PRIVATE EQUITY: TWO TYPES - MSRE Alumni Association · PRIVATE EQUITY: TWO TYPES WHAT ARE VENTURE CAPITAL AND LEVERAGED ... In case of an LBO (public to private) it is called a reverse

PRIVATE EQUITY: TWO TYPES

WHAT ARE VENTURE CAPITAL AND LEVERAGED

BUYOUTS?

Venture Capital: providing risk-bearing capital to high growth

start-up firms

Significant burn rate: negative cash flow

Intangible assets makes lending problematic

LBO are leveraged purchases of established firms

High debt to equity ratios

Stable cashflows

Scope for restructuring and acquisition

Often public to private transactions

LEVERAGE BUYOUTS IS RELEVANT FOR REAL ESTATE

WHY IS PRIVATE EQUITY NEEDED?

ROLE AS INTERMEDIARY:

INTENSIVE MONITORING

SUPPLIES MEMBERS OF SUPERVISORY BOARD

REDUCES PRINCIPAL AGENCY PROBLEMS BETWEEN

MANAGEMENT AND OWNER

SPECIALISM

BANKS: REGULATORY LIMITS ON EQUITY INVESTMENT

AND BASEL III

INSURANCE COMPANY: SOLVENCY II

MUTUAL FUNDS: LIQUIDITY CONSTRAINT

HISTORY OF PRIVATE EQUITY

DEMAND:

1979 EMPLOYEE RETIREMENT INCOME SECURITY ACT

ALLOWS INSTITUTIONAL INVESTOR TO INVEST IN

ILLIQUID HIGH RISK ASSETS

LOW INTEREST RATE LED TO APPETITE FOR RETURNS

SUPPLY:

1980s DEVELOPMENT OF JUNK BONDS BY MICHAEL

MILKEN OF DREXEL BURNHAM LAMBERT

BARBARIANS AT THE GATE: REVOLUTIONARY LBO OF RJR

NABISO BY KKR

WHO ARE THE LPs?

Angel Investors

Endowments

Pension Funds

Insurance Companies

Corporations

Trend: rise Sovereign Wealth Funds

Fund-of-Funds

THE LIMITED PARTNERSHIP

AGREEMENT

Characteristics of the Fund

Minimum (economic) and maximum (true to style) size

Minimum amount that GP contribute

Life of the Fund

Management of the Fund

Activities of the General Partners

Types of Investments

Trend: more opportunistic funds investing in distressed real

estate assets

ALIGNMENT OF INTERESTS: FEES

AND CARRY

Management Fees

Carried Interest

Capital Calls

Trend: fees under pressure

SELECTION CRITERIA USED BY LPs

Track record

Fit with objectives of the fund

Experience of the team of GPs

Quality of other LPs

Trend: it takes 6-7 months longer to close

a new fund than before Global Financial

Crisis

INCREASING CONCENTRATION

STRICTER REGULATORY REGIME

AIFMD (EU)

Dodd-Frank Act (US)

Disclosure

Supervision

Custodian responsibilities

Risk management

Leads to higher cost burden…

…and increases economies of scale

TREND: cost control though outsourcing and off-shoring and

M&A activity to achieve economies of scale

DEAL SOURCING AND EVALUATION

FINDING THE DEAL

Proprietary Deals

Directly form GP network

Exclusivity

Specialized sector expertise

Competitive Deals

Investment banks

Commercial banks

Accountants

Lawyers

DEAL EVALUATION CRITERIA

STRUCTURING A BUYOUT

EXIT ROUTES

Initial Public Offering

In case of an LBO (public to private) it is called a

reverse LBO or RLBO

Trade Sale

Sale of company to a peer

Privately negotiated

Other Exit Routes

Selling the Shares Back to Original Owner

Shutdowns

IPO PROCESS

Research report: sector trends, strategy

Beauty Contest: knowledge, access and

distribution

Mandate: ranking in hierarchy

Definitive research report based on due

diligence

Positioning and Pricing: Case Study ING

RISK AND RETURN