The Private Equity Toolkit: A Step-by-Step Guide to Getting Deals Done from Sourcing to Exit

THE PRIVATE EQUITY TOOLKIT

A STEP-BY-STEP GUIDE TO GETTING DEALS DONE FROM SOURCING TO EXIT

TAMARA SAKOVSKA

Copyright © 2022 by Tamara Sakovska. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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To my family

Preface

The Private Equity Toolkit aims to be a book like no other in its field. It is the industry's first practical reference guide to cover all critical aspects of private equity deal execution, from sourcing to exit. As an experienced deal practitioner, I focus on the technical fundamentals and practical judgment skills required by investment professionals throughout the entire lifecycle of a private equity transaction.

This book will introduce you to a number of my proprietary frameworks, checklists and cheat sheets that will enable you to develop your own personalized blueprint for originating, evaluating, executing and monetizing private equity investments. With The Private Equity Toolkit by your side, you will be able to dive straight into actionable advice to address your most pressing needs, including:

Building a solid deal origination capability through thematic and opportunistic deal sourcing (Chapters 1, 2 and 3);

Identifying the best deal opportunities for your investment mandate and saving time by eliminating the rest (Chapters 4 and 5);

Evaluating the quality of the top management team you are seeking to back in your private equity investment (Chapter 6);

Analyzing the business plan of an investment target, identifying the main drivers of value creation and developing your own investment base case (Chapter 7);

Performing company valuation and robust deal structuring, for both majority and minority investments (Chapters 8 and 9);

Pursuing best-in-class deal execution through rigorous due diligence and thoughtful negotiation of the main transaction agreements (Chapters 10 and 11);

Adding value to your portfolio business by establishing effective governance processes and implementing an ambitious yet realistic Value Creation Plan (Chapter 12); and

Monetizing your investments through conventional routes, or alternative exit strategies (Chapter 13).

Private equity is one of the most fascinating fields in contemporary finance. Private equity professionals get to explore promising investment themes, meet accomplished entrepreneurs, walk the factory floors of real businesses, determine the value of illiquid assets and engineer the main transaction terms, with heated deal negotiations often extending into the late hours of the night. Since private equity is an interdisciplinary field, successful investors need to master a wide range of skills. Thorough technical knowledge of accounting and finance does not suffice on its own and needs to be combined with solid commercial judgment and exceptional relationship-building skills. Those private equity professionals who want to succeed are expected to originate attractive investment opportunities, generate differentiated deal insights, form productive working relationships with management teams, add value on portfolio company boards and achieve profitable investment exits.

How do they acquire these skills at present? Mostly, on the job. Apart from the book that you are about to read, there appears to be no universal reference guide that one can turn to in order to get a systematic overview of the practical aspects of private equity deal execution, from sourcing to exit. When investment professionals start their careers at a private equity fund, they learn how to do their job from senior colleagues by following a master—apprentice training model. However, senior private equity professionals generally have little time to dedicate to coaching new hires because they themselves are spread very thinly, often consumed by live deals or portfolio company crises that always take priority. Another obstacle that young investment professionals face is a lack of opportunity to acquire more advanced and specialized skills—for instance, those relating to creating effective reporting guidelines for an investment target post-acquisition, managing an investment in distress or preparing a portfolio business for exit—as these situations arise less frequently within the lifecycle of a typical private equity investment. Given these challenges, it takes multiple years for anyone to become truly skilled across all the main aspects of the private equity profession.

My experience was no different when I started my own private equity career a few decades ago. There was no practical handbook that could walk me through the key principles of private equity investing. I had to learn on the job and am grateful to all my senior colleagues who generously shared their knowledge with me. During my formative years as an investment professional, I thought it might be a good idea to start collecting various strategies and checklists that I came across on various transactions in order to create a single sourcebook to support me in my day-to-day work. Over the years, I incorporated a number of additional useful concepts that I discovered by reading books written by experts operating in adjacent business fields, such as mergers and acquisitions, value investing, equity research, behavioral finance, strategy, sales and marketing, business operations, restructuring, organizational behavior and corporate governance.

It took me a number of years to test the multifarious concepts in my home-made private equity primer on real-life transactions and transform them into a series of simple, actionable frameworks to underpin key decision-making principles that—in my opinion—apply best to each phase of a private equity investment, from sourcing to exit. This extensive compilation of ideas and multidisciplinary best practices formed the basis of my personal toolkit that I could turn to every time I needed inspiration or wanted to expand my professional repertoire. These proven techniques, together with the key lessons I learned during my own investment career, represent the core of The Private Equity Toolkit.

