Lecture 1

1. Motivations for equity finance:

- Cash-oriented
- No access to debt market / limited exposure to bank loan due to risky investment as
young / small / mid-cap companies
- Compared cost of debt / cost of equity
- Large company with limitation on debt capacity

2. Types equity financing instruments:

- Preferred stock
- Convertible preferred stock
- Convertible loans
- Common share / with or without warranty

3. Private Equity:
(1) Key items in a pitch: problem / solution / product / business model / market
opportunity / competition / growth / traction / financials / team / funding
(2) Phase of entrepreneurial financing:
Seed – startup – Expansion – Bridge (prepare for an IPO / taken over by industrial
investors) – MBO / MBI
(3) Types of PE investors:
3Fs (family, friends & fools) / crowd-funding / business angels / (here become more
formal) incubators / narrow defined PE and VC
(4) Relationship: LPs provides money and GPs provides management
(5) Hierarchy: GP (received carried interest of net profits), Investment Manager (received
usually 2% of management fee), subadvisor (received transaction and monitoring fee)
(6) Divide the PE investors according to different criteria:
o Investment focus:
 Financing stage:
Seed / early stage (start-up) / growth-stage (expansion) / buyout
 Industry / business model focus
 Portfolio management:
Passive / operative involvement / financial engineering
 Location focus: regional / world-wide
o Fund type:
 Independent fund: Fund is backed by many different investors and
organizationally not linked to one of their investors, no one holds more
than 50% of shares
Stock market listing: money raised from the capital market
Limited partnership: private channel to raise capital
 Dependent fund: one investor with 50% + ownership
Captive fund: financial institution as main investor
Corporate fund: strategic investor as main investor
Dry powder: uninvested, yet, committed capital. It is a slang term referring to marketable
securities that are highly liquid and considered cash-like. Dry powder can also refer to cash reserves
kept on hand by a company, venture capital firm or individual to cover future obligations, purchase
assets or make acquisitions. Securities considered to be dry powder could be Treasuries or other
short-term fixed income investment that can be liquidated on short notice in order to provide
emergency funding or allow an investor to purchase assets.

Private Equity in a narrow sense, is dominated by Leveraged Buyouts (LBOs). “A leveraged buyout
(LBO) is the acquisition of a company, division, business, or collection of assets (“target”) using debt
to finance a large portion of the purchase price. The remaining portion of the purchase price is
funded with an equity contribution by a financial sponsor.” (Rosenbaum/Pearl (2009), p. 161)

(7) Investment cycle:

o General for Investors (LPs): fundraising – investor relation – distribution of
returns
o Portfolio Companies (or Buyout Companies): Investment origination –
investment due diligence – Investment structuring – investment development –
investment exit

Lecture 2

1. Comparison between VC and PE:

Typical stages VC: early, start-up, seed, growth, expansion

Typical stages PE: (expansion), later, late, buyout

(1) Similarities:
o Holding period 3-7
o Equity investment driven
o Same legal structure (GP, LP, etc.)
o Improve / scale-up to increase business value
o Invest Equity
o Enforce corp. governance
o Realize return through exit

https://technation.io/news/what-is-a-scaleup/

(2) Differences:
o Venture Capital:
 Minority equity stake
 Founders (GP) constitute C-level mgmt., hold significant stake
 smaller investment ticket
 very high risk profile, failures are part of investment strategy
 typical exit through IPO, trade sale or secondary transaction (esp. early-
stage VC)
 o Private Equity:
 majority equity stake
 larger investment amounts and use debt
 hire management on C-level/mgmt. holds small stake
 sometimes GPs hold temporary mgmt. positions
 moderately high risk profile, failures are not part of the business strategy
 typical exit using IPO or trade sale

2. Venture Capital:
(1) Effect of subsequent rounds of funding:
- Necessity to grow/scale
- Dilution of existing shares (esp. founders)
- Fragmentated cap table
- Necessity to incentivize key mgmt. (1st and 2nd level get options from option pool)

(2) Mechanics and rationalities:

