In GP LP structure different LPs come together and they are treated the same, amalgamate different

types of investors. The terms of the LPA cannot be changed during the hold period. No reality to change
the terms after.

You know they have all these portfolio companies have always said hey fund a buys 10 companies 10
bucks each we never talked about what those companies are how they value those companies and so
we're gonna focus by and large in you know how you value companies varies across different strategies
so I don't want to spend a ton of time on all of them because we're gonna discuss them individually over
time but how do they source investments and even that will vary depending upon different strata but in
your mind if you had to guess how is it that private companies end up for sale and how do they end up
getting bought how do private equity funds get access to these companies anybody wanna venture to
guess how did the private company go how does somebody sell a house if you guys have ever sold out
seconded by the fire how did they generally do that from a company perspective yeah

so whether it's a company or a piece of hair house like how do you can use like an intermediary so you
get a broker if you're if you're selling a house you might hire a real estate agent they're gonna take
pictures of your house posted online and ask people to you know what they're willing to pay I guess or
post a price and hope people will want to pay that depending on the environment so private companies
not super different if you're a private company and your ownership wants to sell the method that's used
by and large is to hire an intermediary bank so you'll hire a bunch of investment bankers you'll tell them
hey I want to sell my company go fetch me the best possible price you can get

So what is the intermediary do they'll put a book together and you know there's different names for this
but a confidential information memorandum or an information memorandum they'll put a book
together that describes every detail they can possibly come up with four to describe the company that's
activities it'll put up financial project they'll put up financial performance historically and projections for
what they believe future performance will be and then they'll go out to the market and I use the word
the term market and we'll get back to that and what that means but we'll walk to the market and say hey
what are you willing to pay for this they'll run often what's called the process right just like a Bing process
and this is nothing but those markets say hey what are you willing to pay Saturday get prices and then
whoever bid the highest price they'll they'll solve the company with them they may do this in phases
they may do you know phase one where hey I'm gonna give limited information let me know what
you're willing to pay and then in the second phase I'll give you much more information then let me know
firmly what you're willing to pay for this company figure out along the way all the financing you gonna
need to get it from the acquisition it's all it's all up to you I'll I'll tell you what that profile that come of
the company is today you know you go out and figure out what you're willing to pay now when I say it
goes out to the market private companies are could be bought by who generally question who can buy a
private company investment firms asset managers asset managers or private equity fund can buy them
who else can run anyone with anybody with their capital that's that was kind of the actual anybody can
participate in these processes right so it could be if you're selling a food product if you're selling a
different type of chip it could be crap a different type of like potato chip it might be pretty lady that
might be willing to buy you or a private equity fund that does or it could be a a grocery store chain that
decides hey we wanna bring the sun to that in the house like there could be all sorts of different types of
buyers right the reason I say that is because the buyers will all have their own approach to valuing this
company right in private equity land a private equity fund manager is valuing these opportunities based
on the the economic return they could generate and so how do they do that we talked about what what
in a buyout context for instance what a private equity fund so how does a private equity fund come up
with what they believe they will generate in terms of returns from an investment they in a bio context
don't

they focus on the reducing costs and then multiple expansion on the zip good so reducing so these are I
think you you you hit on the themes that I think you'll read in the headlines all the time right private
equity funds are looking to do 2 things one the buy private company cut cost as much as they can and
two they're gonna be able to sell to a buyer who's willing to pay more for that for that more profitable
multiple expansions one I wanna focus on as well