Remarkably, to this day, there is still no single finance book that can adequately fulfill the role of a practical how-to guide for the private equity industry. Even though there have been many useful private equity titles published in the last 10 years, you will quickly see that they are either academic textbooks that focus on theoretical principles, or private equity war stories that highlight prominent transactions in the industry. So far, not many private equity deal practitioners have taken the time to step out of the deal frenzy and write a practical reference guide capturing the industry's best practices across the private equity deal lifecycle. The Private Equity Toolkit intends to fill this gap and become the industry's missing manual.

The incessant growth of the private equity industry has created increased demand from curious professionals—such as yourself—who seek to embark on an investment career and look to acquire practical knowledge of the main skills required by the private equity profession. The Private Equity Toolkit will serve as a helpful guide for business school students, investment banking and consulting practitioners exploring a private equity career, as well as private equity professionals who are just starting their journey. Even though I assume that you possess a basic background in corporate finance and accounting, I made a deliberate effort to make this book as accessible as possible to a wide audience of readers by presenting the content in plain English, skipping graphs and equations and suggesting additional resources as I step through the chapters. While The Private Equity Toolkit primarily reflects my own subjective investment experience and utilizes stacks of personal notes, it is not entirely devoid of academic rigor. In fact, in preparing this book, I have performed extensive research of each topic across both the relevant academic literature and scholarly research in order to capture the most prominent findings and incorporate what I considered to be pragmatic, actionable advice.

Still not convinced? The chapter-by-chapter outline at the end of this section provides more insight into how you might be able to enhance your existing knowledge and optimize your own approach to private equity deal execution, from sourcing to exit. Use The Private Equity Toolkit as a reference guide and feel free to jump directly to the most relevant chapter whenever you require targeted support during a particular phase of a private equity investment. Once you've taken a look at the overall book structure, let's delve into the critical components of every deal that will make up your own private equity toolkit.

Disclaimer

While this book discusses at length my own approach to making decisions at every phase of the private equity transaction lifecycle, I am not offering any investment, legal or tax advice.

How to Get in Touch

If you have comments or suggestions, why not share them with me so that I can incorporate your thoughts in the next edition of this book? I welcome your contributions and feedback. Thank you! Please email me at: [email protected]

Chapter 1: First Thoughts on Deal Sourcing

Key Topics:

Why deal sourcing remains an obscure field

Six action steps to take today to enhance your deal origination prowess

Proven deal sourcing strategies and the search for the mythical proprietary deal

How to assess your current deal sourcing capabilities

Key trends to look for now to spot future private equity deals ahead of others

Chapter 2: Thematic Deal Sourcing

Key Topics:

Take the mystique out of thematic deal sourcing with the ICEBERG Roadmap™

An effective way of breaking down your deal search into simple, executable steps

How you can systematically generate promising investment themes

Best practices for mapping out an industry, finding deals and meeting sector experts

A time-tested strategy for approaching companies directly

How to make the most out of your first meeting with a deal target

Chapter 3: Opportunistic Deal Sourcing

Key Topics:

Develop an edge in opportunistic deal sourcing with the DATABASE Roadmap™

No luck required: why having a clear focus pays off in an opportunistic deal search

Actions you can take now to get the most out of your professional network

How active brand management can help your fund stay top of mind

Creative ways to supplement your opportunistic deal ideas

How to manage your deal origination workflows effectively and effortlessly

Does a dedicated business development function work for everyone?

Chapter 4: Deal Selection: Eliminating the Wrong Deal

Key Topics:

Why killing deals is as important as doing deals

How skilled investors overcome biases and minimize investment errors

Why the best investment of your career might be a deal you never pursue

Nine deal breakers you need to check for before proceeding on any deal

Chapter 5: Deal Selection: Identifying the Right Deal

Key Topics:

Save time and effort: why it makes sense to evaluate the transaction dynamic first

If you choose to remember one thing about deal selection, make it the business model

The four most common sources of competitive advantage for any business

Forget the detail: just a few key financial metrics that matter for deal selection

How clever structuring can help you overcome valuation concerns

Chapter 6: Assessing the Top Management Team

Key Topics:

Why motivating superb managers is the key ingredient in private equity's secret sauce