- VC funds invest minority stakes in start-ups to develop defensible, fast-growing
businesses by disrupting existing products and services through innovation
o Not the percentage alone, also founders depend on future investments and
amount determines control and voting power. Usually, power tilts in favour
of future investors and profit entitlement varies by how big their shares are.
- VCs invest over several subsequent rounds to reduce exposure and spread risk over
time
- lack of voting power due to minority shareholding is compensated by voting (also
certain veto) and information rights (The right to access the company's books and
records, inspect its facilities, and request information) to control corporate
governance
- the uncertainty in valuation is compensated by certain cash flow rights to control
liquidation (i.e. cash distribution in case of an exit) or to handle dilution
- VC investing is characterized by tail-end returns, with one or two “home runs”
typically offsetting the failed investments in a successful fund.
- VC funds invest in specific industry verticals (An industry vertical, however, is more
specific and describes a group of companies that focus on a shared niche or
specialized market spanning multiple industries.) and stages of company
development, from seed to early to late stage

(3) Business Model – Characteristics of a strong candidate:

a. Top-line growth
i. Steady (past) growth in customers, bookings, revenues as a sign for
validity of value proposition and business model (aka Transactions)
b. Sales pipeline and effective sales funnel
i. Knowing where and how to reach target customer (marketing), pipeline
filled with leads/opportunities at various stages, funnel showing strong
conversation rates
c. Hiring skills
i. Scaling an organization needs solid hiring plan, and the ability to attract
top candidates
 d. Competitive market position
i. Customer relationship, brand name recognition, superior
products/services, favourable cost structure, scale advantages etc.
e. Low capex requirements
i. Limited capital expenditure needs for investments c.p. enhance a
company´s cash flow generation
f. Efficiency-raising chances
i. Improving operational efficiencies and generating cost savings (sales
margin improvements)
All this sums up to a management team that is strong in execution

Top line: as in top-line growth refers to sales or revenues, which is the top line item in the
P&L. Proof of traction is dependent on the business model, instead of sales this can also be
documented user interaction (e.g. daily active users in gaming)

Sales pipeline: is a set of stages that a prospect (potential customer)moves through, as they
progress from a new lead to a customer. Once each pipeline stage is completed, the
prospect is advanced to the next stage. the pipeline is forward looking, showing the
expected order entries in the (near) future

Sales funnel: represents the quantity and conversion rates of prospects through your
pipeline stages. It’s called a “funnel” because of its shape: wide at the top as prospects
enter, then increasingly narrow as they are disqualified or decide not to buy. the funnel is
backwards looking, analysing the past sales performance

The typical PE transaction is a buyout (BO), which can be distinguished from a buyer’s or a seller´s
point of view

 Who is buying?
o Institutional Investors: IBO, aka LBO or buyout
 A PE investor initiates the transaction and acquires the business directly from
the vendor. Often the target´s management will take a small stake.
o Current Management: MBO
 An LBO originated by a target´s existing management (usually with support
of a PE firm)
o New Management: MBI
 The company is sold to a new team of managers, with the new management
team taking a majority stake (usually with support of a PE firm)
o Employees: EBO
 An LBO in which employees buy a majority stake in their own firm (usually
with support of a PE firm).
 Why selling?
o Succession problems
 Selling the company to the incumbent management might help to keep the
tradition of the company.
o Spin-off
  Activities which don´t fit in the strategy anymore. Concentration on core
business.
o Turnaround / Distress
 Urgent need for financing. Buyout should restore profitability of the
company.
o Privatization
 Government organization wants to privatize some of its operations to raise
money.
o Going-Private
 A publicly listed company is taken private (delisting)

Defining Characteristics of Buyouts:

 Acquisition of majority stake

 Increase financial leverage
 Incentivize management

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3. The Term Sheet:

(1) Definition:
- Negotiation tool in VC fundraising, non-binding, like LoI and MoU - Memorandum of
Understanding
- Economic/control terms of the round: rights/obligations and share class
- Formalised into share subscription agreement and articles of association and
shareholders’ agreement later

(2) Key economic items:

i. Price and valuation:
Pre-investment valuation, after investment shares and price

ii. Liquidation preference:

Determines the liquidity events
Most cases: x multiple before distribution to common share holders
Converted cases: common shareholders receive first

iii. Option pool:

For employees

iv. Anti-dilution:
Receive additional shares in the case of downwards valuation

v. Conversion rights:
Determines the conversion events, time and converted ratio

(3) Control items:

i. Board representation:
 Observer right to the board
ii. Protective provisions:
Right to block certain corporate actions: e.g. IPO, equity financing or equity
increase
iii. Drag-along provisions:
For major shareholders to force others to sell their shares
iv. Tag-along provisions:
Right for minor shareholders to sell their shares
v. Transfer rights and new issue restrictions:
The priority to buy the sold shares from other shareholders
vi. Information right:
To gain the financial information

4. The cap table and distribution waterfall:

(1) Typical share classes:
- Common shares
Basic form, usually by the founders, typically no rights
- 2Preferred shares
Priority to capital distribution before other classes and have right to convert into
other common rights
- Non-voting shares
Does not change the controlling percentage of others but distribute the profit;
usually to family member or employees
- Others
Including convertible loans and so on

(2) What cap table reveals:

- Historic / current shareholdings
- Voting / cash flows
- Future funding

(3) Important relationship between share capital and nominal value: market value = par
value + paid-in surplus

(4) Specifics for German GmbHG:

- Shares: minimum 25 k Euro

- Nominal value of 1 Euro
- The legal ownership transaction only settles when the payment is already in cash or
wire transfer

Lecture 3

1. Financial Plan:
(1) Aim of a financial plan:
- Dashboard / check viability
- Financial health of a company / check value creation
- Valuation
 - Cash projections / usage of the cash

(2) Principles:
- No overcomplexities, no top down; clear assumptions, clearly estimate the cost for
market and etc
- Total sales funnel shall be far in excess of the target

2. Private Equity in narrow sense:

(1) Trends: Dominated by leveraged buyout
(2) Buyers of LBOs:
- Institutional buyer: PE fund and etc.
- Current management: usually with support of a PE firm
- New Management: MBI, usually with support of a PE firm
- Employees: EBO, also with support of a PE firm
(3) Motivations:
- Succession problems
- Spin-off
- Turnaround
- Privatisation: usually with government organisation
- Going-private: delisting
(4) Ideal candidates for LBO:
- Strong and stable cash flow
- Competitive market position and efficiency-raising chances to expect an increase in
EV
- Low capex requirement to ensure a stable cash flow / less cyclic
- Strong Asset base to reduce the risk in the bankruptcy
(5) Conflicts in the buyout – explain in an MBO case:
- Major problem: conflict of interests among time, price and information
- Info: insider information is all held by management team rather than seller. The
problem could be solved by releasing the material information
- Price: management has incentive to maximise the sale-price for shareholders but as
a buyer, they prefer a minimum price
- Time: all processes are time-consuming
- Advantages & disadvantages between MBI and MBO:
MBO: familiar management team with procedure and monitoring / information
asymmetry for a cheaper price
MBI: new outside perspective, great potential externally / higher rate of job losses,
weaker competitive market position

3. Agency Theory:
(1) General idea: principal provided the agents with resources but failed to provide best
result as agents utilised the information asymmetry and did not overcome conflict of
interests, which leads to the moral hazard
(2) Different criterion in agency problems:
- Hidden characteristics: only one before contract conclusion, ex-ante hidden, leads to
adverse selection (worse targets selected rather than good targets), signalling /
screening / self selection to solve
 - Hidden information: after, non-observable info at agent’s level, leads to moral
hazard, using different incentive / controlling system / self-selection to solve
- Hidden action: after, agent’s own action, moral hazard, incentive scheme /
controlling system
- Hidden intension: both before / after, hold up issue, incentive scheme
(3) Moral hazard in financing companies:
- Hidden characteristics: during identification and negotiation of investment contract,
which leads to adverse selection
- Hidden information / action: during monitoring / exit: leading to moral hazard
o Consumption on the job: e.g. remuneration to pay luxurious hotel – leading
misemployment of assets
o Being one’s own boss: without supervisory could lead to a misguided effort
and misconception of time horizon
o Establishing a track record could solve / relieve the problem
(4) Causes in the PE financing:
- Conflicts of interests: PE are exit-value driven but management team may chase
other aims including social recognition
- Asymmetric info: management has more insider information

