Investment Banking and Finance: Private Equity Finance

Welcome to my Private Equity course in which I share over 9 hours my 30 years Investment Banking experience, much of it spent dealing with Private Equity firms on both sides of the table.

Its my pleasure to introduce this course and explain its structure and what you can expect to discover inside.

I hope you really enjoy the course, as much as I have enjoyed making it.

Please note this Disclaimer:

DISCLAIMER: Students of this course are not to construe it as investment, legal, accounting or tax advice, and it is not intended to provide the basis for the evaluation of any investment. Students should consult with their own investment, legal, accounting, tax and other advisors to the determine the benefits and risks of any investment.

Private equity investments involve significant risks, including the loss of the entire investment.

This course does not constitute an offer to sell or the solicitation of an offer to buy any security.

If you have any questions, please address them to me as I would love to find reasons to add to this course!

Thanks for enrolling!

Best regards

John

Our starting point for this course, is to understand what is meant by Private Equity. This lecture sets the context for understanding what a Private Equity firm does, how it invests and how it makes money.  We will build on this understanding as we go through the course.

A PDF of the Slide Deck is available to down load from the Resources Section of this Course.

In this lecture I want to briefly discuss the advantages and disadvantages of Venture Capital and Private Equity funding.   I don't want to put you off if you are an entrepreneur but I do want you to enter into this relationship with your eyes open.

A downloadable PDF of the slide deck is available from the resources section of this lecture.

While I am not expecting you to set up your own Private Equity fund, understanding the steps to setting one up is a good place to start.  There are some helpful strategic insights provided in this lecture that will deepen your understanding of Private Equity.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

This lecture explains the relationship between General Partners and Limited Partners within a Private Equity Firm.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

This lecture explains how Limited Partnership Agreements regulate the relationship between the General Partner (or Private Equity Firm) and the Limited Partners (the institutional investors in the Fund).

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

This lecture briefly reviews the hierarchy of a Private Equity Firm and the different roles and responsibilities within that hierarchy.

A PDF of the Slide Deck is available to down load from the Resources Section of this lecture.

As I am updating this course, I find that many terms and topics over lap and inter-relate but I don't want to cut topics down at the risk of making them incomplete.  It struck me that a topic based Glossary would be useful to share with you the meaning of some of the jargon and terminology and how it inter-relates with similar terms.

A PDF of the Slide Deck is available to download in the Resources Section of this lecture.

A deal in which a business is bought from its owners by a Management Team, financed by a Private Equity Firm.  I explain how the parts of the deal fit together in this lecture and why these deals are so popular with Management Teams.

A PDF of the Slide Deck is available to download with this lecture.

While the composition and mechanics of a Leveraged Buyout are very similar to those of a Management Buyout, I thought it would be helpful to show you what is meant by Leverage and how it can be used to greatly increase financial returns in a deal.

A PDF of the Slide Deck is available to download with this lecture.

Before we get started examining Management Buyouts in detail, its important that we are all on the same page about some of the key circumstances and characteristics of MBOs before we start.  I would therefore like to dispel some of the more common myths about MBOs to clear the air.

A PDF of the Slide Deck is available to download with this lecture.

In this lecture I want to discuss the different players in the private company finance and buyout market.  As you will see the market is complex and continues to become more so as investment strategies become more specialised.

A PDF of the Slide Deck is available to download in the Resources Section of this lecture.

Buyouts can be Primary or Secondary and the terminology gets quite complicated quite quickly so here I try to explain some of the variations around this theme.

A PDF of the Slide Deck is available to download in the Resources Section of this lecture.

These are terms relating to the Private Equity and Buyout market with which you should be familiar.

A PDF of the Slide Deck is available to download in the Resources Section of this lecture.

A Fund of Funds is a PE Firm which invests in other Private Equity funds.  The advantages and disadvantages of investing in Funds of Funds from the perspective of the Limited Partner are discussed in this lecture.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

To understand the Private Equity market, it is helpful to understand the differences between Private Equity firms.  This means taking a look at the broad style of deals they do, the details of size and sector, some of the specialised jargon and terminology that describes the Firms and their deals.  This lecture tackles this potentially complex subject to give you a working overview of the different types of Private Equity Firms.

