Venture Capital and Entrepreneurial Finance Midterm

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Rules for the Closed-End Fund

1. general rules 2. internal code of activity 3. investment policy

new PE solutions

1. private debt funds 2. crowd funding 3. venture philanthropy 4. special purpose acquisition companies (SPACs)

Common features of Venture Capital

1. the investment is often characterized by a high level of risk 2. the PEI needs to have a hands on approach 3. the PEI must have a very deep knowledge of the field where the company operates in

Financing and Life Cycle of a Company

Life cycle is important to know if a company can use PE to accomplish its needs and to identify the kinds of PE investment 1. Development - seed financing 2. Startup - startup financing 3. Early Growth - early growth financing 4. Expansion - expansion financing 5. Mature Age - replacement financing 6. Crisis or Decline - vulture financing

Network Benefit

PEI can give the company a strong network - suppliers, customers and banks

Stake of equity of the PEI

minority: VC majority: buy-out can affect the approach (hands on vs hands off)

Write off (exiting strategy)

the PEI cancels the value of the stake in its portfolio - worst nightmare of a PEI happens when the company defaults - may occur in start up and seed financing does not necessarily mean an IRR -100% because the PEI may try to sell some assets to recover the loss driven by a private agreement or by law

lifetime of a closed end fund

-1.5 0 3 N-0.5 N N+3

Fundraising Period (Closed End Fund)

-1.5 - 0 Before launching any activity, the AMC needs the approval by the authority. depends on: 1. size of the fund 2. value of every ticket 3. investment target Once approval is granted the AMC has max. 18 months to collect the money. average takes 4-5 months 50% of funds in Europe do not get to time 0

Draw Down Period (Closed End Fund)

0 - 3 AMC has the possibility to ask the investors to deposit a percentage of their commitment time is set at 3 years because collecting the capital from investors will take more time then it does in capital markets The fund has to cash in all the money previously subscribed by the investors (who can also deposit their investment with installments)

injection of money in expansion financing

1. PEI invests in the company and gets shares the company has to get enough money to carry on the M&A. if this is successful the company and the target will merge (the company uses their money (assets) to buy equity into the target company) (the PEI had given them money for their own equity) Pros: the company will merge with the target and benefit from the synergies Cons: the company is going to give the investor a portion of the synergies created Another way to do m&a addressing the drawback 2. the PEI builds an SPV (special purpose vehicle) - it is built only for the purpose of a specific operation. it does not have any assets or liabilities before the operation. The PEI and the company collect money from the banking system and put the cash into the SPV. can be used in 2 cases: 1. when the company has got a huge financial need and it does not want to increase debt 2. the company wants to keep the SPV as a separate entity - when the company does not want the PEI to share the gain deriving from the M&A The PE will not benefit from the synergies This is more expensive then the first option the PEI has a minor incentive in creating synergies the company has to obtain financing from banks to invest in the SPV

formats of deals

1. The European Union Format: regulated by a directive of the european union 2. Anglo-Saxon format: regulated by US and UK laws Using one of the formats does not mean that the deal occurs in the area of the format

actions to protect value (managing and monitoring phase)

1. lock up: covenant b/w the investor and existing shareholders that forbids both from selling for a certain period 2. permitted transfer: agreement b/w investor and shareholders that prohibits both from selling without the approval of the other 3. staging technique: injection of capital in installments - with a financial target needed to be met before the next installment (stops money from being spent on unprofitable prospects) 4. stock option plan: option given to management of the company to buy stocks at a favorable price - generates commitment to create value 5. callable and puttable security: issuing of securities which the PEI can sell the stocks to the existing shareholders (puttable) and the existing shareholders can buy the stocks (callable) 6. tag along rights: if the majority shareholder sells its stake, the minority PEI can sell its stake on the same conditions and to the same buyer - protects the minority PEI 7. drag along rights: if the PEI sells its stake it has the right to ask the shareholders to sell their stake at the same conditions to the same buyer - maximizes the prices of the sold shares - the PEI can sell 100% of the company without owning it giving them higher contractual power - protects a majority PEI 8. right of first refusal: the PEI can avoid the shareholders selling their stake to undesired shareholders - the PEI has to buy the stake of the selling shareholders at the same conditions offered by the potential buyer 9. exit ratchet: applies to both the PEI and entrepreneur - the "remaining" shareholder has the right to obtain a percentage of the capital gain deriving from the sale of the shares

sources of funds

1.founder family and friends 2.other partners 3.angels/venture capitalists 4.private equity 5.banking system 6.trade credit 7.financial markets Venture Capital (seed, startup and early growth) use friends and family, other partners, angels and private equity Banking system, trade credit, and financial markets are not right for the company in these stages

