Private Equity An Overview
Clark L. Maxam, Ph.D. Director of Research – Braddock Financial Corporation and El Pomar Professor of Entrepreneurial Finance – University of Colorado, Colorado Springs
Private Equity – Broadly Defined
• Technically refers to any type of equity investment in an asset in which the equity is not freely tradable on a public market.
• Less liquid • Long Term in nature
Private Equity – Categories and Players
• Angel
– Early Stage: Seed, Start-up
• Professional Venture Capital
– Early Stage, Expansion, Later Stage
• Private Equity
– Later Stage, Buyout, Special Situations
• Hedge Funds
– All Stages
The Private Equity Market
Key Player Overlap
Angel
Venture Capital
Private Equity Hedge Funds
Traditional Private Equity – Primary Activity
• Professional pools of capital that buy all the publicly traded equity of target companies = “Go Private” • Usually done with borrowed money
– High degree of leverage
• Aka : Leveraged Buyout
The Basic Value Creation Formula Fundamental Ideas
1) Re-focuses acquired businesses resulting in lower costs and improved efficiency.
2)
Value is created through basic finance that says debt can increase firm value if you can afford it! • Exploits corporate aversion to debt (Henry McVey, Morgan Stanley).
Regulatory Arbitrage – Sarbanes-Oxley
3)
The Basic Value Creation Formula Debt can increase Value
Dupont Equation
NI NI Sales Total Assets ROE X X Equity Sales Total Assets Equity
Leverage – Debt as % of Assets Equity Multiplier ROE
The Basic Value Creation Formula Debt can increase Value
Consider a company that takes on debt at a cost of $3 in Net Income, but changes NOTHING ELSE.
NI Sales Total Assets X X ROE Sales Total Assets Equity
16 160 X 160 100 X 100 100 16 16% 100
12 160
X
160 100
X
100 30
12 40% 30
Could drop NI to 4.8 and still match the previous ROE!!
The Basic Value Creation Formula An Example – Carlyle Group
Leveraged Buyout
Case 1 (5 years) – No Profit Increase
Case 2 (5 years) – Profit Increase
Regional Breakdown of Private Equity Investments
Funds Raised 100.00% 80.00% 60.00% 40.00% 20.00% 0.00% 2000 North America
Source: International Financial Services
7%
17%
7%
8%
38%
2%
69% 52%
2005 Europe Asia/Pacific Other
Private Equity Investments by Country
Source: International Financial Services
Source: National Venture Capital Association,Thomson Venture Economics
Source: National Venture Capital Association,Thomson
Cambridge Associates U.S. Private Equity Index
(period ending 9/30/2006) 35 30 25 20 15 10 5 0
1Yr 2Yr 3Yr 4Yr 5Yr 6Yr 7Yr 8Yr 9Yr 10Yr 11Yr 12Yr 13Yr 14Yr 15Yr 16Yr 17Yr 18Yr 19Yr 20Yr
Source: Cambridge Associates, LLC
Private Equity Issues Going Forward
• PE as a new Model of General Management (Jensen) – Overcomes entrenched thinking, management and disjoint between manager incentives and capital markets. – Problematic Trends
• Publicly held Private Equity – oxymoron • Fee Structures not tied to exit • Hedge funds in the PE business – not a transaction business.
Private Equity Issues Going Forward • 2007 estimate of$160B in dry powder $750B $590B in debt appetite.
– Banking capacity is finite and already extended. – Potential regulatory limits
Private Equity Issues Going Forward • PE Boom has been fueled by
– Historically low rates – Regulatory arbitrage
• Both could reverse quickly and change the metrics dramatically