PRIVATE EQUITY

“Private equity fund” = money to be invested.

Variety of sources: individuals , companies, institutional investors (pension funds, banks and

insurance companies).

Specialist funds are created where investors agree to provide funds to be invested in particular types of private companies, usually in the form of a Limited Partnership (tax advantages).
Usually an agreed internal procedure for approval of opportunities (i.e. min/max investment or stake)

“Private equity provider” = investors give money to them by way of a PE fund to invest in deals

Makes their profit by successful investment of PE funds
Often through fees based on percentage profits of successful investment returns.
Will try to maximise profit for the investors whilst minimising the risks of the investment in order to grow its own business successfully and develop a good rep in the private equity market.

Types of investment

Start-up capital (providing financing at the outset of a business);
1. Investment usually by way of subscription of shares in existing co
Development capital (providing finance for expansion); and
1. Investment usually by way of subscription of shares in existing co
Buyouts (where finance is provided for the acquisition of a business)
1. Small management buyout = a direct subscription for shares may be made in the acquiring company.
2. Large management buyout = will be a substantial amount of debt finance as well as PE so a corporate structure may be created for the acq; and
3. Large institutional leveraged buyouts = a fairly complex corporate structure will be used to cope with the numerous layers of investment and debt finance.

Management Buyouts	Management buyout (MBO) Buyout by the existing management team Through a newco established for purpose of MBO Share or asset acq – will likely want majority SH Existing management draw up IM and PE providers bid to fund the deal – existing management expected to fund too so they’re focused on success Funded by a combo of equity finance by management team and PE provider and debt funding over assets of target
Institutional buyout	Institutional investors looked for the opportunity themselves and are the driver of the process. Majority of buyouts will be funded by institutional investors, but won't necessarily be an institutional buyout (e.g. if it is existing management driving the process). Hope to acquire majority stake in target – will need potential to generate sig profits PE provider will try to achieve best debt-to-equity mix in order to maximise profit. PE will consider its internal rate of return (how much gain will be achieved on the sale based on projections for the increase in value of the target ). Will depend on how much equity needed: the lower the equity, the greater the gains per share. Debt funding can be secured against target assets
Leveraged buyout	Leveraged buyouts are where acquisitions are funded through a significant amount of debt finance (bonds and loan notes). Management will not be driving force but instrumental because of knowledge to maximise profitability of target – will be incentivised to give successful exit (e.g. sweet equity) Management on a LB will be either existing, PE appointed NED’s, or a combo of both Management team will be expected to give warranties in relation to its business plan and information provided by it about the target. Structure: (1) Holding / topco = act as the investment vehicle for all the equity funds (those provided by the PE provider and management team). (2) Wholly-owned subsid of topco = will undertake the bank borrowing needed to provide the balance of the acq cost. The actual purchase of the target company may be made by this subsid,or [(3) Wholly-owned subsid of the subsidiary* = may instead make the purchase of target if that suits the tax and other circumstances of the transaction.]*
Senior Debt vs. Mezzanine Debt	Senior debt is the first ranking secured debt. Mezzanine debt is Second ranking secured debt. Mezzanine lenders will not recover any debts until Senior Debt is repaid in full, and has a higher rate of interest than a Senior Debt as it is more risky.
Equity Kicker	An equity kicker is a 'warrant' offered to Mezz lenders, which gives them the lender the right to convert its loan into equity shares for par value. This is beneficial as it can convert its loan to equity shares just before the equity investors are going to float/exit (when there is no risk to being a shareholder) and float its shares above the value it would have received had it remained as a debt.
Equity Investor Loan	Equity investor lends money to the company rather than (or as well as) shares. May have a high rate of interest: unsecured; ranked high; but tax deductible for the company
Sweet Equity	Management pay X amount to take equity in the company. Why is it sweet? Because the management obtain same shares with same value as the equity investors, but the investors have to risk a substantially larger sum of money (e.g. 15m preference shares to the 800,000 equity of the management) to obtain Same amount of return.
Redeemable fixed cumulative preference shares	Redeemable can sell back to the company just before exit or flotation (can’t float preference shares) Fixed cumulative preference receive a fixed dividend in preference to all other dividends (e.g. 4% p/a) the dividend is cumulative, which means that if the investor does not get a dividend in one year, it rolls over into the next year. fixed because the value of shares never changes (get back what you put in)	Isn't this just a loan? Here's X, at the end of the period pay me back. In the meantime I will get a fixed return of X% p/a Looks like a loan - why not just do a loan? no tax no voting rights makes company look healthier (lender has no rights and it is equity, rather than debt finance). Ranks behind lenders, always
Ordinary A Shares	Generally have Same rights as ordinary shares: voting rights rights to dividend rights to capital BUT, crucially they rank behind everything but ahead of ordinary shares. Check articles of association for the rights attached to Shares.
Ordinary Shares	Right to vote Right to receive dividend/capital Essentially what CA 2006 envisaged.
Good / Bad leaver	Set out in the Arts Investment is an incentive, so PE fund will require that any managers leaving will be required to sell their shares in a prescribed manner and at a prescribed price. Price will depend on the circumstances for the departure under good/bad leaver provisions Bad leaver generally get the lower of (a) market value and (b) price when shares were issued Good leaver will get market value GOOD LEAVER = leaving on death, disability, or retirement or may include any dismissed without cause what constitutes without cause may be contentious. BAD LEAVER = those leaving for no good reason (e.g. a new job) or who are dismissed with cause.
Drag Along	Investment agreement and Arts power to force other shareholders to sell their shares if an offer is received from a third party for a controlling interest in Newco 1. Operates by specifying that minority shareholders must transfer their shares to that third party on same terms as those proposed by the PEP. Triggering of drag along rights is subject to negotiations e.g. the minority shareholders may be able to impose restrictions on the timing of any sale and what would be an acceptable form of consideration.
Tag Along	Investment agreement and Arts A drag along provision will not ensure management's shares are included within an exit sale. Tag along provision provides that the majority are unable to sell all or a substantial proportion of their shareholding without B also agreeing to buy a corresponding proportion of the minority shares on same terms. Allows management to participate in an exit

Structure of a typical buyout

Scenario

Target LTD is a wholly-owned subsidiary of S PLC.
Private Equity Fund wishes to acquire Target LTD for 60m using a combination of equity finance and debt finance.

Equity finance (20m)

19.2m equity finance will be provided for by the private equity fund in exchange for 84% A ordinary shares and preference redeemable shares.
800,000 will be provided by 4 of the existing management team equally (200k each) in return for ordinary shares representing a 4% holding each.
The whole 20m will be paid into Newco 1 (the top company) which has the effect of structurally subordinating the equity investors to both the Mezzanine and Senior Debt lenders.

Debt finance (40m)

10m debt finance will be provided by a Mezzanine lender into Newco 2.
30m debt finance will be provided by a Senior Debt lender into Newco 3.
This will have the effect of structurally subordinating the Mezzanine lender (Newco 2) to Senior Debt lender (Newco 3).

The above structure achieves 'structural subordination', meaning that any debts will be paid out in the order of:

Senior Debt will be repaid in full
Mezzanine debt will be repaid in full and finally
SH of Newco 1 will be paid in accordance with Arts

This can also be achieved contractually, but banks prefer structural subordination as it provides more clarity and they do not have to worry about the top company.

Senior debt
Mezzanine debt
Any high yield bonds
Loan notes held by...

#15693 - Private Equity And Takeovers - Mergers and Acquisitions (Private Acquisitions)

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