A PDF of the Slide Deck to the Lecture is available for download.

What is the difference between Private Equity and Venture Capital?  The answer can be defined in relation to Trailing EBITDA which I explain in this lecture.

A PDF of the Slide Deck for this lecture can be downloaded from the Resources Section of this Lecture.

Private Equity Firms raise 10 year funds and this lecture explains how these work and how this 10 year lifecycle affects their investment behaviour.

A PDF of the Slide Deck is available to download with this lecture.

There are three key factors behind value creation for Private Equity firms and these are explained in this lecture.  Over time the relative importance of these has shifted and I explain that change and what this means for Buyers from and Sellers to, Private Equity firms.

A PDF of the Slide Deck can be downloaded from the Resources Section of this Lecture.

It is helpful to understand how Private Equity Firms measure their financial returns and what their return expectations are.  You do not need to know how to calculate an IRR (Internal Rate of Return), just what the PE firm is expecting to make.  There are better ways to calculate returns which I also explain.  

Private Equity Firms' compensation is also important to understand and I explain how they make their money.

A PDF of the Slide Deck for this lecture can be download from the Resources Section of this lecture.

Here is some guidance on finding the right investor for your business.  I also point out a potential major pitfall and advise on why its particularly important to get this right. 

A downloadable PDF of the slide deck is available from the resources section of this lecture.

Before rushing ahead to approach Private Equity Firms, spend a little time deciding whether they are the right type of investor for your business in the first place.  This lecture provides some criteria with which to make that judgement.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

I have provided a Check List which includes the key criteria you need to screen potential Private Equity firms.  It is in word format so that you can edit it.  The lecture discusses the key criteria to make sure that you are focusing on the right firms. 

A PDF of the Slide Deck is also available to download from the Resources section of this lecture.

The types of funding depend largely on the stage of development of the target business.  Broadly speaking, Venture Capital firms invest at an earlier stage and Private Equity firms invest in more developed businesses.  We also briefly discuss exit scenarios.

A downloadable PDF of the slide decks is available with this lecture in the resources section.

Private Equity firms have clear investment criteria for their deals and these are briefly explained in this lecture.  Unlike Venture Capital firms, they are looking for established, more mature businesses with real opportunities for growth.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

I want to draw you deeper into some of the complexities of the Private Equity Market and share a perspective from both the view point of the Private Equity Investor and the Corporate seeking finance.  Many dynamics are at work here and the deeper you go, the more complex the market and process becomes.  I don't want to overwhelm you but I want to take you beyond the superficial summary of Private Equity which is so often presented.

A copy of the Slide Deck in PDF format is available to download with this lecture.

A good understanding of a Private Equity Deal Funnel is an important part of any company's homework if they are seeking financing.  You need to understand how and why Private Equity Firms are so rigorous in their deal selection and I explain this in the lecture.

A PDF of the Slide Deck is available for download with this lecture.

While every deal is different, Private Equity deals or Buyouts use Leverage (debt) to enhance returns to the equity holders.  This lecture explains the Capital Structure of typical deals to help you to understand how this works.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

Private Equity is packed full of Jargon, so in this lecture I want to explain some of the key Deal Structuring Terms that you will hear used during a transaction.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

It is important that you understand what Equity, Stockholders Equity and Common Stock is and how they relate to one another and this lecture explains this.  

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

Preferred Stock or Preference Shares are a class of equity which has superior rights to Common Stock or Ordinary Shares.  These rights are used by Private Equity investors to manage and protect their position in a deal.  You need to understand these rights in detail.  In this lecture I explain some of the rights and what the benefits they confer on the holders of the Preferred Stock.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

Part of the benefits accruing to Preferred Stockholders are Liquidation preferences.  These dictate how much of the proceeds from a liquidation event are received by them before Common Stockholders receive any money.  These are important and there are different terms which may apply which are explained in this lecture.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

In this lecture I want to make you aware of some more rights that apply to classes of shares and which are baked into the structure of Private Equity Transactions.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

Capital Structures are not a template but a judgement and when constructing the capital structure for your deal you need to carefully evaluate a number of potentially conflicting factors which we discuss in this lecture.

