Private Equity Strategies. By Ascanio Rossini

Transcription

1 Private Equity Strategies By Ascanio Rossini

2 Outline 1. What is Private Equity (PE) and what distinguishes it from other asset classes? i. Definition ii. Key Features iii. Fund Structure 2. Private Equity Strategies i. Strategy Classification 1. Early Stage: Venture Capital 2. Expansion Stage: Growth Capital 3. Maturity Stage: Buyout (LBO, MBO) 4. Decline Stage: Distressed Debt/Turnaround 3. Exit Events 4. Concluding Remarks

3 1. WHAT IS PRIVATE EQUITY (PE) AND WHAT DISTINGUISHES IT FROM OTHER ASSET CLASSES?

4 i. Definition Private Equity (PE) is an asset class falling under the alternative investments spectrum commonly involving 1. Investments in equity securities and debt of companies NOT quoted on a public exchange (Baker, Filibeck, Kymaz 2015). 2. Takes the form of a PE fund: a collection of investors retail and institutional that pool funds to invest in ownership of a company with the aim of improving its financial performance in view of capital gains upon an exit event (sale transaction). 3. PE funds tend to specialize in strategies that differ primarily on the basis of the stage of development (lifecycle) of the company they invest in (i.e. Venture Capital, LBO, Growth Capital, Mezzanine ) 4. A transformational, active investment strategy calling for highly specialized skills by the investment manager whose only aim is to create VALUE, without hesitating to align the management of the targeted company with that objective.

5 iii. Key Features High Risk Potentially High Return Performance Driven Incentive System Active Value Creation Investments promise above-average real adjusted returns to compensate for the many risks committed capital is subject to. Performance is the consequence of a strong alignment of interests between i) fund managers (GPs), ii) management teams of the portfolio companies, iii) the investors in the fund (LPs) PE must create value by providing resources to firms, being responsible owners and actively supporting management to improve company outlook. Confined Investment Power Investment power is confined to the fund manager (GP), once the capital is committed investors have no say in the investment process. Flexibility as a Strategic Value Extreme flexibility and creativity allows funds to harness emerging opportunities and capitalize on new markets and varied strategies.

6 iv. Fund Structure Typical Structure of a PE partnership i.e. Pension funds, Insurance Companies, HNWi, Sovereign Wealth funds, Family Offices, endowments, FoF. General Partner GP Limited Partner LP A Limited Partner LP B Limited Partner LP C GP Ownership Fund Management Fund Ownership Private Equity Fund Co-investment Portfolio Company 1 Portfolio Company 2 Portfolio Company 3

7 2. PRIVATE EQUITY STRATEGIES

8 i. Strategy Classification PE has developed an incredibly wide array of specialized funds with investment strategies characterized according to: Stages of Investment (Company life-cycle) Geographic focus Sector and Size of Investments Strategic approach We will analyze and compare investment strategies on the basis of the Stages of Investments, with reference to the stage in the development life cycle of a company.

9 Source: Cumming, Johan 2009

10 Revenues 1. Early Stage 2. Expansion Stage 3. Maturity Stage 4. Decline Stage Time

11 Strategy Classification cont d Early Stage Venture Capital Expansion Growth Capital Maturity Buyouts Decline Turnarounds Investments in early stage activities targeting young companies often with a tech component and high potential for growth. VC invests in target startups before their true revenue potential has been validated. Investments in fast growing companies with realized profits that need money to grow. Capital usually goes to increasing PC, internal restructuring (market/product development) or goes to financing an acquisition. Natural slowdown in growth, peak in terms of financial stability, good cash flows and little investment req. Investment at this stage look for management buy-outs, where new owners can create opportunities for growth or even turn around companies Firm experiences difficulties and declining revenues. Investments are made with a view to reestablishing prosperity. Venture Capital Seed Capital Start-up Capital Venture Growth Capital Angel Investors Growth Capital Replacement Capital Bridge financing PIPE RD Buyouts MBO LBO Mezzanine Distressed Debt/Turnarounds Distressed-to-Control Loan-to-Own Rescue Financing

12 1. Early Stage Strategy What is it? Pros Cons Venture Capital Seed Capital funds Start-up funds VG Capital funds Pre-IPO Specialized minority equity investments in young, small companies. High-risk/high-return due to potential that has not yet been validated. Generally involves a new technology, concept, business model. Large say in management and business operations. Highest potential for above-average returns. Usually initial capital commitment is small (i.e. seed and startup) although some tech developments may require large amounts. High in growth promoting economic development and job creation. Commercial uncertainty, betting on potential. Cash flow unreliability, sometime may not even be profitable businesses. Tend to be small size investments accounting for a relatively small portion of the equity ( %).

13 2. Expansion Strategy What is it? Pros Cons Growth Capital or Growth Financing Growth Capital Funds Minority equity investments in quickly growing, relatively established companies to help support further growth. Companies that generate revenues and operating profits but without sufficient capital to pursue transformational changes. Capital goes to expand, restructure operations, enter new markets or finance a major acquisition W/O a change of control of the company Relatively safer w.t.p VC since companies have already demonstrated their pull and are mature enough. These deals tend to require less money than buyout deals. Popular in emerging markets where businesses don t always have access to capital from banks or from capital markets. Requires extensive work in system s development, heavy recruitment of management team, investment in production, build up of advertising etc.

14 3. Maturity Strategy What is it? Pros Cons Buyout; Leveraged Buyout LBOs Management Buyout MBOs Management Buy-in MBIs Provide capital to mature companies with stable revenues and some further growth or efficiency potential. Buyout funds hold the majority of the company s AUMs. LBO: Most of them acquire large stakes via borrowed funds! Leveraging the investment with up to 60-90% debt financing. LBOs involves debt which is often nonrecourse to financial sponsor and has no claim on other investments managed by the fund. The investor itself only needs to provide a fraction of the capital for the acquisition. The returns to the investor will be enhanced as long as the ROA exceeds the cost of debt. Lenders can insure themselves against default by syndicating the loan by buying CDS of CDOs. Leverage is beneficial since it limits committed capital, but if buy-out and exit goes wrong the loss is amplified by the leverage. Large operations involving very large firms that can take on big debts, preferably at cheap interest.

15 4. Decline Strategy What is it? Pros Cons Distressed Debt and Turnaround Control-oriented Approach Turnaround Approach A type of financing to companies that are experiencing financial stress that may range from declining revenues to an unsound capital structure or an industry threat. Control-oriented approach: PE firm acquires debt securities of the company to have control over restructuring or bankruptcy procedures. Turnaround approach: the PE fund will attempt restructuring by investing new equity and take control of the company. Distressed financial situation may favor the PE fund, in that it can acquire it with very low multiples cheap equity creating a good investment opportunity (assuming that it can then exit). Risk of not being able to reverse the financial distress.

16 3. EXIT EVENTS

17 Wide held perception is that successful PE investments are normally exited through flotation on the stock markets, IPOs but in reality these only account for 16% of European buyout exits (EVCA: 2012). The most common exit route for buyout and capital financing are TRADE SALES: In a trade sale, private equity investors sell off all of their shares held in a company to a trade buyer. i.e. a third party often operating in the same industry as a company itself. This method is preferred by the investor because it provides a complete and immediate exit from the investment. Other exit events include: Secondary Buyout Sale to Management Leverage recapitalization

18 3. CONCLUDING REMARKS