Getting to time N (Closed End Fund)

3 - N the investors have entirely injected all the money equivalent to their tickets by 3 so the AMC now keeps on investing until the end of the fund. some investing can have already taken place but not using the entire amount length of the fund can be determined by the AMC as long as it is shorter then 30 years. 90% have a maturity of 10 years. within 10 years two investments can be made: year 0-3: first investment year 3-5: exit first year 5-7: second investment year 7-10: exit from second

Why would a company use PE/let an external investor sit on its board of directors? (Benefits for a company financed by a PEI)

If a company needs at least one of the four benefits then PE is the only choice 1. Certification Benefit 2. Network Benefit 3. Knowledge Benefit 4. Financial Benefit

Economic Mechanism of an AMC

Investors will be paid and a gain or loss will be generated at the end of the fund AMC remunerations: 1. Management Fees 2. Carried interest

Extra time (Closed End Fund)

N - N+3 the possibility to use up to 3 years of extra time after the closed end fund Because PE has a low liquidity, sometimes an AMC does not have the whole liquidity it would need to pay off the investors right away When the fund ends the AMC evaluates the fund and spreads the value among all the investors coherently with the amount of tickets bought by the investor

Business Angels (US PE player)

PE investors without any professional skills (foundations, universities, individuals, HNWI, charities) can benefit from the Qualified small business stock rule (QSBS rule): if they invest in PE and the capital gain is immediately invested in another private company under the form of PE taxes are not paid mostly active in venture capital - mostly with seed and start up financing

Knowledge Benefit

PEI can transfer knowledge to the company Soft knowledge: capability to manage the business Hard Knowledge: specific field knowledge of a business (applies to high-tech and pharmaceutical industries)

Certification Benefit

PEI has a long screening phase before investing in a company - confirms the very high quality of the company's accounts - gives a sign of great health of the company which can be used as a promotion for the company's brand

The difference between PE and Investing in a public company

Pricing Public: price is driven by the market Private: price is the result of the negotiation Liquidity Public: very high liquidity - investor can sell shares whenever they want - there is always a buyer Private: since there is no stock exchange finding a new shareholder can be hard and time consuming Monitoring Public: very high level of protection for the shareholders on the stock exchange, regardless of their stake in the company Private: the PEI have to protect themselves and the value generated by the company - all rules are stated in formal agreement

Investment Firms (Europe PE player)

Type 1: do not have any specific constraints to manage their activities and the supervision impact is soft. they do not undergo any regulatory capital rules type 2: most widespread kind of firm in Europe, face the same constraints set for banks and supervision impact is hard. entail a regulatory capital as if they were banks Balance Sheet: 50% cash (collected through debt and equity) - private equity investments 25% debt 25% equity - A-shareholders and B-shareholders A-shareholders: act as an AMC. remunerated with the management fees and a yearly carried interest (yearly because the firm does not come to an end like closed end funds) B-shareholders: act purely as investors and cannot influence the management of the investment. remunerated with the difference between the profits and the carried interest given to A shareholders two reasons to use investment firms to invest in PE: 1. investors may want to leverage (closed-end funds can't use debt) 2. a small group of investors may want to create a captive vehicle and they do not want to comply to strict regulations (ex: family offices - group of family members who want to invest their own money)

Asset Management Company

a financial institution approved and supervised by the local authority whose task it is to manage the fund can host many funds at the same time (can be closed and open end) can manage financial services as defined by the financial services act a cluster of people advising owned by banks, private individuals, and the government No constraints in terms of shareholders - except the commitment the AMC must own in every fun = 2%

