© 2021 Viney Sawhney

Private Capital Investing

Private Equity – Private Debt

Introduction
Private Equity MGMT S-2790
Summer 2021 Session 1
Textbook Slides based on Private Capital Investing by Robert
Ippolito 2020 edition

© 2021 Viney Sawhney

Introduction Private Equity – Private Debt
Contents
• Description of the asset class
• Private Equity AUM
• Impact of COVID-19
• Company Life Stage
• Expected returns (IRR)
• Private Debt
• Terminology

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Introduction Private Equity – Private Debt
Private Equity
• Central pillar of contemporary financial system
Definition
• Private equity is an asset class consisting of equity
securities in operating companies that are not publicly
traded on a stock exchange
Asset class includes
• Buyout funds
• Distressed equity
• Expansion capital (growth equity)
• Quasi-Equity (mezzanine financing)
Private Equity is a critical component of modern finance

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Introduction Private Equity – Private Debt
Private Equity
• Private equity is the investment activity by institutional
investors in the equity capital of non-listed companies
• Goal of the investment is to increase the value of their equity
• Equity value is increased through the following:
• Operational improvements
• Cost cutting
• Financial engineering
• Changing management
• Consolidation
• Divesting parts of the target firm
• Ultimately, investors sell / divest the equity within the medium /
long term

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Introduction Private Equity – Private Debt
Private Equity
• Although private equity investments are viewed as being
considerably more risky than equity investments in public
markets, sophisticated institutional investors have been
committing increasing amounts of financing to private equity
• Private equity has become and accepted element of most
diversified institutional investors
• Investors in PE funds expect to receive returns of 5% to 10%
higher – calculated on a comparable levered basis – than
they might expect to receive from public securities

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Introduction Private Equity – Private Debt
Private Equity AUM reached $4.418 trillion in 2020, driven by
• Low interest rates
• Abundant dry powder fuel deal activity
• Despite a pause in Actual Forecast
growth in 2020 caused by
the coronavirus
pandemic, strong
performance is expected
in 2021
• Net inflows into the PE
are expected to drive a
global growth rate of
AUM of 15.6% over the
next 5-year period
Source https://www.preqin.com/insights/research/blogs/private-equity-aum-will-top-9tn-in-2025

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Introduction Private Equity – Private Debt
COVID-19 Has Not Dampened Investor Appetite
• Preqin’s Future of Alternatives 2025 survey shows
• 23% of respondents expect to significantly increase allocations to private
equity by 2025
• A further 56% planning a slight increase
• Just 4% of respondents were planning to decrease allocations
• Preqin expects this capital to flow into a smaller number of larger funds
• This trend was well established going into the COVID-19 crisis:
• Average buyout fund sizes increased from $765mn in 2017 to $1.3bn in 2019
• Annual number of funds closed dropped from 299 to 246
• The pandemic has since presented LPs with operational challenges in
the form of remote due diligence, so capital concentration is likely to
accelerate as LPs stick to managers that they know
• This makes for a challenging environment for emerging managers
raising capital
Source https://www.preqin.com/insights/research/blogs/private-equity-aum-will-top-9tn-in-2025

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Introduction Private Equity – Private Debt
COVID-19 to Accelerate Existing Sector Trends
• Pandemic has accelerated a number of industry-specific trends that
GPs are likely to remain focused on:
• E-commerce
• Online grocery
• EdTech
• Technology-focused strategies will tap into these key themes, with
growth and venture capital funds likely to attract significant attention
• Negative forces in the PE and VC markets over the coming five years:
• Barriers to trade
• Geopolitical landscape
• Regulation
• Domestic politics
Source https://www.preqin.com/insights/research/blogs/private-equity-aum-will-top-9tn-in-2025

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Introduction Private Equity – Private Debt
Asia Set to Light up Global Private Equity
• Ongoing developments in capital markets in China are expected to lead
to rapid growth in the PEVC industry in Asia-Pacific over the next five
years
• China’s growth comes as it continues to move away from more opaque
financial products in the shadow financial system
• Moves toward a more formalized investment industry are positives for
China’s growth
• However, the extent of cross-border GP-LP flows may be curbed in both
directions if international relations between the US and China continue
to deteriorate
• Risk are barriers to trade and the geopolitical landscape

Source https://www.preqin.com/insights/research/blogs/private-equity-aum-will-top-9tn-in-2025

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Introduction Private Equity – Private Debt
PE Deal Volume Expected to Rise in 2021
• Private equity managers are
optimistic about deal-making and
exit activity in 2021 and are gearing
up to spend unallocated capital
after a 2020 second quarter jolt and
the subsequent onset of recovery
• The second half of 2020 has shown
that deal-making will continue -
Ross Allardice, partner, Dechert LLP
• There is "a ton of dry powder out
there," and Allardice believes deal-
making will continue to be strong in
the first half of 2021
https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/pe-deal-volume-expected-to-rise-in-2021-more-pricing-certainty-anticipated-61775053

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Introduction Private Equity – Private Debt
Private Equity Firms
• Apollo Global Management
• Bain Capital
• Blackstone
• Carlyle Group
• CD&R
• KKR
• Silver Lake
• Thomas Lee Partners
• TPG
• …