Why the best CEOs are not the charismatic and articulate leaders we see in movies

What makes the job of a private equity CEO among the most demanding in the world

Nine key qualities to look out for when assessing CEOs for private equity businesses

How you can apply the latest best practices in your assessment of management teams

Chapter 7: Analyzing the Business Plan

Key Topics:

Why skilled investors explore business fundamentals before diving into the numbers

Key problem areas to spot immediately in every business plan you review

How to poke holes in overoptimistic projections and make your investment case add up

Ten cold, hard questions that every solid business plan needs to address

My trusted business plan tool: Master List of Most Common Drivers of Value Creation

Chapter 8: Valuation

Key Topics:

Enterprise value, headline price and cash consideration: why they are each different

How experienced investors use flawed valuation methods and still get to the right answer

Seven valuation metrics and six valuation methods I like (and hate) to use

Two valuation approaches for those times when you find difficult to value companies

You've done the valuation: How much will you pay to win the deal?

Chapter 9: Deal Structuring

Key Topics:

Capital structure considerations: what type of leverage to use and when it is too much

Management Incentive Plans: target A, reward A and achieve A

Enhance your deal through earn-outs, earn-ins, escrows and vendor loan notes

Minority deals: negotiate robust exit rights or be held hostage by majority owners

Advanced deal structuring techniques for minority investments

Chapter 10: Deal Execution: Transaction Process and Due Diligence

Key Topics:

What to expect in a typical private equity transaction process

Don't boil the ocean: ten principles of a well-managed due diligence effort

Who does what and why you need it: an anatomy of the key due diligence workstreams

Chapter 11: Deal Execution: Legal Documentation

Key Topics:

Why you don't need to be a lawyer to provide valuable input in legal negotiations

How to translate due diligence findings into legal clauses in the deal documentation

My cheat sheet summary of common issues in the key transaction agreements

Chapter 12: Adding Value Through Active Ownership

Key Topics:

Develop your own success formula with a Value Creation Plan

Four value-accretive actions for every portfolio company to consider

Create powerful performance improvement momentum with a 100-Day Plan

Governance and reporting: strategic priorities of a well-run private equity board

When things go wrong: spot the first signs of company distress and take radical action

Chapter 13: Exit Strategies and Deal Monetization

Key Topics:

How to exit a minority investment (effortlessly)

Exiting a majority transaction: Should you time the market?

Conventional exit routes: an IPO, strategic sale or sponsor-to-sponsor buyout

Can't exit your investment? Alternative deal monetization strategies to the rescue

The finishing touch: exit preparation roadmap for every portfolio company

Acknowledgments

I owe a debt of gratitude to my family, who supported me throughout my book-writing journey and helped bring this project to fruition. A warm thank-you to my wonderful husband Frederik, who was the first reader of every chapter in the book (not always entirely by choice). I would also like to acknowledge the invaluable support of my children, August and Daria. Thank you for coming with me to my office during numerous weekends and inspiring me to persevere during challenging times. I also would like to thank my sister Julia, my parents and grandparents for instilling me with a strong work ethic and teaching me the importance of critical thinking.

I am fortunate to have an extraordinary group of friends, many of whom encouraged me to write this book and provided constructive comments on my manuscript: thank you, Stefan Loesch, Oksana Denysenko, Helena Clavel-Flores, Irina Grigorenko, Vittoria Stefanello, Leopoldo Carbone, Julia Shur and Oksana Tiedt. In addition, I am grateful to Lee Barbour for delivering first-class editing support, and to Emma Stefanello and Michael Majdalani for providing excellent research assistance.

I would like to express my gratitude to Eli Talmor, Dirk Donath, Giampiero Mazza, Joshua Rosenbaum, Joshua Pearl, Alex Emery and Ted Berk. Each of these highly accomplished individuals were kind enough to read my book and provide me with their personal endorsement.

A special thanks to everyone in the Wiley team who assisted me in making this book a reality: my acquisitions editor, Bill Falloon, my assistant acquisitions editor, Samantha Enders, my managing editor, Purvi Patel, and my Editorial Assistant, Samantha Wu.

Finally, I would like to say thank you to a long list of brilliant work colleagues who taught me everything I know about private equity and dedicated their time to developing my investment acumen early in my career. I can't name you all, but you probably remember the long hours we worked together and know who you are, folks. Thank you!