Management Fees (AMC remuneration)

a fixed percentage of money calculated on the value of the closed-end fund in the beginning of the fund ex: A $100 million fund bearing 2% management fees - every year the AMC receives $2 million from the fund calculated to cover: 1. operating costs 2. remuneration of the advisor helping the AMC in the consulting 3. remuneration of the technical committee Percentage is calculated with the capital budgeting approach if the AMC belongs to a bank the costs are easily covered. But if it is an independent entity it is tough to cover the costs. In Venture Capital AMC's are owned by professionals and not by financial institutions (because they need a workforce that is completely devoted to the venture backed company)

Venture Capital

a very specific case of PE The investment in the very early stages of a company's life

deal making (investing phase)

activity related to the financial and legal issues setting up contracts b/w investors and the company finding the right balance between the need of money of the company and the expectation of IRR and capital gain for the PEI is based on: 1. targeting: the vehicle used and the % of shares the PE gets the vehicle: direct investment: business is totally interesting for the investor, control is complete, commitment is high and exclusive indirect investment (SPV): investor pays only the relevant assets, investment is tailor made on the business plan, entails use of leverage # of shares: majority v minority relative and absolute size of investment capital requirement impact voting rights and effective influence with the BOD 2. liability profile two decisions: the syndication strategy: find other equity investors to build a syndicate to invest together- multiple the investment power, share the risk debt issuance: combine equity investment with the usage of leverage, requires hands on approach 3. engagement: set up rules by which PE can govern the company three activities: categories of shares: the choice of shares the PE has to buy to guarantee the best way to develop the investment (common - common shares, shares with limited or increased rights, shares with embedded options, tracking stocks) paying policy: the questions a PE firm needs to address for the fact that a PEI is buying another companies shares governance rules: negotiation of the functioning of the board to ensure the capability of the PE to interact with the company in the best way (# of directors, can the PEI be on the BOD, scheduling of board meetings)

SPACs

an empty shell - a form of SPV 20% of the SPV is held by the promoter the company is listed in the stock exchange so that they can collect the other 80% of the equity can collect money only to do one investment - to buy another company if it succeeds it will merge with the target, if not the investors get their money back - "one shot vehicle"

private investment in public equity (expansion financing)

an investment made in a company listed in a stock exchange - the profit mechanism is still not related to the stock exchange Not done with trading purposes - purpose is to buy a minority stake and then sell it to another share holder at a price not based on the stock exchange. the stake must be big enough to become the biggest shareholder - the PEI must understand the small amount of shares necessary to be the owner of the company

Venture capital Trusts (UK PE player)

based on the UK Trust (an old british institution) - an entity, not a company the settlor = the owner does not have to manage the assets the trustee - a third player will manage the assets and is fully liable in case that it has maturity at the end the owner gets back the assets belonging to the trust IN PE: Trusts want to combine retail investors with PE activity GPs create a trust with a term and they set portions of their assets in the trust which they use as collateral to show the LPs the commitment in management of the fund investors become the settlers a management company becomes the trustee the trust does not own any assets, rather it just has the cash injected by the investors used to make VC investment (investors - settlers put in the cash and get 99% equity management company - trustee manages and gets 1% equity) investors get a certificate listed in the stock exchange - high level of liquidity the trust - an empty box - does not publish any financial reporting investors trust the reputation of the trustee can invest in listed securities but 70% of the cash must be invested in non listed companies fiscal incentive are granted to the investor

IPO (exiting strategy)

best option for a PEI - PEI can maximize capital gain - occurs in 1% of cases through an IPO the PEI sells its stake in the stock exchange PEI is the advisor or manager of the IPO - very difficult because the company must be ready for it