A PDF of the Slide Deck may be downloaded from the Resources Section of this lecture.

We have already briefly discussed how Private Equity Firms generate their returns, I want to explore this in more depth with a hypothetical example to show how returns can be generated in a deal.  I also caveat that this is an upside only viewpoint and that there are a number of issues which add to transaction complexity which are not addressed in this case study.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Private Equity Firms are not passive investors and are always actively seeking to find ways to improve the returns on their deals.  This lecture discusses several ways in which PE firms can add "Alpha" value - direct value added - to their deals.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

We are going to walk step by step through the whole deal process involved in a Private Equity deal from origination to closing.  I have broken this up into five sections as the alternative would have been a very long lecture.  In Part 1 we review the deal origination, the initial due diligence and the submission of the deal to the PE Firms Investment Committee for the first time.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

In the next stage of the deal process, the Private Equity firm submit a non binding letter of intent - an LOI.  We discuss the contents of this important document.  Assuming that the terms of the LOI are accepted, the PE firm then moves into the next stage of Due Diligence and is given access to the virtual data room.  Using this detailed information, the investment team in the Private Equity firm can now prepare their detailed financial operating model of the business.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

The Private Equity Investment Team now prepare their Preliminary Investment Memorandum. This is a detailed 30-40 page document which is presented to the PE Firm's Investment Committee making the case for the deal.  Initial discussion are also held with potential providers of debt finance.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Now the Investment Team in the PE firm can start working towards finalising due diligence and submitting a final binding offer.  This of course remains subject to the approval of the Investment Committee.  Initial drafts of the deal legal documents are started and the Investment Memorandum is finalised and presented to the Investment Committee for their sign off.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

In the final stage, all parties sign the deal and then work together to close the transaction.  The bank debt and other sources of funding are agreed and finalised and the transaction then move to close once all the other outstanding issues are sorted and cleared.  The time between signing and closing can be as much as a year.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

A PDF of all 5 Parts of this Process can also be downloaded from the Resources Section of this lecture.

Before we get started I want to make sure that you understand what Due Diligence involves and of course what the term means.  This is a critical area in the Private Equity deal process so its worth spending some time on it.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Competition and Markets are a core aspect of Due Diligence - what are the characteristics of the external environment in which the business operates.  This lecture contains a series of topics outlined so that you can understand the areas that need to be investigated if you conduct this category of due diligence in the future.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Understanding the Industry and Sector Growth factors helps us to understand the potential for the company in the future. The company's performance will be materially affected by the condition of the markets in which it operates.  You need to understand these.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

In any business you want to understand the nature and the relative strengths of your relationships with your Customers and your Suppliers as these are critical to the performance of the company.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Understanding how capital works inside your business may not be something they specifically teach you in business school but capital is critical as it cash.  You need to understand the working capital, the operational capital and the capital expenditure required for your business and to factor this in accurately to your modelling.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Now we want to understand the historical and future performance of the business and the degree to which we can believe and rely on the managements future projections.  We do this partly by analysing their historic performance but also by challenging them on the assumptions and drivers underlying the forecasts they have prepared for the deal.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

This is a major area of Due Diligence which is undertaken by the Reporting Accountants to the transaction. This lecture highlights the main areas for review.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

It is important that there is a very detailed review of all the legal aspects of the company's business and operations and the main topics for these are explained in this lecture.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Valuation of Public companies is relatively simple: Shares in issue x share price.  Private companies don't have a publicly traded share price to start with so you cannot rely on this for your valuation.  We discuss several ways around this problem in this lecture and also briefly touch on the EBITDA multiple which is frequently cited by PE Firms in their transactions.