About the Author

Tamara Sakovska is a private equity investor, board director and the founder of Lavra Group. She has over two decades of finance and investment experience gained at Goldman Sachs, HarbourVest Partners, Warburg Pincus, Permira, Eton Park and Global Family Partners.

Tamara's investment experience includes originating, leading and executing leveraged buyouts, minority and control growth equity transactions as well as private investments in publicly listed companies. She has also invested in private equity funds-of-funds and structured strategic co-investment partnerships with institutional investors, corporations and ultra-high-net-worth family groups. During her investment career, she has gained in-depth, global transaction experience across 14 countries in the technology, telecommunications, energy, natural resources, real estate and consumer sectors, among others.

Tamara is a tenured board member with a strong track record of managing complex strategic and corporate governance issues in both publicly listed and private companies. She has extensive corporate governance expertise, holds a Diploma with Distinction in Company Direction, is a Chartered Director and a Fellow of the Institute of Directors (UK). In 2018, Tamara received the Director of the Year Award in the Chartered Director category. She currently serves as an Independent Director and Chair of the Nominating Committee on the boards of two public companies listed on the London Stock Exchange and the Nasdaq, respectively.

Tamara holds an MBA with Distinction from London Business School (UK) and a BA with Honors and Distinction in Economics and Art History from Stanford University (USA), where she graduated Phi Beta Kappa and received the Anna Laura Myers Prize in Economics.

1

First Thoughts on Deal Sourcing

Key Topics in Chapter 1:

Why deal sourcing remains an obscure field

Six action steps to take today to enhance your deal origination prowess

Proven deal sourcing strategies and the search for the mythical proprietary deal

How to assess your current deal sourcing capabilities

Key trends to look for now to spot future private equity deals ahead of others

Introduction to Deal Sourcing

Private equity begins with finding a suitable investment opportunity. Preferably, a great one. The first three chapters of this book discuss exactly that—the process of finding a private equity deal that represents a perfect fit for your investment mandate. In my personal experience, I have found this to be a tedious and frustrating process. Why? The private equity industry has been operating for nearly half a century, yet there is no one source that educates others in a granular and systematic way about how to build a solid private equity origination capability. Therefore, I set out to put my own detailed thoughts and experience in writing in order to share my perspective with others about this complicated process. My aim is to be as thorough as possible so that, after reading these first three chapters, you will walk away with a couple of solid and useful frameworks that will positively transform your deal sourcing outcomes.

Let's begin.

Why is understanding deal sourcing important? There are two primary reasons. First, creating and sustaining a flow of high-quality deal ideas is one of the core competencies of a successful private equity professional. This competency resonates very closely with the perceived brand of every private equity fund and, eventually, with your personal brand. Every limited partner (LP) investing in private equity funds is looking to identify a team of rainmakers who can demonstrate that they are capable of developing differentiated investment themes, finding sustainable sources of deal flow and closing successful transactions. As you get more experienced in private equity, the people you report to will increasingly expect you to originate your own deals proactively.

The second reason is that deal sourcing—while being critical to investment success—remains remarkably obscure. There is extremely little written specifically about private equity deal sourcing and how to master it. The books on private equity that I have researched seem to include only a high-level discussion of this topic. If you are interested in private equity, chances are you regularly come across articles in the trade press discussing the challenges of finding a good deal. If you have attended private equity conferences, as I have, then you've also heard a good number of deal origination war stories. However, I wasn't able to find a single resource that sets out a detailed private equity deal origination framework in one place. Hence, I believe I can make a contribution to this area with my deal sourcing guide.

In my research, I was able to identify only one study, conducted by Teten and Farmer (2010), analyzing deal sourcing strategies across the private equity industry and outlining a number of actionable steps aimed at improving the deal origination process. Unfortunately, I could not use the valuable lessons of this study in my own career because this research was published many years after I had been tasked with originating my own private equity transactions. In the study, the authors reaffirm the importance of deal sourcing in private equity: it turns out that late-stage venture capital and growth equity investors with proactive origination programs are almost all top-quartile performers across stage, vintage and sector. This makes sense. You can now understand why LPs might be very interested in examining your firm's deal sourcing process in agonizing detail.

When I started my first private equity job at a firm focused on large leveraged buyouts (LBOs), I found the process of deal origination and initial review fairly exciting. It was great to think through numerous business models and admire new ideas. However, it was also extremely exasperating. I was a member of the consumer team and it was not unusual for us to analyze over 100 large buyouts a year, bring 10–12 deals to the investment committee and work on three or four full deal execution processes in order to close just one transaction that year.

