Published on February 14, 2014
Different Forms Of Private Equity Funding
Contents • Why do companies need funds? • When is equity financing preferred? • Forms of Private Equity Funding • Recent Trends • General Process • Valuations • Structures and Instruments • Exit Options • Advantages and Disadvantages • Important factors for consideration • PE at crossroads… 2
Why does a company need funds? Capital Expenditure Working Capital Retiring Debt Expansion Acquisition Finance • Plant & Machinery • Land & Building • Fund Based • Non Fund Based • Term Loan Repayment • Vertical – New Product Lines / New Segment • Geographical – Operations in International Markets • Leverage Buy-out • Management Buy-out 3
When is equity financing preferred? Over leveraged Ideal for start ups Equity Financing Difficult to meet interest commitments 4 Inconsistent cash flows
Forms of Private Equity Funding Mature Business Stages of Business SME’s Ideas Incubation Funds by Promoters Mid - Large Business Micro Business Family & Friends, “Angel” Investors & Venture Capitalist Venture Capital, Private Equity & Mezzanine Types of Private Equity Funds 5 Capital Markets / Private Equity & Mezzanine Buy Out Funds/ Capital Markets
Recent Trends in PE Volume Value (US$ Bn) HY1 09 HY2 09 HY1 10 HY2 10 H1 11 HY1 09 HY2 09 HY1 10 HY2 10 H1 11 PE 89 117 125 128 203 1.78 1.66 2.95 3.28 5.09 QIP 5 49 26 30 4 2.02 6.59 2.56 3.66 0.65 Total 94 166 151 158 207 3.80 8.25 5.51 6.94 5.74 Source: Grand Thornton Deal Tracker 6
Recent Trends in PE - Sectorial Breakup For H1 2011 Source: Grand Thornton Deal Tracker 7
Recent Trends in PE - Performance of various funds • Expansion / growth capital accounts for 46% of total deals of 2011 • Big trends for 2011 was surge in start-up/early stage deals from 18% of total in 2010 to 33% of total in 2011 Source: Economic Times on 6th January, 2011 8
Angel Investor • Provides „seed funding‟ • Usually affluent individual providing capital for business start-ups • Different from venture capitalists • Limitation on amount of money that can be raised • Bear high risk • Require very high return • Investment holding period of <5 years 9
Transactions (Illustrative) 10
Venture Capital • Typically occurs after seed funding stage • Subset of private equity • Venture capital consists of investing in equity, quasi equity and/or conditional loan in order to promote unlisted, high risk or high tech firms driven by technically or professionally qualified entrepreneurs. • Finance companies that have demonstrated extraordinary business potential • The risk anticipated is very high • Follow the concept of “high risk, high return” • Year 2011 is record year for early-stage Venture Capital investing – Deal values & volumes at all time high – Euphoria around e-commerce, across mobile, internet and related verticals – Evident from recent deals of InMobi, Fashionandyou, Snapdeal – Exit in MakeMyTrip touted as poster deal for domestic venture industry – JustDial , One97 Communications and others lining up for exit over coming months 11
Venture Capital Sector Majorly in emerging sectors Early Stage Funds start up & early expansion Key Driver Innovation Highly skilled professionals, scientist & innovators with innovative business idea, new product & new technology Investment & Exit Upto $10 mn, exit through strategic sale or IPO Success High mortality rate & few great success 12
Transactions (Illustrative) 13
Private Equity • Equity investments in relatively mature, primarily unlisted companies requiring growth capital • An asset class that involves value enhancement and high returns generation by sharing business expertise of the Investor complementing the Entrepreneur • Typical value additions from the PE Fund House could include Strategy Formulation Financial Formulation, Expertise and Global/Domestic Networks (including other investee companies) • Offer greater opportunity to exercise control over investments as compared with other passive asset classes like equities, mutual fund, real estate, commodities, fixed income – Active involvement and influence on the company, including board seat • Each investment is backed by an investment thesis which plays out over a period of 3 to 5 years • Private Investment in Public Entities (PIPES) 14
