Private Equity Strategies

By Ascanio Rossini
Outline
1. What is Private Equity (PE) and what distinguishes it from other asset classes?
i. Definition
ii. Key Features
iii. Fund Structure

2. Private Equity Strategies

i. Strategy Classification
1. Early Stage: Venture Capital
2. Expansion Stage: Growth Capital
3. Maturity Stage: Buyout (LBO, MBO)
4. Decline Stage: Distressed Debt/Turnaround

3. Exit Events
4. Concluding Remarks
1. WHAT IS PRIVATE EQUITY (PE) AND WHAT DISTINGUISHES IT
FROM OTHER ASSET CLASSES?
i. Definition

Private Equity (PE) is an asset class falling under the alternative investments spectrum commonly involving…

1. Investments in equity securities and debt of companies NOT quoted on a public exchange (Baker, Filibeck,
Kymaz 2015).
2. Takes the form of a PE fund: a collection of investors – retail and institutional – that pool funds to invest in
ownership of a company with the aim of improving its financial performance in view of capital gains upon an
exit event (sale transaction).
3. PE funds tend to specialize in strategies that differ primarily on the basis of the stage of development (life-
cycle) of the company they invest in (i.e. Venture Capital, LBO, Growth Capital, Mezzanine…)
4. A transformational, active investment strategy calling for highly specialized skills by the investment
manager whose only aim is to create VALUE, without hesitating to align the management of the targeted
company with that objective.
iii. Key Features
High Risk – Potentially Investments promise above-average real adjusted returns to compensate for the
High Return many risks committed capital is subject to.

Performance Driven Performance is the consequence of a strong alignment of interests between i)

Incentive System fund managers (GPs), ii) management teams of the portfolio companies, iii) the
investors in the fund (LPs)

PE must create value by providing resources to firms, being responsible owners

Active Value Creation
and actively supporting management to improve company outlook.

Confined Investment Investment power is confined to the fund manager (GP), once the capital is
Power committed investors have no say in the investment process.

Flexibility as a Strategic Extreme flexibility and creativity allows funds to harness emerging opportunities
Value and capitalize on new markets and varied strategies.
 iv. Fund Structure
Typical Structure of a PE partnership
i.e. Pension funds, Insurance Companies, HNWi, Sovereign Wealth funds, Family Offices, endowments, FoF.

Limited Partner LP Limited Partner LP Limited Partner LP

General Partner GP …
A B C

GP Ownership

Fund Ownership

Fund Management
Co-investment
Private Equity Fund

Portfolio Company 1 Portfolio Company 2 … Portfolio Company 3

2. PRIVATE EQUITY STRATEGIES
i. Strategy Classification

PE has developed an incredibly wide array of specialized funds with investment strategies characterized according to:

• Stages of Investment (Company life-cycle)

• Geographic focus
• Sector and Size of Investments
• Strategic approach

We will analyze and compare investment strategies on the basis of the Stages of Investments, with reference to the
stage in the development life cycle of a company.
Source: Cumming, Johan 2009
Revenues

1. Early Stage 2. Expansion Stage 3. Maturity Stage 4. Decline Stage

Time
Strategy Classification cont’d

Early Stage Expansion Maturity Decline

Venture Capital Growth Capital Buyouts Turnarounds

• Investments in early • Investments in fast • Natural slowdown in • Firm experiences

stage activities growing companies growth, peak in terms difficulties and
targeting young with realized profits of financial stability, declining revenues.
companies often with that need money to good cash flows and • Investments are made
a tech component and grow. little investment req. with a view to re-
high potential for • Capital usually goes to • Investment at this stage establishing prosperity.
growth. increasing PC, internal look for ‘management
• VC invests in target restructuring buy-outs’, where new
startups before their (market/product owners can create
true revenue potential development) or goes opportunities for
has been validated. to financing an growth or even turn
acquisition. around companies