So what what what do we mean when we're talking about multiples in whether it's public lands or or
private equity like what does multiple mean what what multiple of what event so generally the metric
that's used in why is it why does it I mean this is like semantics whether you why why would you use one
or the other cash with her uh not necessarily a cash return but the DA's are are could be pretty reporting
factors and but you know like when when why why do you like sports teams transact and this is relevant
to private equity incidentally because like private equity firms are buying up sports franchises everyday
like what's so critical about this is like an accounting question so I don't bore people with this and even
that sounds important but why why are people going to pay up for sports franchises these days there's a
few there's a few reasons but like sports I'm just I don't know it's a Baltimore oriole just created so
somebody bought about the Baltimore City of Baltimore has a baseball team who can't even watch
baseball anymore now I'm gonna eat myself out like I'm nobody not one person watches baseball a little
bit nobody wants you've broken my trust a former ohh one that's crazy OK so you know what the the
doesn't that like embarrassing myself now so a multiple of EBD is the the the the the the metrics that
typically used so a private equity fund is willing to pay a multiple of other certain size how does a
multiple translate to what the private equity fund manager is trying to achieve they're trying to achieve
as a reminder on higher on right so you are trying to determine as private equity fund how you can
generate a return of at least 8% and hopefully your target return of 20 right so the the reason I
emphasize that is because people think of the multiple as being an input into the price that you're willing
to pay what's actually the output what you're trying to figure out is what you're willing to pay for private
company when you're going through the exercise right