4. Paper summary of agency theory in PE:

(1) Public corporations:
- Characteristics: diverse debtholder, shareholder, management team
- Advantage: risk diversification
- Disadvantage: more conflicts among various parties
- Controlling solutions: product market / internal control system including supervisory
board/ capital market
- Risk: in low-growth industries, manager might invest in the negative internal project
(2) Conflict in usage of free cash flow:
- Companies must distribute excess free cash flow to investors from investors’
perspective
- Different ideas from management team:
o More autonomy in capital market, retain more cash for future needs
o Increases the firm size in order to have higher salary
- Solution: higher debt/equity ratio by using more debt in financing as the debt has
obligated payment reducing the discretion of management as well as covenants
(3) LBO structure:
- Key differences: management = part of shareholding and the strong relationship
between pay and performance; more decentralised; heavily leveraged – well-defined
obligations to creditors and residual claimants
- Management incentive: tied to cash flow instead of earnings; PE manager received
carried interest
- Decentralisation: all shareholders on board; lean structure of managers
- High leverage: risk diversification through high-yield bond and easier to control with
concentrated shareholder structure
- Well-defined obligation: returns must be distributed to limited partners
 5. Entrepreneurial finance vs corporate finance:
(1) Interdependence between financing and investment decisions:
EF: lower expected return easily with negative NPV and less independent with financing
strategy
CF: more independent

(2) Management involvement & diversifiable risk:

EF: involvement of investors and more concentrated in venture investment
CF: passive investment & diverse investment

(3) Info problem & incentive:

EF: severe info asymmetries and management’s incentive committed by stakes
CF: tiny info gap but requires stock options and performance bonus to ensure
management’s commitment

(4) Harvesting the investment:

EF: no dividend but with predetermined exit date
CF: return through dividend but no predetermined exit date

(5) Value to investor / entrepreneur:

EF: investor-backed venture and management to maximise the financial claims
CF: management acts as agent to maximise the equity value

Lecture 4:

1. Asset class:
(1) Asset management / allocation:
- Strategic: long-term decision regarding risk and return based on inclination to risk,
liquidity preference, time horizon, tax and legal context
- Tactical: temporary decision to catch market inefficiency and relevant changes
recently

(2) Different classes:

- Traditional: stocks, notes, currencies and commodities
- Alternative: PE, high-yield bonds, real estate, hedge fund, art and antiques

(3) Trends:
- In no liquid market of private equity or so, efficient frontier is larger
- When including private equity, the risk of the portfolio is lower

(4) Mix of risk:

- Systematic risk: PE has independence from the economy
- Unsystematic risk: PE has diverse exposure by investing a portfolio of companies
2. PE as financial intermediates and the contribution:
(1) Transaction costs:
- Reduce the number of transactions
- Reduce initiation cost by quickly judging the value of the company; reducing info cost
by exploring possible investment opportunities; reducing controlling cost as owner of
a portfolio; reduce contracting, adjusting and execution cost based on rich
experience

(2) Reduce minimum value for investment

(3) Risk management:

- Pros: diversification; long-term historical outperformance; high degree of monitoring
- Cons: volatility in the market; management costs; lack of liquidity and J-curve;
expertise required and top fund hampered

3. Forms of PE-Investing:
(1) By the approach:
- Direct: more extreme investment multiples
- Funds-of-funds: most neutral
- Fund investment: risk and return balanced

(2) By organisation forms:

- Closed-end funds: upper limit of fundraising volume; pre-defined lifetime; return of
the investment is distributed to the investors at exits
- Open-end funds: continuous subscriptions, no pre-defined liquidation date; returns
are usually reinvested

(3) Common legal structure: limited partnership

- Limited partners: no participation in management and only liable with the invested
capital
- General partners: the fund managers; are liable for the debt and management

4. Fundraising process:
(1) Process regarding investors:
- Asset allocation: weight of PE and diversification as well as the organisational
integration
- Fund selection: legal DD (structure); commercial DD (Private Placement Memo,
personal discussion and calls)
- Monitoring: portfolio / partnership / investment

(2) Pre-marketing:
- Attracting investors: informal announcement; informal talks; Info Memo (target
market, strategy, team, legal conditions)
 - Investor type: academies, banks, foundations, companies, individuals
- Aims: diversification from public market, sector…

(3) Fund DD:

- Investor selection: time investment from low to high and limiting the circle from
hundreds to lower than 30 / 40
- Management team track:
o Team: adequate size, previous experience, industrial / financial management
experience, value adding capabilities, low turnover rate of seniors;
o Track record:
 No records: raising money deal by deal or just in small amount; co-
investing;
 With records: check level of returns; achievement of non-financial
goals

(4) Fund structuring:

- Commitment: number of subscription varies / maximum or minimum capital /
gatekeeper to make decision for institutional investors / placement agents to find LPs
- Capital calls: LPs are not required to invest 100% of the capital at the initiation but
need to pay at the “calls”
- Investment limitations: range of % in each portfolio company (usually 5% to 20%);
requirement on foreign jurisdictions
- Borrowing limitations: VC usually prohibited the borrowing amount more than 10%
to 20%

(5) Fund closing:

- First closing: when minimum requirement of capital reached; start to investing
- Second closing: several months later

5. Investor Relation Process:

(1) Definition: relationship among PE, investors and investor community
(2) Instruments:
- Impersonal: annual reports / press releases
- Personal: various meetings, committee and road shows

6. Measures of fund performance:

(1) Life cycle:
- During the fund’s life: part liquidation and part of the information
- End of the fund’s life: full liquidation with full of measures
- J-Curve of cash flow: first out and then in

(2) Internal return rate:

- Equivalent to the discount of cash flows
 - Pros / cons: consider time value and all CFs / no risk factor; lack of comparability;
calculation sensitive to the time value
- Changes in the different stage of fund life: interim IRR (received CF = NAV); final IRR
(distribution CF = drawdown CF)
- Gross / return bridge:
o Entry: EV entry – Net Debt entry + transaction cost – debt for LBO = Equity
(drawn-down)
o Exit: ( EV exit – Net Debt exit – transaction cost )* fund’s share –
management fee – GP’ profit share = Net fund proceeds (Gross one including
Management fee & GP profit)

(3) Return multiples:

- Returns from the fund / invested money
- Pros / cons: easy to calculate / time value and risk ignored
- Distributed value to paid-in ratio: CF received / paid in
- Residual value to paid-in: Net asset value / CF paid in
- Total value to paid-in: (CF received + Net asset value) / CF Paid in
- Example: Contributions – management fee = total received
- Returns are distributed due to different percentages of LPs / GPs

Lecture 5:

1. Benchmarks in PE:
(1) Public Market Equivalent:
- Check how much would be returned to the investors when the same amount of the
money is invested in the public market
- PME larger than 1 means the investment in public market is more successful

(2) Peer group:

- Main challenges: hard to find a comparable universe; high residual value leads to
unprecise performance measure; different risk patterns

2. Academic findings of private equity returns

(1) VC performs better than public market in 1990s but not later than 2000s; PE is always
better than index
(2) When quantify the trends, VC’s IRR changes from 44% into -1% but PE keeps a rate of
constant 12%

3. Fee components:
(1) Types:
- Management fee: fixed fee to cover the running / operational costs
- Portfolio fee: paid directly by portfolio company including transaction fees, advisory
and monitoring fees
- Extra fees: penalties when LP missing a capital call
 (2) 2 – 20 principles:
- 2% as the management fee
- 20% carried interest and compounded 8% yearly

4. Distribution of return process:

(1) Fund life cycle:
- Commitment of capital: 1-2 years, fundraising process
- Investment by GPs: 3-5 years, capital call, drawdowns; now management fee
changes on invested capital instead of committed capital
- Exits: holding period of 5-7 years
- Possible extension: up to 2 years when LPs wait for higher returns

(2) Types of distribution of return:

- Carried interest: part of the incentive-based compensation, would be divided when
hurdle rate or preferred return is achieved
- Hurdle: minimum IRR that LPs must achieve
o Hard hurdle: floor of the minimum return
o Soft hurdle: the fixed part GP receives after LP had their hurdles

(3) Distribution waterfall:

- American waterfall: GPs receive carries deal by deal, which means it would ignore
the overall loss in the total investments
- European waterfall: GPs only receives until all the preferred return is distributed