Yes, you read that correctly: the goal of my team was to review over 100 potential deals in order to close one deal per year. If you are lucky enough to complete one transaction a year, you are right on track! Sometimes, even this modest goal was out of reach. For example, when a target company was sold through a highly competitive auction process, our team would often not be chosen as the preferred (or highest) bidder. This means that there were years when we, as a sector team, would close no deals at all. Yes, we would still review over 100 potential deals that year and close zero. Talk about a low-energy Christmas party.

This is a rather frustrating, yet typical, fact in private equity: a lot of work goes into deal sourcing yet there is no guarantee of a successful outcome. Sometimes several years will pass from your first meeting with the management of a potential investment target to the time they are ready to consider a transaction. Sometimes the company will even go through multiple rounds of ownership until the management team is prepared to meet with you again. Sometimes the company shareholders are finally ready to accept a private equity investment, just not one from your firm! However, the stars do align at some point and, with perseverance, you can manage to get a private equity transaction to a final close.

What influences the successful outcome of sourcing and closing a private equity transaction? If you had asked me this at the beginning of my private equity career, I would have said that there was a fair degree of randomness and luck in this process. It is about being connected and about maximizing your options by doing 1,000 things to cover more ground. And being in the right place at the right time. And balancing cold-blooded investment analysis with the animal spirits of a competitive auction. Back then, I would have said serendipity deserves its fair share of credit, too.

Would I give the same answer now? Actually, I would not. I no longer think of sourcing and closing transactions as a game of chance. While the rules of probability do apply to finding good deals, I think there are steps that you can take to skew the odds in your favor. Sometimes significantly. Depending on what your competitors are doing in your sector or country of focus, you can definitely enhance your deal origination prowess by a considerable margin. I have certainly seen this in my own efforts of sourcing private equity transactions.

First, let's take a look at a broad overview of these action points and then I'll delve into each one in more detail.

Commit. Make deal origination an institutional priority and aim to create a sustainable long-term competitive advantage both for yourself as an investment professional and your firm through sourcing high-quality investments. This means dedicating time to deal sourcing throughout the year even when it seems like there is no time for it.

Organize chaos. Deal sourcing is tricky because it is an informal process that involves many variables. Decision-makers change their minds. Companies get taken over by strategic investors and cease to be private equity targets overnight. What can you do when things seem out of your control? Attack the mercurial nature of deal sourcing by turning your reactive activities into a number of intentional and predictable routines. Systematize your efforts and turn them into a framework. Focus on perfecting your deal sourcing process and do not pay excessive attention to interim outcomes. A better process will eventually lead to superior results.

Conduct deep industry research. Create a unique information advantage for yourself and your team by developing expertise in a couple of industry subsectors. Make sure you build a detailed knowledge base in these subsectors, generate your own insights and initiate a flow of proprietary deal ideas. How do you do that? I have spent many late nights leading various industry deep dives and have developed my own framework for tackling this exercise. I will share these tactics with you later in the book.

Prepare your firm to move quickly. Institutional agility can be a remarkable advantage, especially in a highly competitive deal environment. It is important to provide regular updates to your firm, especially your investment committee and key decision makers, on the main investment themes that you are working on. The goal is to get as much support as possible and ensure that everyone is aware of the detailed knowledge your team has acquired through deep research. One of the best ways to do this is for your team to develop and share their proprietary analysis of a sector with the rest of the firm. That way, once you identify a suitable deal in this industry, your investment committee should already be warmed up. They will trust your team to come up with a differentiated deal angle, giving you the ability to move forward with confidence and progress the deal ahead of your competition.

Develop an efficient deal sourcing process. Take a step back and identify the areas of your deal sourcing process where most of your time is wasted. Does it feel like you are busy creating too many options by doing 1,000 things? Are you attending too many meetings with intermediaries who miss the point of your mandate and bring deals that make no sense? Is your deal sourcing network fully optimized? Are your meeting notes well-organized, searchable, synchronized and easy to access, both in the office and remotely?

Once you have had an opportunity to reflect, try to come up with ways to streamline your deal sourcing process. Aim for the end result to resemble a clock with a precise Swiss movement. Instead of doing 1,000 things to cover more ground, reduce your efforts to the 10