SBIC (US PE player)

considered the beginning of the PE development in the US because they were created to stimulate the VC market a legal entity: one shareholder must be a US public admi - holds 50% of the equity, a pure investor, cannot manage the other can be any shareholder - has the duty and right to manage Both receive a management fee but asymmetric profit distribution: US PA gets the remuneration up to a threshold stated in the SBIC agreement the extra profit generated goes to the other shareholder losses are distributed equally 33% of debt can be borrowed from the federal reserve system at a low fixed rate set yearly capital gains and revenues are tax free - taxation starts with distribution of earnings popular because with a US PA parter investors feel they can invest riskier considered among the best models of PPP's (public private partnerships)

the managerial process of PE

day by day activity of the managers managing the investment made by the investors 1. fundraising 2. investment activity 3. managing and monitoring 4. exiting

actions to create value (managing phase)

dedicated to qualify the presence of the investor within the managerial process of the venture backed company depends on: 1. the stage of the investment (stages moving from the seed to replacement financing -involvement of the investor is decreasing) 2. the style of the investor and the nature of the investment agreement (hands on vs hands off) the key activities the PEI takes to create value: 1. Board services: active participation in the life of the company - support decisions, introduce professional expertise, impose severe discipline. always necessary except when exiting through a put option with a bank 2. Performance evaluations and review: development of the processes to monitor and measure value inside the company and between the company and investor 3. recruitment management: choose the right people to hire if the management team is not adequate 4. relationship management: can benefit from the investors network 5. mentoring: PE must be completely available to the entrepreneur 24/7

vulture/distressed financing

final stage of a company life cycle when it enters its decline phase or worse, a crisis Money is used to sustain the financial gap generated from the decline of growth - it is used to launch a survival plan very risky - level of risk also depends on the sector of the venture backed company. The PEI fully understands the field in which the company operates two deals: 1. restructuring financing (turnaround) 2. distressed financing

PE players in US

financial market is driven by common law and great importance is covered by the local and federal courts Federal acts have created a general framework for the financial system. not based on financial institutions but on financial activities. pillars: 1. discipline on stock exchange and securities 2. corporate governance rules 3. discipline for insurance and pension funds 4. general rules for banks players: 1. venture capital funds (VCF's or funds) 2. small business investment companies (SBIC's) 3. banks 4. corporate venture 5. business angels

Financial Benefit

generated through the injection of cash in return for shares of the company the increase generates a positive effect on the cost of capital: higher equity higher rating

Management and Monitoring phase

have to ensure the creation of value and to control the opportunities for the financed venture the PE is a shareholder in this phase because the PE decided to invest in the VBC managers have to support and sustain the company in ordinary activity want tot enhance value of the company as much as possible while also finding another buyer in order to exit and get their capital gain Made up of: actions to create and measure value rules to protect the created value these mitigate divergences of opinions and avoid conflicts b/w the PE and entrepreneur

Anglo-Saxon Format

in this world PE is not a financial service, it is an entrepreneurial activity regulatory framework of PE: common law, ad hoc fiscal rules, and special regulations for the PE world in the end - there is no supervisor investments in PE are not regulated by a regulation framework, rather they are market related - idea that the market discipline is more powerful and important than a financial authority regulation

Closed end funds (Europe PE player)

investments made though a closed end fund consider a two level system involving two different institutions: 1. asset management company (AMC) 2. Closed-end fund three players 1. AMC 2. Closed-End Fund 3. Investors closed end fund: a separate entity that invests money for a pool of investors, managed by the AMC The money can be used to invest into financial assets or in other assets closed end funds have a fixed maturity and a fixed number of money to invest (open end vs closed end is driven by maturity and amount of money to invest) NEVER use debt most important vehicle in Europe for PE - perfect because their length is fixed and the liquidity is no problem for the investors nor the AMC average size = 100-300 million euros - typically divided into 1 million euro tickets that an investor can buy

internal growth (expansion financing)

it plans to grow "by itself" - investment will be made in fixed assets and in working capital role of the PEI: needs to provide money, not difficult for the PEI so the offer is very wide and there is a high number of investors providing this financing this can be alternative to a loan (may choose PEI over a bank for the 4 benefits)

Venture Capital Funds (UK PE player)

legal entity operating like LPs in US (UK and US aim to attract same investors, also in terms of risk-return) allowed to leverage must have a set maturity of 10 years

Development Stage

life cycle begins with development When the founders start to create and try to develop the business idea. Uses seed financing to sustain R&D and create a business idea

PE players in UK

like US financial market is driven by common law and great importance is played by the courts it is possible to use the schemes designed through EU banking and financial services act - we find out a great variety of types of equity investors 1. VCF 2. VCT 3. Banks 4. Business Angels 5. Local PPPs