Growth Stage – Private Equity Success Investment & Exit Key Driver Innovation Growth Stage Sector Capacity expansion, new products, new geography etc. Investor funds at growth stage of the company All growth sectors 15 From $5 mn to $500 mn, exit through IPO Few failures & great success
Transactions (Illustrative) 16
Buyout Funds • Globally most important strategy of PE; though not a very prevalent strategy in India • Generally buyout‟s done at matured stage of business • Mature companies with leading market position, active management team, strong cash‐flow • Taking a controlling stake in the company through leveraged buyout (LBO) or through management team alongside the PE fund (MBO) • PE funds provide capital for expansion, promoters‟ / corporate divestures, succession issues… • Development of a business plan over 4 to 6 years in order to add value • Revenue growth + Margins improvement + deleveraging = added value 17
Transactions (Illustrative) Company Flextronics Software Systems GE Capital International Services (GECIS) Financial Investor Kohlberg Kravis Roberts & Co. General Atlantic Partners, Oak Hills Value (US$ Mn) Type 900 LBO 600 LBO Phoenix Lamps Actis Capital 29 MBO Nilgiris Dairy Farm Actis Capital 65 MBO WNS Global Services Warburg Pincus 40 MBO Infomedia India ICICI Venture 25 LBO Nirula‟s Navis Capital Partners 20 MBO Gokaldas Export Blackstone 165 MBO N.A. MBO Paras Pharmaceuticals Actis Capital Sequoia Capital 18
Mezzanine Debt / Structured Product • Mezzanine financing is provided by mezzanine funds and sometimes hedge funds • Finance as Debt instrument / structured product like partly or optionally convertible instruments etc., immediately subordinated to equity • Mezzanine financing might include, besides coupon bearing debt, an equity sweetener as well • Considered as debt instrument with very high yield which at times in substitution of equity • Returns generated by the fund are – – • Interest ‐ fixed rate or fluctuate along an index (e.g. LIBOR) OR a pre agreed IRR Upside potential through Equity Illustrations: 19
Sector focused funds • Real estate funds – • Focus on investments in real estate and real estate intensive businesses Infrastructure funds – Roadways – Port projects – Railway projects – Power projects – Telecom – Logistics 20
Key Differentiators Particulars Stage Level of risk Assessment Focus Investment Size Angel Investors Very Early Very High Mostly Technology < $ 1 Mn Venture Capital Early High Mostly technology < $ 10 Mn Private Equity Growth Moderate Diversified > $ 10 Mn Buyout‟s Mature Moderate Diversified > $ 50 Mn All stages Moderate Diversified > $ 5 Mn Mezzanine 21
General Process Stage Preparation 3-4 weeks Investor Identification Term Sheet 3-5 weeks 4-6 weeks Final negotiations and Closing 4-6 weeks Timing Process » Understanding and evaluating historical performance » Recast of Historical numbers; if needed » Preparation of IM and Projections » Industry Overview Total Time 14 – 21 weeks » Identify target Investors » Share Information » Follow-ups » Promoter Meetings » Plant visits » Negotiate valuations and other terms of the transaction Sign NDAs 22 » Due Diligence » Definitive Agreements Sign Term Sheet » Pre & Post Closure formalities Sign Definitive Agreements
Valuations Peer/ transaction Multiples Revenue EBIDTA PAT NAV DCF Willing Buyer – Willing Seller 23
Structures and Instruments Primary Investment • Involves fresh infusion of capital in the company against issue of fresh shares to augment future growth • Ideal for growth companies Secondary Investment • Involves payment to existing shareholders of the company • Could be either on account of buying out or providing some liquidity to existing shareholders • Ideal when promoters wants to cash out (fully or partially) or buyouts 24
Structures and Instruments Private Equity Investment Secondary Investment Primary Investment Direct Equity Convertible Preference Shares / Debentures Warrants / Options 25 Equity Purchase / Earnouts
Exit Options • • Three important pillars Modes of exit – Valuations – Initial Public Offering (IPO) – Timings – Exit via M&A – Restrictions, if any to exit – Sale to another investor – Secondary sale on stock markets – Buy Back / Call / Put Option Nature of Exit 2009 2010 Volume Value (US$ Mn) Volume Value (US$ Mn) Initial Public Offering 2 31.64 15 502.22 M&A 18 157.97 40 1,238.13 Open Market 69 1,390.10 76 1,448.54 Secondary Sales 8 78.17 18 160.85 Buyback 6 500 15 1,695.32 103 2,158 164 5,045 Total Source: VCEdge 26