Lecture 6

1. Effectiveness of the PE incentive system:

(1) Funds like Bain capital decided to use various fee systems in order to help investors not
to overpay the management fee
(2) Conflict of interests:
- Zombie funds: delay the liquidation of poor investments but the GPs still receive the
management fees
- Hurdle rate distortion: GPs would be motivated to secure the hurdle rate which
might lead to an overly conservative strategy
- Dark side of the fee structure as the private equity might ask for monitoring and
transaction fee from portfolio firms, which might also reach 10% of the total fee

2. Recent PE Market
(1) Key trends:
- Lower fundraising amount but investors have larger appetite
- Capital more concentrated in the larger funds
- Deal flow hits new highs / industry AUM hits new high
- Lower cash flow despite of high distributions
 - Market correction may lead to new challenges for asset valuation, based on the
perspective of the fund manager
- Domestic investments are still main stream of the PE investments
(2) Top four investing industries for PE: ICT, consumer goods and services, business products
and services, biotech and healthcare

3. Performance Persistence and relevant criteria:

(1) GP experience: before LPs are not so willing to invest in first-time funds but now it is less
important
(2) The fund ranking: the gap in PME / IRR among first or second quartile of the funds were
quite wide before, especially for venture capitals, but the gap is narrowed after 2000
(3) Trends:
- top / flop movements are two most common movements;
- persistence in NA instead of EU
- High premium does not pay off at the moment

4. Co-Investments:
(1) Method: invested by the fund and directly by one of the LPs together
(2) Why co-investment is relevant?
- Reduced carried interest / management fees
- Fight against when fundraising is difficult
- Dual monitoring to reduce the information asymmetry
(3) Trends:
- Co-investments take a larger slot after 2004
- Due to the hotness of PE market after 2000, the average performance of co-
investment is poorer than solo investment
- As co-investment usually relevant to the lack of the capital, the deal size is larger

Lecture 7

1. Investment Origination:

(1) Trends:
- Investment managers must search for more deals as investors’ appetite increases
- Only 1% of the investment are made under actual opportunities
(2) Channels of coming across potential investment opportunities:
- Proactive origination
- Request from other funds
- Investment banks
- Online deal source platforms
- Referral by portfolio companies
- Submission from targets (only VC)
(3) Transaction types in PE:
- Proprietary deals:
 Direct negotiation between the fund and the company
- Special situations: typically for bankruptcy
- Auctions: held by investment banks
Potential buyers – sign DNA – send info memo and procedure letter – indicative offer
– management meetings with short list – binding offer – sales and purchase
agreement – signing & closing
(4) Key characteristics for VC candidates (based on strong management team):
- Top-line growth
- Strong sales pipeline and effective sales channels
- Persuasive hiring skills
- Competitive market position
- Low capex requirements
- Efficiency-raising chances
(5) Key characteristics for PE candidates (based on strong management team):
- Strong cash flow generation
- Competitive market position
- Potential growth opportunities
- Strong asset base
- Low capex requirements
- Efficiency-raising opportunities

2. Investment Due Diligence:

(1) Types of DD: commercial / operational / financial / legal / tax /IT
(2) Investment Thesis:
- Foundation of the investment
- Identify the timespan, exit and value creation plan
- Determine the topics of the DD later on
(3) Pre-DD to decide if bid or not
- Real result identification
- Growing opportunities
- Risk
- Forecast and financial plans
- Management abilities
(4) Formal DD:
- Discuss the pre-set issues
- Duration 1-2 weeks to 1-2 months
- Parallel negotiation and discussions
(5) Commercial DD:
- Firm analysis
- Market analysis: customers / competitors
- Top-line model
(6) Operational DD:
- Growth
- Cost
- Cash

3. Academic findings:
 Most deals are generated by banks or the firm itself

4. Recap of financial statement, one missing point equity:

- Book value of equity could be negative rather than market value
- Possible reasons: buybacks / dividend recapitalisation / severe write-offs /
accounting policy changes

