way of to account for inventory and other assets that are difficult to pin down pre-closing. There are often three key issues that arise working capital provisions: Discretion of sellers to provide an estimate at Closing; Relationship of working capital adjustment provisions to indemnification provisions; and Accounting standards under which true up is calculated.

15 I conclude based on the plain terms of the Agreement that the present dispute over the calculation of net working capital fairly may be raised under the purchase price adjustment procedure even though that dispute implicates issues of accounting methodology that also could form the basis of an indemnification claim for breach of a representation and warranty. I further conclude that where a dispute could be brought either as part of the purchase price adjustment procedure or as an indemnification claim, the Agreement specifically provides that the exclusive remedy provision in the purchase price adjustment procedure trumps the exclusive remedy provision for indemnification claims. Alliant Techsystems, Inc. v. MidOcean Bushnell Holdings, L.P., C.A. No CB (Del. Ch. Apr. 24, 2015) (Bouchard, C.)

16 Indemnification Because private equity targets are not often public companies, limited information concerning targets is available to the market. Increases the need for more fulsome representations and warranties from sellers and target companies. Further, indemnification can be pursued against a discrete group of sellers rather than a broad group of public stockholders. Increasingly, representation and warranty insurance is being used to satisfy these claims. Such insurance is also particularly attractive to private equity sellers, as it allows immediate distribution of proceeds and reduces or eliminates the amount of funds subject to escrow.

17 Certainty of Funding Because a private equity buyer is often a newly formed shell company, sellers often ask the sponsor for a direct commitment to fund the buyer with the equity capital required for the transaction. Commitment is typically provided through an equity commitment letter, allowing the sellers to force the sponsor to fund under certain conditions. Sellers right either comes directly from the commitment letter or as part of the specific performance provisions of the purchase agreement. Sellers will typically also request a reverse break fee, with a limited guaranty by the sponsor to fund the buyer s obligations under such break fee.

18 Remedies for Failure to Fund The size of the reverse break up fees in private equity deals tends to be around 5-6% of the deal s equity value

19 Management Buy In Private equity buyers will often rely on pre-acquisition management to run and operate a target after closing. Three ways to align management and buyer expectations: Equity rollover Be aware that recent final and temporary regulations from the IRS, Treasury Regulation T, have clarified that when a partnership is the sole member of a pass through entity, the partners in the partnership will be treated as the owners of such entity. As a practical matter, this can complicate attempts by private equity buyers using LLC structures to provide equity to management, as such equity could render the management ineligible to participate in tax favored benefit plans of the operating company. Earnouts Historically used in 30% to 50% of private equity deals Employment agreements

20 Monitoring and Transaction Fees Monitoring and transaction fees are fees charged by private equity firms for their costs and time spent in connection with an investment. Recent trends have put significant pressure on such fees, with monitoring fees hovering around 2.0% of EBITDA and transaction fees around 2.0% of deal value. In addition to pressure from investors, the SEC has taken a recent interest in private equity fees. A recent enforcement action against Blackstreet Capital Management found that transaction fees not subject to an offset were illegal brokerage fees Previous enforcement actions were brought against the Blackstone Group and KKR concerning the disclosure and allocation of fees among investment vehicles, respectively. Private Equity enforcement actions were the subject of the SEC s Security Enforcement Forum West 2016 Keynote Address

21 Now, why is the SEC spending its limited resources on the private equity industry given the sophistication of most investors? Because it is important to understand that retail investors are significantly invested in private equity. For example, public pension plans frequently invest the retirement savings of their plan beneficiaries which include teachers, police officers and firefighters in private equity funds. Similarly, institutional investors have increased their investments in private equity funds, often on behalf of retail investors who themselves are saving for retirement. Further, university endowments which fund scholarships and other important academic programs invest in private equity funds. So, if an adviser defrauds a private equity fund, the underlying victims frequently include retail investors, who in many cases are not in a position to protect themselves. In addition, while the managers of these pension funds and other institutional investors who invest in private equity can be sophisticated, even experienced investors can be defrauded if they lack transparency into the various fees, expenses, and practices - which has been the case in the past. There is thus little question that private equity is an appropriate focus for the SEC. Andrew Ceresney, Director, SEC Division of Enforcement, Security Enforcement Forum West 2016 Keynote Address