WS7. private equity PDF

Preview

Summary

WS7. private equity...

Description

7. PRIVATE EQ UITY Private equity – risk capital provided in a wide variety of situations, ranging from finance to business start ups to the purchase of large mature quotes companies and everything between, usually failing private or public company to make them better. Then reap the rewards ×

Could asset strip it- sell of the assets may be left with a failing company

PREP 1 1. Briefly outline what you understand by the phrase “private equity fund” and how, in general, investments in a private equity fund differ from ordinary investment funds which invest in FTSE 350 companies.

-

pool of money that is to be invested – money can come from a variety of sources such as particular individuals or companies – pension funds, banks and insurance companies to make profit via a team of investment managers

-

Private equity fund = an actively managed collective investment vehicle that invests almost exclusively in securities which are not publicly listed or traded or which will cease to be publicly listed or traded after an acquisition by way of a public to private transaction.

-

collective investment vehicle that invests in the securities that are not publicly listed higher risk but higher reward short life span greater risk – locking money away for a long time will usually have a statement as to the type of investment it will be aim to make profits through investing into private companies how successful the fund is depends on the reputation of the private equity house to make successful

Why is it structured like this?

-

Tax transparent for the investors – when disposing of share if you are an individual you can claim entrepreneurial relief reducing it to 10% (don’t want it to come in as income tax) Management team will be tax payers Investors want to keep Management motivated

Rather than FTSE 350 shares?

2.

350 are bought and sold easily whereas private funds are locked away for longer tax reasons; entrepreneurial relief the scheme is structured in a way to keep liability limited those paying CGT will be reduced or exempt FTSE- there is less risk

Most private equity funds have until now been structured as Limited Partnerships.

(a) Briefly outline the advantages for investors of this business medium and how the investment would be structured as a result.

-

-

A potentially high risk may be matched with a high return Typically the private equity fund will delegate its investment management duties to the private equity fund manager, benefitting from the expertise of the private investment professionals Investor is putting its money in so they wont be taking an active role they have limited liability to the amount they actually put in Easily to wind up/ less admin

-

Tax transparent – Not subject to corporation tax. Individual partners will be taxed. This is the main reason why the fund is structured as a partnership.

-

PFLP- there is a limited list of activities that they can get involved in without losing LL

-

The advantage for the investor is they’re putting money in; they’re not going to be taking an active role they will have only limited liability to any amount of capital they have put it. They no longer have to put large amounts of capital in at all, and the structure – it’s flexible, tax transparent, relatively private and it is structured so that money coming out of the scheme comes out by way of Capital Gains.

Structured: Two categories  General Partner (‘GP’).  Will have management control, and unlimited liability. And the GP may manage the fund itself, but more usually it delegates management functions to another manager which is a limited company. - This chain of limited companies is typically what we mean when we refer to PEH.

 Limited partners (There will be several).  These are passive investors without active management rights. (One of these passive investors in the fund, is the Chartman partnership.  Will have limited liability.  The limited partners invest in the fund, they invest in response to what’s called a term sheet/info memorandum (example in the materials).  Their investment unlikely to be called up in one go, good thing for investors because they don’t have idle cash lying around, so investment of limited partners not usually called up in one.  The partner, Chartling – looks around for investment, deals at fee earner level, and then general partner will make investigations as to the private company there planning to invest in. Then eventually the investment will be proposed to an investment committee, when approval has been given, that means that all the solicitors and accountants can press ahead, which takes a few weeks. When the investment committee approve a particular investment, then manager in the fund, will set up an investment vehicle to make the investment.  Investment vehicle setting it up – means instructing fee earners, and solicitors. This means setting up 3 NewCos, they will be sitting on the shelves, and the trainee will get these 3 Newcos ready, so the investment can be made. (b) Describe the main changes introduced by the Legislative Reform (Private Fund Limited Partnerships) Order 2017 and how these changes benefit investors in private equity funds.

-

-

3.

created a new class of limited partnerships- private fund limited partnerships these are subject to a simplified statutory regulatory regime, making them the most suitable vehicle for the majority of modern transactions make it clear what a limited partner could and couldn’t do don’t have to put capital in the scheme- they can loan the money instead of putting it as a capital contribution

Briefly outline the usual means by which investors in private equity funds get a return on their investments (in respect of both capital returns and income) and any factors that may affect the rate of any capital return on their exit from the investment.