5. Recap of financial ratios:

(1) Profitability ratios: four levels from revenues to net earnings
(2) Efficiency ratios: cash conversion cycle (pay attention that days of payables should count
changes of inventory as well)
(3) Liquidity ratios:
- Current ratio: current asset / current liabilities
- Quick ratio: (cash + short-term investment + accounts receivable) / current liabilities,
quicker than current
- Defensive interval: (cash + marketable securities + accounts receivable) / projected
expenditures/365, to calculate how long the company is out of liquidity
(4) Leverage ratio: debt to assets, equity and EBITDA, important to PE transactions
(5) Coverage ratio: to identify firm’s ability to cover the debt
- Interests coverage: EBIT / Interests
- EBITDA coverage: EBITDA / (principal payment + interest expenses)
- Debt coverage: cash flow before interests and financing / (principal payment +
interest expenses)
- Time-out-of-money: cash on bank / monthly cash burn rate
(6) Valuation ratios: P/E, EV/EBITDA, market/book ratio, EV/EBITDA or sales

Lecture 8

1. Valuation: Multiple is the most common use for PE investment

- Pros: quick and convenient / reflecting growth and risk from public view / timely
advantage regarding comparable companies
- Cons: market inefficiency / no pure comparable companies
2. Developing and funding structure
(1) Key source of financing: equity / debt / mezzanine / debt-like
(2) Covenants:
i. Negative covenants: restrictions upon certain actions of the firm
ii. Financial covenants: maintain financial ratio through several actions
iii. Affirmative covenants: acquires the company to do the actions
(3) Ranking of the financing source
(4) The obligations of the management and the requirements of bank in an MBO:
i. Management:
o Investment from their salary
o Reward as incentive for success
o Total commitments
ii. Bankers:
o Cash flow
o The ownership of 30% to 40% and even higher in larger buyouts
 o Typically, senior A debt should be paid back within 7 years except the setup
of the call/pay-back event
o Covenants

3. Academic findings:
(1) Economy-wide credit condition is the main determinant of leverage in buyouts;
(2) Europe buyouts have more risky equities in structuring buyouts but less high-yield bonds
comparing to the US ones

Lecture 9

1. Value Driver:
(1) Operative and strategic value driver:
- Support / restructuring
- Strategic orientation through market / product on core competencies
(2) Corporate governance:
- Reduction of the monitoring costs through interest alignment and strict monitoring
- Mentoring support by PE firms (network and knowledge know-how)
(3) Financial value driver (no value creation):
- Just arbitrage
- Financial engineering: debt creation / tax deductibility / leverage effect / reduction of
agency cost
(4) Conflict of interests when only value transfer: shareholders are negatively effected e.g.
increased leverage created default risk
(5) Conflict of interests when also value creation: no conflict

2. Academic findings in value creation: usually formed by changes in EBITDA / cash flow /
multiple effect
(1) Leverage effect: issuance of debt to increase risk and also increase the expected return
from the investment
(2) EBITDA growth
(3) Free cash flow effect: influence the de-leveraging time and frequency on an invested firm
(4) Multiple effect: change of the multiple due to economic or capital market change /
reposition of the company / negotiation between sellers and buyers
(5) Combination of EBITDA and multiple
(6) Trends of the value creation in the market:
- Operational growth and leverage effect: two most important factors; asset
improvement and market valuation: increasingly important
- Always gap of EV / EBITDA multiple between entry and exits; smallest in 1999

3. Build pre-LBO model:

(1) Purchase price assumptions: usually use simple Multiple approach
(2) Use of LBO funding proceeds in company:
- Three main usages: equity purchase (including goodwill) / repayment of existing debt
/ transaction costs / reserve (optional)
(3) Source of the LBO funding
- Equity: management’s money / pure equity from the investors or shareholder’s loan
 - Debt: Senor debt from the banks or subordinate loans from hedge fund or just bonds
(4) Envy ratio: investment by investors / managers, to check if investors are actually
investing more than managers to ensure the controlling of the target company
(5) Creating LBO model

Lecture 10

1. Investment Exit Overview:

(1) Possibilities:
- Liquidation: bankruptcy
- Trade-sale
- Secondary sale to another PE
- Buyback from entrepreneurs
- IPO
(2) Role of PE:
- Decision-making
- Grow along with the decision
- Selecting advisors
- Validation of expected price
(3) Process:
- Identify exit
- Mandate advisors
- Launch
- Bidding negotiation
- Closing and post review
(4) Difficulties in liquidation:
- Sunk cost
- Admitting failure