Advantages • Fills funding gaps for long term capital • No interest cost. Seeks return through capital appreciation rather than immediate and regular interest payments • Adds value because, apart from funding, PE contribution includes: – – Networking and Global Integration – Confidential as compared to IPO or even debt funding – • Financing expertise and strategic management support Independence of the capital markets volatility Positive signaling effects to the market: – Debt, IPO – M&A – Employees, Suppliers and Customers – Increases Industry Visibility • Corporate Governance • Relatively less expensive fund raising exercise in comparison to IPO 27
Disadvantages • Raising Private Equity finance is demanding, time consuming; at times the business may suffer if promoter devotes more time for the transaction • Depending on the investor, promoters may lose a certain amount of power to make management decisions • Will have to invest management time to provide regular information for the investor to monitor • Might create conflict or differing opinion in long‐term strategy due to pressures of EXIT from the investor • The cost of complying with regulations could be relatively higher • Non‐alignment of Interest of fund manager on the board and entrepreneur could hamper the growth of company 28
Important factors for consideration Growth Potential Exit Market Positioning Returns Management Bandwidth Stage / Sector / Structure Historical Performance Competitive Scenario Project Period Industry Trends 29
PE at Crossroads… • PE operating in a challenging environment today • Difficult fund raising environment • A large number of India focused funds were raised during 2004-06. Many of these are due to raise their next fund • Funds with dry powder putting monies to work in environment beset with intense competition • Tremendous competition amongst funds to win deals resulting in bid war • Expensive entry valuation continues to frustrate • Investments by real estate funds have reduced - slowdown in sales & high borrowing cost continue to plague the sector Number of funds raised and announced Value of funds raised and announced ($ Mn) Particulars 2010 16,853 Announced Announced 52 51 Funds Raised 17,828 2011 Funds Announced 2011 2010 10 25 Source: Economic Times on 6th January, 2011 4,111 2,024 Raised Raised 30
PE at Crossroads… (contd.) • Deep inventory of future exits in the PE pipeline – PE exits will take a lot of PE manager‟s time, energy and bandwidth – Approximately 68% of PE deals made through boom years of 2006-08 remain in PE funds‟ portfolios – Now reaching the upper end of their investment holding periods, many of these holdings should soon be coming up for sale – PE exits account for only 20% of PE activity in 2011, indicating strong potential for M&A transactions in the coming years. Also reflected in increased preference towards exit through M&A route. More than 100% rise in instances of exit through this option in 2010 over 2009 • Source: Economic Times on 6th January, 2011 Funds will look to learn from past and spend greater time on deal evaluation and make investment decisions based on merits rather than sentiments • PE firms also expected to spend considerable time on their portfolio management as holding periods have been stretched 31
PE at Crossroads… (contd.) • Motivation for PE players to provide high yield debt finance continues to grow. Such endeavors undertaken to cater to all investment needs of promoter, debt & equity • Increased activity in PIPES deals – Volatile capital markets in 2011 – Conventional fund raising options for listed companies not available – New Takeover code provides a boost for PE funds – Greater number of listed companies expected to source growth capital needs from PE • Early stage investing is in the limelight & will continue to gain momentum • Deals in cloud computing, clean technology, online commerce and technology enabled services such as mobile & online advertising, analytics and data management business will continue to attract Venture Capital funding • Strong growth potential for Venture Capital, Buyout funds and Pre-IPO / late stage placements 32
Private equity multiples are highly dependent on the portfolio company's industry, the size of the company, and the availability of LBO financing. 
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