-

-

Income – dividend Or Capital Money goes back up the scheme and youll be paying off your debt and money will keep flowing back up the scheme and eventually it will go up the limited partnership when youre breaking up that limited partnership, closing it down then effectively you’re looking at gains Leverage buy out: high level of debt into equity, security over assets Management buy out

 Capital Gains  Very key point is that when portfolio company is sold, the intention is that there has been a capital gain made on the value of those shares, the return of the fund , so when portfolio is sold, the return is focused on mainly on capital gains (increase in value). - So, Investors will put their money into a low running business, and then get capital returns from selling their shares from a much higher price than they originally purchased them from.  Process of making the gain: Money goes back up the scheme, you’ll be paying off your debt, and money will keep flowing back up the scheme and, eventually it’ll go up to the limited partnership when you’re breaking up that limited partnership, closing it down then, effectively you’re looking at gains.   Income  Dividends are declared and paid  Interest on a loan – PEH is putting in a loan note of 36 million, so there will be interest on loan note. What may affect rate of any capital return?  Most private equity transactions, including the one in our task is a leveraged buy-out, often there will be a large amount of borrowing, and a relatively small amount of equity.  When large amount of borrowings, and small amount of equity, that gives you a high percentage return, because most of the gain, relates to that small proportion of equity or shares. So large borrowings and small equity results in high percentage return, matters to PEH they like to publish their rates of return.  Return depends on the nature and risk of investment  ‘Debt capacity’, so how much are banks and lenders prepared to lend, and how much security for the debts available.

4.

Provide simple explanations of the following words and expressions as they are used in the world of private equity.

Leveraging

-

Another way of borrowing- high level Will put less money in, high risk but can be greater reward

Leveraged buyout

-

Buyout that is largely debt financed

Management buyout

-

you're putting in a significant level of debt to equity. You are having the lenders coming in and they're taking security over the assets

Is a transaction by which the target is acquired some or all of its management usually through the vehicle of a new company established for this purpose

is often where you have got the managers themselves going to the BVCA - the British Private Equity & Venture Capital Association - and they are looking - the private equity houses - who would come in and put money into the company to make it better Public to private transaction

Captive fund

-

that's where you are usually acquiring an failing public company,

-

typically banks, insurance companies, pension funds ect

-

converting it into a private company so that there's not so many corporate governance rules and you can have more freedom to do what you want to make that company better.

-

that's somebody like Barclays or Lloyds, as opposed to a mixed fund where you've got a variety of different institutional investors. It didn't say this, but senior debt obviously it should have been in that list. Those are the lenders who are committing a considerable amount of money to be used for the private equity purposes, they'll get a high rate of interest and it will be secured over the assets of anything that moves within the structure, including the assets of the target.

BVCA

Senior Debt

- British Private Equity & Venture Capital Association - a source of funds, and it's just the trade organisation.

Mezzanine debt

-

Secondary debt after senior But ahead of any other lenders egunsecured creditors Often enter deed of priority with senior debt

-

First ranking priority when repayment occurs

Equity investor loan

-

Loan provided by the investors Terms are similar to mezzanine debt

you have maybe one of your institutional investors is also lending money to the scheme.

will get an even higher rate of interest, but that's because they have an unsecured - often - or lesser security loan that they have made, tends to be more like a revolving credit facility, and they will have the ability - with an equity kicker, usually just for the mezzanine debt providers - to convert a bit of their loan into shares to take advantage of capital growth of the scheme

Sweet equity

-

Incentivise to work hard and grow the company

Equity kicker

-

The option to buy shares

that is the element of giving the directors or the managers put in by the private equity house in the target company, keeping them motivated and driving that target company to better and better performance. That sweet equity is shared in the top company, they all want a share of the top company, where all of the money flows back to

Good leaver / bad leaver Good leaver: somebody maybe who is resigning due to ill health or they've been unfairly dismissed, it could even be that they've died and the shares have passed to the personal representatives, so they've left through no fault of their own and the personal representatives would be able to realise the investment of those shares without penalty A bad leaver would be somebody who would just be leaving because they want to move, they want to move away from the structure or they've been dismissed or bankrupt. And so they would either totally forfeit their shares or would only be able to get a small proportion of the value.

-

If they become a leaver they have to sell their shares The price will depend on the type of leaver- good or bad?

Drag along/ tag along rights

-

-

Forcing management to sell shares drag-along rights says when the decision is made to sell off the shares people who don't want to sell are dragged along anyway, they are forced to sell because the buyer would want to acquire the entire company. And tag-along rights are the reverse.

PREP 2 Based on this information, annotate the diagram (overleaf) to show all the parties to the proposed transaction and indicate the key documentation that will govern their respective relationships. (add slides in email of the structure) 1. Key documents: normal acquisition with add on:  Seller - don’t know who it is selling the target. Bidco is the buyer.  Investment agreement  Limited partnership agreement  There will be a SPA disclosure letter  Due diligence report  Tax deed  Confidentiality agreement  Sale and purchase agreement  Disclosure letter  Board minutes

Extra things: Investment agreement (Subscription and shareholder agreement)  Parties:  4 directors  Top Co  Private equity shareholder NB: Bank is NOT a party to the agreement 2. Articles of Top Co  We have a whole range of private limited companies that we will be creating, and setting them up with Articles of Association  Will have the ability to create different forms of ordinary shares  Redeemable preference shares.  Loan notes  Will have different rights attached like good leaver/bad leaver, drag/tag along.  Sweet equity.  In relation to the Target you would be changing the articles of the Target to be consistent with what Private Equity House wants, and if you had crucial directors who were involved in initivive business, then you would want service contract, and restrictive covenants.