A PDF of the Slide Deck is available to down load from the Resources Section of this lecture.

EBITDA - Earnings Before Interest Taxation Depreciation and Amortisation - is one of the key profitability metrics used by Private Equity firms and having a clear understanding of what it is, why its important and how to calculate it is important.

A PDF of the Slide Deck from this Lecture is available to download from the Resources Section of this lecture.

This section could be a course in its own right.  I am setting out here to explain to you how an LBO is put together without spending hours on Excel Coding.  You need to understand the framework first, plus this is not an Excel Modelling course. 

This introduction helps you to understand how this section is organised and how each of the lectures fits in the framework I have constructed to explain this complex modelling process.  I hope you find this useful.  Definitely watch this lecture before you tackle this section of the course and download the framework from the PDF Slide Deck in the Resources Section of this lecture.

We start our exploration of LBO Modelling by introducing you, at a high level, to the structure of an LBO model so that you can understand its constituent parts; inputs, calculations and outputs.

The core is the three financial statement integrated model which is used for a number of purposes in investment banking and then we add the bells and whistles to turn this to our purpose of evaluating our LBO transaction.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

Putting all the information together for an LBO presentation or model can be a daunting task, particularly for private companies. For Public Companies the task is much easier and this lecture helps you with a quick list of places where you may be able to find the information that you need.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

This lecture explains the highest level of of model assumptions where we set up all the major labels and rates which impact the model.  Specific examples from an actual LBO are shown in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

A well constructed model has clear input areas/sheets where you can set up your Key Assumptions for your model where you can set everything from the Funding Structure, the Sources and Uses of Funds, the Equity Capitalisation tables and all your growth factors.  The better these are laid out, the easier your model will be to work with and understand.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

This is the third and last lecture where we discuss the model assumptions and focus on the importance of the granularity of your Income Statement and Working Capital assumptions.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

The sources and uses of Funds table calculates how the deal is funded and how the money is applied in the acquisition. This shows all sources of money, including adjustments within the existing company or rolled over investments. The Uses detail all the different levels of debt and their cost. The detail of the equity is also recorded. This is an input to calculating the balance sheet adjustments and the debt schedules going forward.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

We can now create the three integrated financial statements in our model; Income Statement, Balance Sheet and Cash Flow.  The Cash Flow statement also alllows us to populate our Debt Schedule where we manage the interest and capital repayments on all the deals debt instruments from Senior A Bank Debt to PE Firm Loan Notes.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

In every integrated financial model, the financial statement linkages are critical. In an LBO model you also need to factor in the Balance Sheet Adjustments arising from the deal. We discuss the impact of both of these issues in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

Circularity is a common problem in financial modelling when you are creating a dynamic or integrated model. It normally occurs in the Interest Expense line in the Income statement. I explain why this is a problem and show you how to fix it.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

In order for our model to integrate, the working capital must respond to changes in the Income Statement and flow through to the Cash Flow Statement. It is much easier to set this up if we have a separate Working Capital Schedule which is explained in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

These are two important terms in LBO modelling and while you may not need them in less complex models, you need to be aware of what they are and how they work.  This is explained in this lecture.  

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

Goodwill arises in an LBO as an excess of the purchase price over the net assets of the target company.  You need to know how to treat Goodwill in your financial model. Although it has no cash impact it can have tax implications.  We discuss Goodwill and negative Goodwill in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

Tax is an important issue in LBOs.  On the one hand you cannot afford NOT to pay taxes. On the other hand the company to do everything it can to optimise its tax position within the confines of the law.  The timing of tax payments is also another issue which argues for careful modelling all of which is discussed in this lecture, along with an example of a Tax Schedule from a real model.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

The Amortisation of Fixed Assets and Intangible Assets while not a cash item can have tax benefits and there by reduce tax payments.  It is therefore worth planning these carefully and the best way to do this is with an Amortisation Schedule which is explained in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