what the private equity firm is trying to do is come up with a price that they'll offer to this investment
bank and to the owners of the company not by just applying multiple is they're trying to solve for return
because they need to generate an 8 or 20% return and the output of that will be I'm willing to pay extra
which translate to a multiple of X or Y everybody following along an extra while on the profitability of
that company like what is the is the metric we're using but think of that as the at the the profitability of a
company to to simplify and oversimplify for the context of this course but that's all that's important in
the context of valuation that we're discussing so private equity fund is coming up with the price they
decide hey we're solving for return and they think if we pay X we can generate a return of Y and now the
other factor comes in which is how are they gonna change how how can the private equity firm possibly
make these companies more proper so one thing we discussed earlier on and is is in buyouts in
particular is the ability to add leverage right so a you've now introduced your your cost capital your a
lower cost capital base right you're trying to generate 20% returns which you've introduced debt that
only cost you four or five so now you're winding down how much more incremental return you could
drive from the equity that's something I think that's fairly intuitive everybody's probably gone through it
now the concept of cutting cost so we just described how people are willing to pay certain multiples of
profitability for a company right that's how people think of valuation of of a certain entity how much
profit can I generate how many years worth of profit of my willing to pay right if the company generates
$10 in profit beer and I won't make 10 times that it's because I'm willing to pay for I'm going to pay $100
because I'm willing to pay 10 times profitability today so for private equity firm that pays up there are
other instincts to see how they can increase that probably now because if I buy it and it earns $10 today
and I believe I could sell it for 10 * 10 years from now but I could turn that $10 into $20 worth of profit I
will have doubled up my money right and then in those ten years except for that same company
everybody following along very like basic example I guess but again I have $10.00 of profit if I could turn
that into 20 and sell it for 10 times again so your your point about multiple expansion private equity fund
managers will very rarely think to themselves here I'm gonna get a higher multiple if I pay if the market is
assuming that people pay 10 times for a chip company today about like a potato chip company very
rarely will a private equity fund manager take the view a in 10 years from now they'll pay 20 times why
would they pay 20 times right so why would somebody pay 20 times the profitability of of a chip
manufactured 10 years from now if you're only paying 10 times today now there's some nuances there if
you look at the growth sector like they're a growth your investment you might have heard that there
might be some multiple factor but that's a really aggressive view for private equity firm so generally
they're they're of the sense the way they'll tell you that they underwrite these opportunities we talk
about underwriting what that means everybody remembers hopefully is to have the same assume the
same multiple at the end of the road So what can you do along the way to increase profitability for
company so bringing it back to how you value it US private equity firm have taken a view on what you're
willing to pay today to generate a 20% return what you believe you be able to sell that assume you'll be
able to get the same multiple you pay at today so private equity firms the reason they and their the they
have the reputation they have is because over the years it's they've been perceived as going in and
cutting costs because hey I'm I'm a private company that can fire a bunch of people there's no real
backlash that comes with that I can double my profitability usually what are the big expenses for any any
company real estate and people right so if I can cut personnel in half than 10 years down the road I'll
have potentially double I will increase profitably if not doubled up right and I can I can get a good price
on exit on a higher profit base So what the private equity funds that we support along the way so if
you're an LP backing private equity fund managers you're trying to identify one to have some repeatable
strategy right so they'll pay whatever the market is willing to pay for these companies but you're trying
to support the ones that you believe can do something to that company in their whole period that's
different than what everybody else is capable of so one of those might be they're really cut throat they
can cut up on the cost the other strategies that exist within private equity firms often and this wasn't
that you know regardless of the of the industry you're looking at or where the regardless of what
strategy you're looking at within private equity but some private reforms have developed expertise for
instance in growing companies into international markets so yeah I have a very profitable company that
operates in the US or in Canada sell chips here if I can take over this company I have I've developed really
good expertise into going into Europe and selling consumer products there so or or edible products
there so I believe I can take this company Europe get manufacturing lines open there and sell my product
they have great relationships all the grocery chains in Europe so I believe I can do it so that's another
way maybe to double up or to increase the profitability of my company right what are some of the other
mechanisms that exist you guys have heard us ohh please share the LVMH group let's hit the order for
like so RAD so RAD I was going for that not the word Rd. but what's the word we do we hear of when
there's murders that happen for any companies don't think right so if I'm if I own if I buy potato chip
company that generates extra amount of profits and I think I can go buy four more of them well the
other four also need an HR department accounting department can I maybe fire a bunch of people that
work in a factory and consolidate the actual facilities that are manufactured in what can I do to optimize
the cost basis right so many fund managers have plans for M&A for instance so they'll go in with the
assumption that I'm going to buy this potato chip manufacturer and I know I can buy four more because
there's these other 4 have have you know are are in the market and you know they're operating a
certain amount of profit I can go over I can go buy those companies and roll them in now here's the key
why is it if I use the chip example and by the way there are several private equity funds who are in the in
consumer like snacks like there are three or four really good private people how is it that a frito lay who
has a giant footprint by the way people who make Fritos lays like the chips you guys are familiar one of
the largest ship manufacturers are people familiar probably snacking on the Super bowl obviously all this
is in all of our minds all the time so so you guys are familiar with the company yes yeah OK good so how
is it that I as private equity fund manager can operate a chip manufacturer better than if lays the spot
them or frito lays bought them and roll them into their operation right like how is it that they can
possibly do that more efficiently than how can I possibly do that more efficiently than them right they
call them strategies the frito lay in this context would be a strategic buyer right I already made it in I'm in
the the game of manufacturing yeah manufacturing chips how can someone who works out of an
awesome finance by wearing a student in office do this better than I do why would they be willing to pay
more than anybody wanna guess I mean they could have some vision on on how much overhead they
can they can avoid compared to some large corporation yeah so private equity funds could be a lot
leaner generally I think that's like the thought processes last probably has 50 different people that weigh
in on every decision that happens in public or public company it's practically part of Pepsi I don't even
know anymore like this is probably young brands so large public companies generally have a lot of
government there's a lot of decision making that has to go into any decision whether it's to cut a job
whether there's like big HR departments so there's a lot that goes into the decision making process for
large strategics right and for them to roll up an independent chip manufacturer that makes ship that sells
1 area it's probably a lot more work than sport they can just redeploy the capital and build a new lace
flavor and like that's probably an easier exercise for them because that's what in the game of doing
buying a smaller private company is not what ladies expertises or frito lays expertise so all this to say in a
normal environment we're in and by the way big balance sheet they have a lot they don't have money to
do this but their shareholders have expectation in terms of what returns have to be generated right and
they have to report on those on those tricks every quarter so public companies every quarter have to tell
their shareholders hey we bought this company this is what we paid this is what we expect to achieve
from this company and if it doesn't go very go sideways then the other person separate so if you and
there's the first there's stock price if you've you know I guess followed Kate different case studies and
M&A line so you guys have all probably taken an M and a course somewhere along the way merchant
acquisition course for those of you there so I was thinking more like for those of you that were business
undergrads for instance there's not many courses in there 4/15 OK very fine yeah so in any case I guess
there there there's no reason to dwell on it but private equity funds have a way for the private equity
funds their whole appeal is they have a strategic approach to buying private companies and whether it's
expanding them globally whether it's MA whether it's cost cutting whether it's optimizing the capital
structure which we described earlier on it's like how efficiently they could put that they can do these
these functions in a way that allows them to to value you could tangibly value that when to determine
the price you willing to pay for a private company right all of those are quantifiable metrics right how
much cost I can cut if I'm able to buy five more companies at the same price at the same multiple if I can
fire all their HR people and fire all their accountant and fire their marketing department rolled out of
mine I'm taking all that profit and adding it to mine without adding all the overhead that they have right
so you can quantify all these so that's the purpose of what I what I was getting at today is private equity
fund managers are valuing private companies no different than how you and I would value any
investment opportunity it's how much capital I can derive from it but private equity funds are all there
PO is every GP has some sort of pitch in terms of how efficiently they can do this or what their path is to
get into that extra profitability that allows them to drive these better returns last tidbit before the break
so we discussed how these private equity funds get access to these opportunities we said typically
private companies that are of a certain scale will run certain sort of a process they'll hire a banker and
they'll and you know they'll go out to the market and and reach out to other private equity funds and
reach out to strategics if it's a chip company they'll go out to the purely so they'll they'll gather interest
from the market set a deadline again many private equity funds in fact by and large most private equity
funds that have had success over the years Will claim and you know we can measure the reality of this is
that they will not participate in processes so there is tons of private equity fund managers who as a
starting point will say hey we never participate in a process that involves us bidding and then on
investment property on private company we think that that inevitably leads to people overpaying for like
basically every single one will say that we don't source our opportunities the same way the rest of the
market does the reason by the way for that and this is probably last one even though privately fund
managers the best determinant of your investment outcome is the price you paid up right so like if you
overpaid up front it's going to be hard to get a good return in the end that stands for reason right but
ultimately what's empirically what's been shown is that then this is true for any investment asset class
it's the best determinant of your outcome is you know what kind of value you get on the device so if
you're participating in processes where everybody's bidding then you're probably for the viewpoint is
from these fund managers that you will have overpaid participate so many private equity funds when
they state they source their investments they'll say we have proprietary sourcing methods which means
what we'll go approach private companies will basically go down the yellow page we'll find companies
that you know work in the sectors that we believe have expertise in that for that have the kind of levers
that we can pull on like cost cutting that are floating companies that are run by family members that are
run by non institutional are non strategic owners or poorly run we can go in and do a better job and I will
go back to the example you have a few minutes ago sports teams historically run by Rachel white guys
right so like Rachel white guys have had a lot of success there's been a lot of growth in these in these
sports franchises but not run like companies right they're not run like how you can optimize revenue
how can you can optimize expenses how you can cut as much personal as possible like there are
different levers you can put which is why the private equity industry has been like trying its hardest to
get into the sports industry into into sports Formula One went through ownership of CVC Capital
Partners it's a private equity fund managers very good they like quadrupled in value and their whole
period because they went and said hey like why aren't you not charging higher for your TV rights why are
you like so you think of they find all these different levers that legacy owners don't think of if I inherited
a business and you know my and you know I have no expertise in that sector I can't officially run it so I'm
just using the sports now because it's the one that we see in the news all the time these days or are we
see relatively frequently all these leagues that have changed ownership right or a private equity firm
bought the Spanish Soccer League like these are not entities that trade very often they're help they're
owned by very wealthy individuals who have no care for money right by and large that's what sports
franchises are but when you get an institutional owner when you get somebody who's driven by profits
you can drive from these investments very material profitability and therefore we have good returns and
they're looking for private so take a quick break maybe 10 minutes 7/15 and then we'll come back we'll
continue on and come on the right