Banks (US PE player)

like europe, they can invest but have many restraints so it is rare that they directly invest in PE - usually act as GP or LP in VCF's

Taxonomy of the formats

local players (the perimeter of the investment is within the country of origin of the PE): must apply the legal framework of the country of origin of the investor global players (the perimeter of the investment is outside the country of origin of the PEI itself): can opt for one format or the other according to the needs of their portfolio

Seed Financing

most complex and riskiest activity among PE investment the investment of an idea or of R&D very industry oriented uncertainty of the project is high - the investor has to trust the idea of the entrepreneur - the managerial role of the investor is very limited two levels of risk: 1. The capability for the idea to generate an output 2. if there is an output does it have marketability? three rules: 1. 100/10/1 - the investor has to screen 100 projects, finance 10 of them, and find 1 successful one. It is so risky you must invest on more then on project and you must invest a huge amount of money. "psychological threshold" = 1billion euros. By the time the winning project is found they will have lost much of their beginning investment. 2. Sudden death risk - the investors have to protect themselves in case the person owning the projects idea suddenly can no longer perform his or her job. solution - the Incubator Strategy, an ad hoc infrastructure in which the inventor can work without worrying about his or her ideas being stolen 3. Size of the market - investors usually invest in markets they know best. but, the idea may be a good one without a market willing to buy it. such is the case in which the investors look for venture philanthropy, set up by nonprofit institutions with the investors themselves

What is the relationship between the PEI and the venture-backed company?

most critical aspect of PE: the strict relationship between the investor and entrepreneur The investor gets shares of the equity of the company in return for the inflow of cash. This relationship is based on: 1. the company needs money for a certain and clearly identified reason 2. the company collects money with the issuance of equity on the private market- the company does not pay and interest expenses to the PEI 3. the newly issued shares are bought by the PEI 4. the investor is not only a shareholder, but contributes to the management of the company (the smaller the company is the larger the contribution of the PEI in management will be 5. the investor will create profit only through the generation of capital gain (ex: exiting by selling shares on the market)

Venture Capital Funds (US PE player)

most popular PE instrument in US. can operate every PE deal Limited partnership: the legal entity supporting a VCF. Means that PE investment is considered a business activity and not a financial activity (as it is in europe) equity must have two groups of shareholders (set up by US law): limited partners: must own 99% of the equity of the LP. solely investors, do not manage the company and are limited to the extent of their investment General partners: must own 1%. the managers of the company, are fully liable for the liabilities (compared to Europe: LPs are like investors in closed-end funds GPs are like the AMCs) because these funds can leverage they are hedge funds (opposed to europe's closed-end funds which cannot leverage) - entails a higher risk-return combination than Europe functioning of a fund is regulated by a limited partnership agreement which is made by GPs and LPs - content is similar to the internal code of activity (europe has a code, US has a contract - battle goes before supervisor vs court) GPs are usually a management company and it operates via a LLP- to protect themselves due to full liability - the assets of the LLP will be collateral of the debt of the VCF LPs are usually banks, insurance, pension funds, private investors. success is due to the simple scheme of functioning and the tax transparency taxes = 0% if: 1. the fundraising lasts 1 year 2. the maturity is 10 years 3. the maximum extra time is 2 years

Crowd Funding

new and digital way of collecting money players can launch their own financial needs and make a call on the internet to collect money through their platform very recent approach - cannot say with certainty whether this works or not for startups

Local PPP's (UK PE player)

not as popular as SBICs are in the US operate at a local level and do not have to comply to rules, rather local laws

Corporate Ventures (US PE player)

not proper legal entities - are a division or department of a corporation which wants to invest in venture capital only aim is to run seed and start up financing investment to promote R&D, outputs, patents aim is not to generate IRR but to enhance the value for the corporation

external growth (expansion financing)

plans to grow by acquiring another company to enhance sales and exploit the synergies Much more complicated than the internal growth. May be undertaken to enter a new market role of the PEI: has to sustain the M&A. have to provide the money but also: 1. screen and scout the market 2. support the negotiation with the potential target 3. provide the company with money 4. support the m&a process (also from a legal and fiscal point of view) 5. legal and taxation support 6. the integration process after the operation