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Introduction Private Equity – Private Debt
Company Life Stage
• Companies tend to follow a similar path through four distinct cycles
• Start-up
• Costs tend to outpace revenue
• Share price is determined more by expectations of future growth than current
earnings
• Rapid Growth
• As the company grows, so can profits
• Early-stage investors realize returns on their investments
• Maturity
• Revenue and costs flatten
• Decline (or Rebirth)
• Companies in decline might be hanging on to outdated technology or a product
line whose popularity has diminished
• At this stage, a company might make a move—Restructuring—to reset the cycle

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Introduction Private Equity – Private Debt
Private Equity
• Various types of Private Equity
• Type of private equity investment is a function of the Life Stage
of the target company

Life Stage Type of Private Equity

Start-up Venture capital (early-stage financing)
Development Growth equity (development or expansion capital
Maturity Leveraged Buy Out (replacement capital)
Restructuring Distressed equity

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Introduction Private Equity – Private Debt
Private Equity course will focus on:
• Growth equity
• PE investors typically take a minority state in the target company
• Aimed at supporting development plans via organic growth
• Launch of new products
• Enter new markets
• Acquire competitors or complementing products
• Leveraged Buy Out (LBO)
• PE investors acquire a majority stake
• Financed by a mix of equity and debt
• Investor’s equity
• Bank debt
• High-Yield debt

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Introduction Private Equity – Private Debt
Internal Rate of Return (IRR):
• Metric used in financial analysis to estimate the profitability of
potential investments
• IRR is the discount rate in a DCF that makes the net present value (NPV) of
all cash flows equal to zero
• Due to different levels of risk
• Investors in private equity require different rates of return depending
on the particular type of investment
Type of Private Equity Required IRR (%)
Start-Up >40
Distressed Equity >35
Expansion Capital >25
Leveraged Buy Out >20
Quasi-Equity (Mezzanine) 15 - 20
Equity Distressed Debt 10 - 15

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Introduction Private Equity – Private Debt
Example: Internal Rate of Return (IRR)
• PE investor
• Creates projections of a target firms EBITDA and growth rate
• Structures the amounts of equity and debt investments
• Calculates IRR at various time periods after the investment
• The higher the IRR, the more desirable an investment is to undertake
Example Calculation of IRR
Given Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
Purchase Price of Investment $1,000,000,000
Equity Investment $250,000,000
Debt $750,000,000
EBITDA in year of Investment $142,500,000
EBITDA growth rate years 1 to 5 8.5%
EBITDA $154,613,000 $167,755,000 $182,014,000 $197,485,000 $214,271,000
EBITDA Multiple 7 7 7 7 7 7

EV of Firm = EBITDA x Multiple $1,174,285,000 $1,274,098,000 $1,499,897,000

Net Debt $750,000,000 $750,000,000 $750,000,000 $750,000,000 $750,000,000 $750,000,000
Equity Value $424,285,000 $524,098,000 $749,897,000

MoIC 1.7 2.1 3.0

IRR year 2 30% -$250,000,000 © 2021
0 Viney Sawhney
$424,285,000
IRR year 3 28% -$250,000,000 0 0 $524,098,000
IRR year 5 25% -$250,000,000 0 0 0 0 $749,897,000

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Introduction Private Equity – Private Debt
Multiple of Invested Capital (MoIC)
• Indicator of the return on investment
• Enables investors to measure how much value an investment has generated
• Assume the following investment and exit:
• Initial Investment (year 0)
• PE firm acquires a target company by making an initial equity investment of $250M
• Portfolio company borrows the remainder of the purchase price
• Exit (year 5)
• PE firm Exits at $1,000M - assume the portfolio company’s remaining (net) debt is $250M
Example Calculation of MoIC
Year 0 5
Initial equity investment $250,000,000
Exit Price for the Enterprise $1,000,000,000
Less Net Debt $250,000,000
Equity at Exit $750,000,000
MoIC = Equity at Exit / Initial equity investment 3.0

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Introduction Private Equity – Private Debt
Private Debt
• Financing activity by institutional investors in non-listed
companies
• Investment goal is to maximize returns through a combination of
fees and interest charges
• Like private equity, private debt is a function of different Life
stage of the company

Life Stage Type of Private Debt

Start-up Venture capital (early-stage financing)
Development Growth equity (development or expansion capital
Restructuring Distressed equity

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Introduction Private Equity – Private Debt
Types of Private Debt strategies from an Investor perspective:
• Capital preservation
• These strategies, like traditional sponsor-focused debt funds seek to
deliver predictable returns while protecting against losses
• Returns are primarily from cash pay coupons, pay-in-kind interest, and fees
• Equity style returns are generally not part of the transaction
• Return maximizing
• These strategies focus on capital appreciation through a combination of
income and equity-like returns
• Hybrid capital funds
• seek capital appreciation by using a mix of debt and equity
• Distressed credit investors
• seek to generate private equity-like returns by buying discounted loans or
bonds with the expectation of a par refinancing or a return-enhancing
negotiated settlement

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Introduction Private Equity – Private Debt
Private Debt
• Private Debt Financing by private debt funds of transactions where the
shareholder is a PE firm
• LBOs
• Direct Lending
• Financing by private debt funds of SMEs (small and medium enterprises)
• Use of proceeds is usually for supporting growth and expansion
• Required IRR is a function of the debt product / type of fund
Type of Private Debt Fund Required IRR (%)
Senior Debt (unlevered fund) 4-6
Senior Debt (levered fund) 6-8
Leveraged Buy Out funds 5-7
Mezzanine funds 8 - 12
Hybrid capital funds 10 - 15
Distressed credit funds 15 - 18

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