How these private companies are finding investment opportunities they're going through bankers are
going to the yellow the yellow page reference which correct me later like does everybody know the
Yellow Pages yes everybody's aware of what yellow things are there I still get the yellow page delivered
to my house the graphics are sorry so your undergrad never knew what they were but I live in like an
island wait wait wait sorry older demographic so not surprised that it's OK Yellow Pages like they still
distribute the Yellow Pages regardless and like I feel like it's like criminal for the labor right the person
has to walk around and like put those on everybody's doors like I don't even like sweatshop work but you
don't sweat cause it's freezing but that's like another like extreme of how inappropriate it is so we talked
about how these private equity firms source their opportunities so they're they're either participating
processes they're coming up with the price they're willing to pay and they may be going directly to
privately owned companies they're using their networks often they'll talk about you know since they've
been in the industry for fund managers they've been around for a long time have been investing in chip
companies for a really long time I used chips I realize a lot of people think of chips as like microchips that
go into like your devices these days like that's the more topic because I'm like so like chips in terms of like
the stock I've been operating that issue for a long time so I'm I know a lot of the network of people who
are working that so townville talked about sourcing opportunities we talked about pricing in terms of
their return driven right so they're solving for what can I pay today take some assumptions on how I can
derive or how can increase profitability and I sell the company a number of years what to to achieve that
along the way I wanna solve for return that meets the the return that I told my not the hurdles but the
you know the target return on my phone so that's at a high level how they come with price

