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PRIVATE EQUITY: TWO TYPES
WHAT ARE VENTURE CAPITAL AND LEVERAGED
BUYOUTS?
Venture Capital: providing risk-bearing capital to high growth
start-up firms
Significant burn rate: negative cash flow
Intangible assets makes lending problematic
LBO are leveraged purchases of established firms
High debt to equity ratios
Stable cashflows
Scope for restructuring and acquisition
Often public to private transactions
LEVERAGE BUYOUTS IS RELEVANT FOR REAL ESTATE
WHY IS PRIVATE EQUITY NEEDED?
ROLE AS INTERMEDIARY:
INTENSIVE MONITORING
SUPPLIES MEMBERS OF SUPERVISORY BOARD
REDUCES PRINCIPAL AGENCY PROBLEMS BETWEEN
MANAGEMENT AND OWNER
SPECIALISM
BANKS: REGULATORY LIMITS ON EQUITY INVESTMENT
AND BASEL III
INSURANCE COMPANY: SOLVENCY II
MUTUAL FUNDS: LIQUIDITY CONSTRAINT
HISTORY OF PRIVATE EQUITY
DEMAND:
1979 EMPLOYEE RETIREMENT INCOME SECURITY ACT
ALLOWS INSTITUTIONAL INVESTOR TO INVEST IN
ILLIQUID HIGH RISK ASSETS
LOW INTEREST RATE LED TO APPETITE FOR RETURNS
SUPPLY:
1980s DEVELOPMENT OF JUNK BONDS BY MICHAEL
MILKEN OF DREXEL BURNHAM LAMBERT
BARBARIANS AT THE GATE: REVOLUTIONARY LBO OF RJR
NABISO BY KKR
WHO ARE THE LPs?
Angel Investors
Endowments
Pension Funds
Insurance Companies
Corporations
Trend: rise Sovereign Wealth Funds
Fund-of-Funds
THE LIMITED PARTNERSHIP
AGREEMENT
Characteristics of the Fund
Minimum (economic) and maximum (true to style) size
Minimum amount that GP contribute
Life of the Fund
Management of the Fund
Activities of the General Partners
Types of Investments
Trend: more opportunistic funds investing in distressed real
estate assets
ALIGNMENT OF INTERESTS: FEES
AND CARRY
Management Fees
Carried Interest
Capital Calls
Trend: fees under pressure
SELECTION CRITERIA USED BY LPs
Track record
Fit with objectives of the fund
Experience of the team of GPs
Quality of other LPs
Trend: it takes 6-7 months longer to close
a new fund than before Global Financial
Crisis
INCREASING CONCENTRATION
STRICTER REGULATORY REGIME
AIFMD (EU)
Dodd-Frank Act (US)
Disclosure
Supervision
Custodian responsibilities
Risk management
Leads to higher cost burden…
…and increases economies of scale
TREND: cost control though outsourcing and off-shoring and
M&A activity to achieve economies of scale
DEAL SOURCING AND EVALUATION
FINDING THE DEAL
Proprietary Deals
Directly form GP network
Exclusivity
Specialized sector expertise
Competitive Deals
Investment banks
Commercial banks
Accountants
Lawyers
EXIT ROUTES
Initial Public Offering
In case of an LBO (public to private) it is called a
reverse LBO or RLBO
Trade Sale
Sale of company to a peer
Privately negotiated
Other Exit Routes
Selling the Shares Back to Original Owner
Shutdowns
IPO PROCESS
Research report: sector trends, strategy
Beauty Contest: knowledge, access and
distribution
Mandate: ranking in hierarchy
Definitive research report based on due
diligence
Positioning and Pricing: Case Study ING