As we have seen Debt is a critical part of the financing structure of LBOs and it can become very complex.  All debt is carefully ranked and has a descending priority to cash repayments.  This needs careful modelling.  We have briefly touched on Debt Schedules earlier in this section but for completeness sake, I think its important to give Debt Schedules their own lecture to make sure that the explanation is complete.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

It is important that the transaction remains within the Covenant boundaries set by the lenders and these are normally set with a small number of ratios of debt and interest cover.  We discuss these in this lecture and examples are provided from real PE LBO models.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

This is the term which explains the priorities of the application of sales proceeds between the General Partner and the Limited Partners. We explain the most common arrangement in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

The LBO model contains all the information to create a simple Discounted Cash Flow which you can use to derive a valuation for the LBO business utilising the Weighted Average Cost of Capital (WACC).  This is not an essential part of an LBO model but its nice to have and easy to build as you have done most of the difficult work already.  We discuss how this can be done and explain in simple terms how to derive the WACC and create the DCF valuation.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

Once you have created your Leverage Buyout Model you can use it to test the returns against the assumed leverage in the financial structure.  We discuss the benefits and risks of leverage and why its important to use your model to understand the balance between IRR returns, cash multiple returns and the level of debt.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

When measuring returns to Private Equity you need to take into account both the IRR and Cash Return Multiple and we discuss how these work and their sensitivities in this lecture.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

This is the first of two Reports which your model must be able to generate.  It brings together the key information from your LBO model and enables you to print it for the reports and presentations you are going to have to make.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

The Financial Report in your LBO Model presents the historic and future projections for the Income Statement, the Balance Sheet and the Cash Flow Statement and makes it easy to present these and discuss the financials of the model in one place.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

The Ability to Pay Analysis enables you to work out how much you can afford to pay, given the financial structure and model assumptions in order to achieve a required IRR or Cash Multiple.  I have created a stand alone spreadsheet to explain this and I step you through the analysis so that you can understand how this works and you should be able to create this analysis yourself either on a standalone basis or as part of your LBO Model.

A PDF of the Slide Deck and the Excel Spreadsheet can be down loaded from the Resources Section of this lecture.

While our LBO model may be showing good returns to equity, we really want to know which parts of the deal structure are creating the value.   This lecture explains how to create this analysis to understand the value creation drivers.  The Excel Spreadsheet is available to download with the Slide Deck PDF from the Resources Section of this lecture.

When you have completed your LBO Model you will need to pull everything you have learned from creating it into a Presentation for the PE Firm Investment Committee. This is an outline framework of that Presentation which can also be used as a Deal Analysis Framework to help you come to the "Go" or "No Go" Deal recommendation.

A PDF of the Slide Deck can be downloaded from the Resources Section of this lecture.

For an investor, Private Equity funds offer the opportunity of higher returns but combine this with the greater risk associated with leverage.  This can be mitigated by investing a portfolio of companies and historically Private Equity funds have out performed public market indexes such as the S&P500.  In this lecture we evaluate the risk return equation.

A PDF of the Slide Deck is available to down load from the Resources Section of this lecture.

While Senior Management are expected to roll over or invest along side the PE investors, most of their returns come from their share options otherwise known as the Sweet Equity.  This lecture explains how this works and incentivises management with the opportunity of very substantial capital gains in the event of a successful transaction.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

Before we directly consider exit strategies, its worth stopping to consider why LBOs happen, what is the motivation behind them.  We also go on to discuss the transfer of wealth in the deal and who benefits and why.  With this settled, we are in a better position to consider the most appropriate exit options for the deal.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

The Exit is critical part of every PE transaction and it is so important to the return that it forms a part of the deal evaluation process.  We explore the options for exits in this lecture.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.

We should just touch on this before we move on to discuss the main Exit mechanisms of IPO and Trade Sale.  Recaps give PE investors a chance to take money out of the deal while still retaining ownership.  We explain in this brief lecture.

A PDF of the Slide Deck is available to download from the Resources Section of this lecture.