veritas financial group introduction to the financial universe week 3 – venture capital &...
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Veritas Financial GroupIntroduction to the Financial Universe
Week 3 – Venture Capital & Private Equity
Today’s Agenda – Private Equity
• What is Private Equity?
• How do PE firms make money?
• What is leverage?
• How are PE firms structured?
• Who are the big players in PE?
• What is an ideal target for a PE firm?
The Private Equity Market
Global Assets > $2.0 trillion
$949 billion of funds available for investment
Global market
Industry agnostic
What is Private Equity?
• Private equity investments can be made by: • A private equity firm • A venture capital firm • An angel investor
• Common private equity investment strategies: • Leveraged buyouts (and management buyouts) • Distressed investments• Recapitalizations, PIPEs• Venture capital • Growth capital
What is Private Equity?
• Private Equity is an investment strategy consisting of owning equity that is not traded on an exchange
• Private Equity funds are pools of money that are used to: • Take Privates: Buy all outstanding shares of a public
company• Private Buyout: Purchase the equity of a private
company (family business, from another PE firm, etc.)• Rollup: Acquire multiple companies and combine them• Corporate Spinout: Acquire a division of another
company
How do PE firms make profitable investments?
• Increase Profits (Operational Improvement)• “Top Line” (Revenue)
• Acquire other business• Introduce new products• Sell more to existing customers• Expand geographically• Improve pricing
• Increase Profit Margin• Reduce Costs (Manufacturing location, headcount)
• Capital Structure/ Fees• Valuation (Multiple Arbitrage)
What is leverage?
• Leverage is the ratio of debt to equity
• A company has $100 in assets• $20 belongs to investors • $80 belongs to creditors• How levered is the company?
Assets $100
Investors (Equity) $20
Creditors (Debt) $80
Debt to Equity Ratio
What is leverage?
• Leverage is the ratio of debt to equity
• A company has $100 in assets• $20 belongs to investors • $80 belongs to creditors• How levered is the company?
Assets $100
Investors (Equity) $20
Creditors (Debt) $80
Debt to Equity Ratio 4
Why would a company use leverage?
• Will starts a company and invests $100. It makes $10 in the first year. What is the return on equity?
• Bobby starts a company and invests $10. He then borrows $90. The company makes $10 in the first year. What’s his return on equity?
InvestmentBorrow Amount
Total Investment
Return
Return on
Equity "ROE"
Will $100 $0 $100 $10
Bobby $10 $90 $100 $10
Why would a company use leverage?
• Will starts a company and invests $100. It makes $10 in the first year. What is the return on equity?
• Bobby starts a company and invests $10. He then borrows $90. The company makes $10 in the first year. What’s his return on equity?
InvestmentBorrow Amount
Total Investment
Return
Return on
Equity "ROE"
Will $100 $0 $100 $10 10%
Bobby $10 $90 $100 $10 100%
Downside of leverage
• It’s about risk/reward• Leverage increases return on equity• However, taking on debt can be expensive (have to
pay interest) • A drawdown can cause serious problems
InvestmentBorrow Amount
Total Investment
Loss
Return on
Equity "ROE"
Will $100 $0 $100 ($10)
Bobby $10 $90 $100 ($10)
Downside of leverage
• It’s about risk/reward• Leverage increases return on equity• However, taking on debt can be expensive (have to
pay interest) • A drawdown can cause serious problems
InvestmentBorrow Amount
Total Investment
Loss
Return on
Equity "ROE"
Will $100 $0 $100 ($10) -10%
Bobby $10 $90 $100 ($10) -100%
How are PE firms structured?
• Limited Partners – provide capital to the private equity fund (firms run many funds)• Receive a “limited” share of the profits (i.e. what is left after general
partners are paid)
• General Partners – make investment decisions and collect fees• Receive payment “off the top” (usually 2% of total investment + 20%
of profits)• Sometimes get to keep interest in the target company instead of
cash (carried interest)
Assets Return Management Fee Performance
Total Comp.
Mutual Fund $2B 20% $20M $0M $20M
PE, VC, Hedge F $2B 20% $40M $80M $120M
What is the ideal target for a PE firm?
• Attractive valuation
• Stability of earnings and high cash generation
• Significant growth potential
• Significant profitability improvement potential