Venture Capital Growth Capital Buyouts Distressed Debt/Turnarounds

• Seed Capital • Replacement Capital • MBO • ‘Distressed-to-Control’
• Start-up Capital • Bridge financing • LBO • ‘Loan-to-Own’
• Venture Growth Capital • PIPE • Mezzanine • Rescue Financing
• Angel Investors • RD
1. Early Stage
Strategy What is it? Pros Cons
• Specialized minority • Highest potential for • Commercial
equity investments in above-average returns. uncertainty, betting on
young, small • Usually initial capital potential.
companies. commitment is small • Cash flow unreliability,
Venture Capital • High-risk/high-return (i.e. seed and startup) sometime may not
due to potential that although some tech even be profitable
has not yet been developments may businesses.
Seed Capital funds
validated. require large amounts. • Tend to be small size
Start-up funds • Generally involves a • High in growth investments accounting
VG Capital funds new technology, promoting economic for a relatively small
Pre-IPO concept, business development and job portion of the equity
model. creation. (10-20-30%).
• Large say in
management and
business operations.
2. Expansion
Strategy What is it? Pros Cons
• Minority equity • Relatively ‘safer’ w.t.p • Requires extensive
investments in quickly VC since companies work in system’s
growing, relatively have already development, heavy
established companies demonstrated their recruitment of
to help support further ‘pull’ and are mature management team,
growth. enough. investment in
• Companies that • These deals tend to production, build up of
Growth Capital or
generate revenues and require less money advertising etc.
Growth Financing
operating profits but than buyout deals.
without sufficient • Popular in emerging
capital to pursue markets where
Growth Capital Funds transformational businesses don’t
changes. always have access to
• Capital goes to expand, capital from banks or
restructure operations, from capital markets.
enter new markets or
finance a major
acquisition W/O a
change of control of
the company
3. Maturity
Strategy What is it? Pros Cons
• Provide capital to mature • LBOs involves debt • Leverage is beneficial
companies with stable which is often non- since it limits
revenues and some recourse to financial committed capital, but
further growth or sponsor and has no if buy-out and exit
efficiency potential. claim on other goes wrong the loss is
• Buyout funds hold the investments managed amplified by the
majority of the company’s by the fund. leverage.
Buyout;
AUMs. • The investor itself only • Large operations
• LBO: Most of them needs to provide a involving very large
Leveraged Buyout LBOs
Management Buyout MBOs
acquire large stakes via fraction of the capital firms that can take on
Management Buy-in MBIs borrowed funds! for the acquisition. big debts, preferably at
Leveraging the investment • The returns to the cheap interest.
with up to 60-90% debt investor will be
financing. enhanced as long as
the ROA exceeds the
cost of debt.
• Lenders can insure
themselves against
default by syndicating
the loan by buying CDS
of CDOs.
4. Decline
Strategy What is it? Pros Cons
• A type of financing to • Distressed financial • Risk of not being able
companies that are situation may favor the to reverse the
experiencing financial stress PE fund, in that it can financial distress.
that may range from acquire it with very
Distressed Debt and declining revenues to an low multiples cheap
Turnaround unsound capital structure or equity creating a good
an industry threat. investment
• Control-oriented approach: opportunity (assuming
PE firm acquires debt that it can then exit).
Control-oriented Approach
Turnaround Approach
securities of the company to
have control over
restructuring or bankruptcy
procedures.
• Turnaround approach: the
PE fund will attempt
restructuring by investing
new equity and take control
of the company.
3. EXIT EVENTS
Wide held perception is that successful PE investments are normally exited through flotation on the stock
markets, IPOs but in reality these only account for 16% of European buyout exits (EVCA: 2012).

The most common exit route for buyout and capital financing are TRADE SALES:
 In a trade sale, private equity investors sell off all of their shares held in a company to a trade buyer.
i.e. a third party often operating in the same industry as a company itself. This method is preferred by
the investor because it provides a complete and immediate exit from the investment.

Other exit events include:

• Secondary Buyout
• Sale to Management
• Leverage recapitalization
3. CONCLUDING REMARKS