Investors

put money in the funds - they lose any right to have a tailor-made investment. Their investment will be managed by the AMC with the other money belonging to that fund Receive a certificate with the value they invested typically: High net worth individuals banks insurance companies pension funds corporations governments

Closed End Fund Generations

revenues: in the form of capital gains dividends: coming from the companies in which the investment is made losses: in case the deal is not successful

Rules for the AMC

rules are verified by the country supervisor, checking over the whole life of the AMC rules concern: 1. minimum requirements to operate 2. governance rules 3. management rules

Business Angels and Banks (UK PE players)

same as US

Private Debt Funds

same vehicles as used in private equity (investment firms, closed end funds etc) - difference is that the investment is made in private debt popular for two reasons: 1. Europe has increasing tendency among companies to collect debt - do not want to do so anymore with banks, but through the market. companies listed issue bonds on the market but most companies in europe are not listed SMEs 2. PE already knows how to deal with fundraising when the company is private

financing within venture capital subsample

seed financing, startup financing, early growth financing

fundraising phase

starts before the vehicle is launched - before time 0 devoted to promote the business idea of the new vehicle of equity in order to find money - hard phase for the PE - must convince investors of their idea better reputation = easier phase (closed end funds this takes 1.5 years VCF this takes 1 year) if they collect the whole investment and get to time 0 the legal entity starts its activities and the other 3 other activities start steps: 1. business idea creation: aim is to create an information memorandum which has to explain the rationale of the business idea (before this they test the waters - informal way to assess whether it makes sense for PE investors to invest in a specific cluster) end the step: in europe - PE must obtain approval by supervisor and then info. mem. is transformed into an internal code of activity in US and UK - does not need approval, info. me. can be transformed in the LPA since its a contract 2. Job selling: managers must convince the investors not only to give an opinion about the idea, but also to invest. actualized by the letter of commitment - investors declare how they want to participate in the fund - often occurs in one-to-one meeting 3. debt raising: only occurs in UK or US, job selling but with the goal to sell a project to a community of financers, strongly related to reputations - difficult step 4. closing: successful - when the PE is able to collect all the money pure - the PE firm was not able to collect all the money

corporate governance deals (expansion financing)

the PEI invests in a company to manage the redesign of the corporate governance. (occur particularly when there are problems in the management succession) there is a repetitional risk, rather than a financial one

Buy back (exiting strategy)

the PEI sells its stake to an existing shareholder or to a buyer chosen by the existing shareholders a trade sale in which the buyer is not a new corporation coming from the market most common covenant used in these cases is the puttable shares (the PE can sell the shares back to the entrepreneur) gives for granted the fact that the entrepreneur has got liquidity enough to buy the shares

Sale to another PEI (exiting strategy)

the PEI sells its stake to another PEI common in American market not easy because different PEI have different goals, must sell to an investor which operates in the next stage of the investment so that the VBC is walked through its lifecycle

trade sale (exiting strategy)

the PEI sells its stake to another cooperation or another entrepreneur purpose is generally an acquisition to develop a strategic business plan from the buyer can be developed through different solutions not a widespread option - entrepreneurs usually do not want to share their company or ideas with another common in LBO and when the PE holds the drag along right sometimes occur in PIPEs

decision making (investment stage)

the capability to understand the market and to pick up on the right opportunities as the process goes on costs and commitment of the PE increase involves all players - managers, technical committee, advisory company origination: decide the destination of the money collected screening: 90% of the dossiers collected in origination will be eliminated. due diligence and valuation: analysis of the business plan, takes very long time - do it only for a very narrow number of companies rating assignment: PE rates and grades the dossiers, assess the rick, also understands if and how the PE firm has to collect funds through debt negotiation: negotiation with the entrepreneur to calculate the numbers of shares a PE owns and the stake to which they correspond in equity. to understand if there is room for an external shareholder decision to invest: the managers have to convince the whole board of the PE firm it is worth it to invest - does not mean to invest immediately, but sets the beginning of deal making

restructuring financing (vulture financing)

the company is facing crisis but still alive. The need for financing derives from the settlements of debts with banks and with suppliers. Money can be used to relaunch the business - sometimes to buy further assets or invested to redesign the business plan The company needs the strategic support from the PEI PEI must be a finance and an advisor The investor is a majority shareholder because of the high risk due to the strategic nature of the PEI - strong hands on approach and this needs majority stake difficult to find a PEI investing in the deal because of the high difficulty and riskiness - more of an investment banking activity