2. IPO:
(1) Success factors:
- Efficiency
- Enough public awareness
- Proper level of scarcity
- Positive view from market
- Favourable exogenous factors
(2) Pro / cons:
- Pro: higher exit proceeds / low conflict potential / reputation / trigger for takeover /
flexible on % of equity sold / participating future value creation / source of capital
- Cons: limited to high-flier / restriction by market condition / no full exit / high costs /
reporting obligation
(3) Lock – up: the period that the current shareholder cannot sell after IPO

3. Trade Sale:
(1) General situations:
- Strategic-driven M&A, strategic buyer
 - Preferred industrial sectors: IT / energy
(2) Relationships in the trade sale:
- Integrations:
o Vertical integration when buyer is customer or supplier
o Horizontal integration when buyer is competitor
- Conflict of interests:
Acquirer and current management competing for the right of controlling
(3) Phases of a trade sale:
- Internal processing: internal exit strategy / company analysis / restructuring when
necessary / internal data room preparation
- Identification of buyers: initial identification / initial contact / info memo distribution
(after NDA) / management presentation (after non-bidding offer made)
- Valuation / Negotiation: LOI after MP to ensure the access to data room / DD by
buyers (sell side at first providing the vendor DD) / start of negotiation / final SPA and
closing (after fulfilment of condition in the SPA)
(4) Success factors:
- Secrecy:
o Prevent leak to trigger adverse reaction from supplier, customer and
employees (not to spook the potential buyer)
o Potential buyers could have lower interests in target when the sale is widely
known
o Negative spiral: in case the sale did not take place, a sign of low confidence
in the future business from the buyer side
- Competition: to balance the relation with secrecy
o A sense of urgency
o Price maximisation
o Back-up: cut continuous attempt on renegotiation; take the other bidder in
case the negotiation fails
(5) Pro/cons:
- Pro: higher proceeds (no IPO discount) / immediate exit / easier and quicker exit
- Cons: interests of conflicts / limited buyers / possible non-cash payment / possible
guarantees in the SPA
(6) Compared to the IPO regarding the influence on growth strategy:
- IPO:
o Require to be a well-rounded company with independence
o IPO-ready mentality
o Public company function including public financial reporting (quarterly and
annual), accounting / disclosure standard for public companies, public
relation (IR), tour including road show
- Trade Sale:
o No need to be a well-rounded or independent company as long as one
interesting function for potential buyer
o One aspect shall be one of the best among competitors

4. Secondary sale:
(1) Trend: main type of exit for buyout fund both by amount and by value
(2) Pros / Cons:
 - Pros: possibility for exit when invested company is still immature / low conflicts of
interests (just one PE investor change to another) / simple and quick / few problems
for potential buyers due to the same character
- Cons: low p for high returns / limited buyers both in character and number

5. Ethics and PE:

Relating the private equity business with responsible behaviour

6. Different perspective on PE and ethics:

(1) Views from external stakeholders (e.g. states, society, customers…)
- “extract the valuable basis and ruin the companies”
- “menace to the healthy companies” “saddled with the debt”
(2) Beneficiary in the private equity:
- 2Investors: through returns in the portfolio company
- Workers (especially for company in restructuring): grow and hire more workers
- Communities: growing company contributes more to taxes for community welfare

7. Academic evidence:
(1) Overall underperformance for companies after IPO;
(2) LBO companies outperformance other asset classes;
(3) Positive relation between leverage and Post-IPO performance;
(4) Other factors including profitability, R&D and etc. also matter

8. ESG and investment:

(1) Components:
- Environment: climate change / resource depletion / waste and pollution
- Social: working conditions (slavery and child labour) / local communities / diversity
- Governance: pay / corruption / political lobbying and donation / board diversity / tax
(2) LP perspective on ESG: most LPs regarding it important to fight against risk
(3) GPs consider it mainly in the phase of fundraising, driven by risk management and LPs
(4) IPO consider ESG issues more importantly / European companies consider it more
importantly
(5) ESG and value creation: (overall increase in the capital market globally)
- Financing: reducing cost of capital / increasing transparency
- Multiple: strengthen brand & image to increase the multiple / faster completion of
M&A / increase long-term value by sustainability
- Operational: strengthen brand & image / reduce legal & regulatory risks / increase
employee motivation / efficiency improvement