3.

In relation to the debt companies Loan documents from Big Bank Mezzamine loan agreement Security document eg debentures Loan notes Intercreditor deed

    

Private Equity- the exit strategy? -

Timing- historically PE would be kept in for 8-10 years

-

They spread the risk within portfolio companies, some will excel and others will fail (you would be looking at it overall so there is less risk)- new development of taking money out with less penalty Many forms of exit, including sale to secondary market, listing, sale to private buyer Normally Private Equity House and the institutional investors gives no warranties when exiting (buyers relies on extensive due diligence)

-

How do you get your return then? -

When you get to the end of period you sell of part of structure and the money is pumped back up the back structure Paying people along the way and will eventually end up in the hands of the limited partnership, the investors and PEH will take out their money in gains When it goes up you pay senior debts, then mezzanine (could convert loan into shares), then preference shares, then any money left it distributed between ordinary shareholders

-

Order: External liabilities 1. Senior debt 2. Mezzanine debt Internal liabilities 3. Loan notes 4. Preference shares 5. Any remaining money will be distributed between ordinary shareholders

TASK 1- WONT BE ASKED FOR CALC IN EXAM

1.

purchase price of £160 million 39.6 million for shares £36 million loan notes – repaid 120 million senior debt – 19.1 million outstanding £20 million credit facility by Bartok – mezzanine debt Outline what return the respective parties would receive in the event that the venture is successful and is sold after 5 years for £330 million; and

£330million sale, then deduct in this order: 1. Senior debt - £70 million 2. Mezzanine debt - £19 million (£100,000 used as equity kicker) Left over= £241 million 3. Loan notes

-

£36 million (£205,000,000)

4. Then work out how many shares there are - Remainder of shares of ordinary shareholders= 205 million

-

3.6m A shares + 400k B shares + 100k equity warrants = 4.1 million shares. massive return of £50 per share

2. Outline what return the respective parties would receive if the venture fails and is sold for £90 million. 90 million sale, deduct in this order: 1. Senior debt - 70 million 2. Mezzanine debt - 19.1 million (no conversion to equity warrants) Available for Internal distribution

-

900,000 only

Loan notes (36m – so 35.1m unpaid) no all loan notes will be paid No Return for Ordinary s/hrs

The key thing is the entire portfolio, as there will be a variety of risk (& reward) between companies

TASK 2



XYZ Fund (the “Fund”) - £39.6 million, acting through Chartling (as general manager/partner of the Fund) and comprising a subscription for 3,600,000 A ordinary shares of £1 each and 36,000,000 Loan Notes of £1 each (each subscribed at par value).



The four directors of the Target Company (the “Managers”) - £400,000 comprising a subscription for 400,000 B ordinary shares of £1 each (each subscribed at par value).

Prepare a note of the substantive provisions that they would want in the documentation and why?

1. Conditions Precedent  Sets out the events that must have happened before the equity private fund are willing to invest in  Details on the subscription of shares  All committed at same time - All documents we have discussed, will be conditional upon all the others completing. All documents, acquisition document investment documents, and bank documents all complete at the same time, and will be expressed to be conditional on each other, no-one wants to invest without the other parts being done.  Deed of Adherence (Accession) - Anyone coming in has to sign up this agreement. The debt, lenders all institutional investors will all be committed. - If anyone transfers shares, then that person needs to enter into this. - How can they transfer? Chartling could transfer because remember syndication rights so can transfer to another investor, so investor enter into deed of adherence - Management team may be allowed to make some transfers – for tax planning purposes they get 100k each, if they exit and get millions, they will have massive CGT, normal to allow them to transfer some, but not all of them to spouses, or family trusts, as that limits tax, those transferees will have to enter deed of adherence to be bound by investment agreement  Compliance (of all company Article’s in the structure)  Insurance (including keyman insurance if applicable)  Remaining management new service contracts (with restrictive covenants) - New service contracts for the 4 directors. - Will have restrictive covenants – (articles and investment agreement). If management leave, they will be tied by restrictive covenants, so they can’t just go to another competing Co, it done to tie them in and not let them leave.

2. Terms of Investment  How much will be invested and the class of shares  NOT details of individual investor’s investment  Type of investment: loan notes, redeemable preference shares, ordinary shares (subordinated to debt) - Chartling with have A ordinary

- 4 management have 100k ordinary B shares.  Amount of Investment - Overall of the fund.  Commitment & Investment periods  Hurdle (projected return) rate - What the private equity house thinks it can get. Anything above that will be really good.  PEH fee structure Restrictions on PEH syndication - PEH puts some of their money, you don’t want the PEH to sell off. - There will ...