Investing phase

the core of the PE business the mission of the equity investment vehicle to create value for the investor through the scouting, screening, choice, managing and exiting of ventures when they decide to invest managers have two problems: 1. they have to valuate the company in which they invest 2. when managers and GPs decided to invest they have to negotiate the mechanisms supporting their management of the company Decision making: valuation and selection to decide whether the investing activity makes sense Deal making: negotiation of the contracts

exiting phase

the decision to sell the equity owned in the portfolio in order to have a gain the PE has to identify another shareholder to which they sell their stake of the company - not easy, low liquidity most important phase - only with exiting is the PE able to exit the investment and generate a capital gain must be coordinated with: 1. the specific rules and covenants of the investment 2. the timing opportunity driven by the companys business 3. the timing opportunity driven by the financial markets 4. the capital requirement and pricing constraints 5. the track record of exiting in the portfolio of the PE firm typical strategies: 1. trade sale 2. buy back 3. IPO or sale post IPO 4. sale to other PEI 5. write off even if the investments agreement for the exiting is clearly defined, only the development of the investment can tell the right choice of an exiting strategy

Expansion Financing

the fastest phase of growth to consolidate its position in the market Cash is only used to sustain the gap existing between the cash flow and money needed. Level of risk is moderate because the trend of development of the business is well known the stake held by the PEI is not usually very high financing deals are bout the growth of a company growth can be internal or external

startup financing

the financing of a new company starting its own initial operations They need cash to buy the equipment necessary to start the business. risk is still very high - high level of protection for the investor. the level of risk depends on the fact that the PEI is betting on a business plan. the investor is not a non-profit organization or a high net worth individual so there are several ways to reduce the risk the business plan is not accurate and reliable. 1. Put option: used to sell back to the entrepreneur the shares the investor bought. quite dangerous - it assumes that if the business plan does not work, the founder will still have money to pay off the PE. May be used with a second tool 2. Collateral: this is a pledge for the investor over some valuable assets of the newly founded company and this is usually used together with the put option 3. stock options for the inventor: Grant the inventor some stock options. The entrepreneur will also enjoy the profitability of the company. 4. balance between money and shares: PEI needs the right combination of not losing all its investments (such as when the PE owns 95% of the equity) and not having any say in the management (such as when the PEI owns 2% of the equity). ex: for the investor the right balance would be owning 48% of the company - the PEI would have the right to lead the company but the founder is the owner of the company

early growth financing

the financing of the first phase of growth of a new company that has started generating sales. Need cash to buy inventory and to sustain the gap existing between cash flow and money needed. cash flow is still negative in this stage, but not as much as the previous stage. Risk is still high for the PEI - it is investing in a young company. Very hands on approach in this stage - if the PEI thinks the company has a good idea but the plan is inadequate, it helps rewrite it - the PEI usually has a high amount of shares in the equity on average this financing occurs up to the end of the first 3 year after the startup stage. The PEI may not have any protections due to the high stake in the equity of the company and to the adoption of a hands on approach

Hands on approach of the PEI

the investor provides the support a company needs in the forms of the 4 benefits and they operate together (Approach can depend on if the PEI is a minority or a majority shareholder)

hands off approach of the PEI

the investor provides the support the company needs in the forms of the 4 benefits but the PEI does not give any additional support (Approach can depend on if the PEI is a minority or a majority shareholder)

expansion stage

the sales keep on growing at a very high rate uses expansion financing to buy additional fixed assets and working capital

Private Equity

two aspects: 1. a source of financing: it is an alternative to other sources of liquidity for the company receiving the financing 2. an investment made by a financial institution: private equity investor (PEI) in the equity of a non-listed company broad meaning also includes Venture Capital

European Union Format

two directives regulating PE activity and regulating the entire financial system in the EU 1. the banking directive 2. the financial services directive These directives lie the idea that the financial system in Europe has to be managed with stability - before a financial institution becomes active there must be an approval by both the local and central authorities three players can be a PEI: regulated by the banking directive: 1. Banks: universal and can provide any kind of financial service regulated by both the financial services directive and the new AIFM (alternative investment fund managers) directive: 2. Closed-end funds: have an ad hoc structured they are the most suitable player that can be a PE investor 3. Investment Firms

carried interest

ultimate goal and desire of an AMC: maximizing the carried interest computed at the end of the closed end fund's life carried interest = % x (Final IRR - Hurdle IRR) IRR: a discount rate that equals the investments with the present values of the future returns carried interest is the spread between the final IRR and a hurdle IRR multiplied by a fixed percentage (usually 25-20%) (hurdle rate usually 7-8%) so, the AMC will receive a carried interest only if the final IRR is larger than 7-8% carried interest formula = the waterfall mechanism without catch-up: the carried interest is computed on the difference between the final IRR and the hurdle rate with catch-up: the carried interest is directly computed on the final IRR with vs without is up to the AMC and agreed in the Internal Code of Activity

Banks (Europe PE player)

universal, can undertake any kind of financial activity except: collective asset management activity insurance activity non financial activity can hold equities of: AMC's insurance companies non financial firms to invest directly in the PE of a company it must follow very strict constraints and rules and must set aside a lot of regulatory capital - the capital gain obtained through the investment can be counterweighted by the regulatory capital it has to set aside rare for a bank to invest directly and become a PEI Usually invest in closed-end funds to ultimately participate in some PE activities. Only invest directly if there needs to be an urgent intervention to save a company or if the company is of particular importance

distressed financing

very common for PEI and occurs when the company is dead aim is not to finance the company but rather to buy the relevant and valuable assets of the company an investor will buy patents, brands, contracts, equipment, etc. Why? 1. the PEI may be a trader of assets 2. the PEI may buy the assets to insert them in other venture-backed companies in its portfolio Assets are bought before a court - may be tough negotiation between the investor and the court. the courts goal is to maximize liquidity of a company so when it goes bankrupt it can pay off its debts the court may implement the "poison pill" - the PEI is going to buy a valuable asset mandatorily together with another less valuable or with debt of the company

leverage buyout (expansion financing)

very common, especially in Anglo-Saxon they account for 45% Role of PEI: finance the company and to identify the target company that the company has to buy at 100% steps: 1. The PEI identifies the target and the PEI creates an SPV of which it is the full owner 2. the PEI collects money up and highly leverages the SPV up to a ratio of 90% debt and 10% equity 3. the SPV receives a huge amount of cash through which it is able to purchase the target company 4. the SPV buys the target company through negotiation or through a hostile process and trough an IPO on the stock exchange. the aggressiveness of the operation depends on the level of debt used by the PE to buy the target company 5. The PE fully owns the target company After the acquisition the PE will sell the target to another company the target usually has 1. relevant cash flow 2. low d/e ratio 3. assets that can be easily sold on the market

venture philanthropy

when PE vehicles invest only in businesses generating a strong social impact mechanisms are the same as other forms of PE but the investors and the management accept to get a lower level of profits in capital gains, carried interest and management fees

replacement financing

when a company is beyond the phase of fast growth and is in the mature stage role of the PEI is replacing an existing shareholder Company needs this financing when it wants to face strategic decisions linked to governance, status or corporate finance decisions. Moderate level of risk and linked to the quality of the strategic process that has to be put in place 3 operations: 1. leverage buyout (LBO) 2. private investment in public equity (PIPE) 3. corporate governance deals (CG) these deals do not derive from the need of money

Crisis or decline stage

when and if the company comes across its decline uses vulture financing to exit from the crisis

Startup Stage

when the business actually starts uses startup financing to start production to buy fixed assets and working capital

early growth stage

when the company starts its growth "the financing of the day after" uses growth financing to support the growth

mature stage

when the sales growth is stable uses replacement financing to launch an acquisition, to buy new fixed assets and working capital, to transform the business


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