the example I've used so far the by and large by and large has been in buyout right you're assuming that
there's some level of profitability and therefore I can you know cut costs and you know there's some cost
structure in place I can cut costs and I can get to a finished line in terms of what I'm willing to pay for
these we talk about venture though already in earlier on just to describe what venture what what
venture investing is what's the problem in trying to come up with the valuation based on profitability or
multiple profitability for adventure it's very like straightforward? Right so like you can't take a view that a
startup is worth 10/20/30 times whatever their profits are for a year because you just they're not
profitable so how are you supposed to come up with a number back to you in venture man how do you
come up with a number that you're willing to revenue multiple revenue multiple might be a possibility if
you're an early starter filter might not be revenues either right then you're going to negotiate with the
buyers maybe do a safe note sorry you have to maybe do a select note convertible equity room yeah so
we're gonna talk about the method by which you might invest in into a private into a into a startup but
generally you have to take a view on what this company or this idea is worth

it's got nothing to do with other or something like that yeah so absolutely so that's what you're gonna
try and value right but ultimately what you're trying to derive is the price you're willing to pay for that
ownership stake and I don't wanna get into nuances of how inventure land you don't we talked about
this but you buy it you you get minority stakes generally you don't to take ownership of the get to start
running the company so there's other months involved as well but to your point of yeah you're trying to
value their patterns their idea of coming up with a value on that patent right so there is no economic
formula you can follow for that you can't just decide hey I'm gonna pay for every patent you have a
certain price some patents might be worthless others might be worth a lot might be a good idea bad
idea it might depend on other factors like how quickly governments adjust to providing preventative care
if you're doing something in healthcare right so if you have some sort of early detection technology for
cancer but you're trying to sell that in Canada where health Republic and you need the government to
pay up for this well how are you get the government to pivot to do this so quickly right so you have to
understand you have to take a view on what this start of this table to achieve based on their idea which
is going to be very difficult to try and quantify economy which is why venture investing is attraction right
like basically venture guys are taking bets on on outcomes that are very difficult to foresee now the ones
that have been successful we'll say that they've developed some sort of methodology right they have an
eye for what works what doesn't so often you'll have as I think I alluded to in the term ventures venture
firms typically specialize in some subject right so if I'm a farmer infector investor I have good contacts
that work in in the regulator so if you're in the states I guess it's the FDA right Drug Administration so you
have good contacts you have a sense of what their approval process is what their testing processes are
so like as a venture for my build you're teasing the domain that I'm trying to enable enable my founders
to succeed right so like I'm I'm I have expertise in those areas if I'm a software venture investor I have a
bunch of people that used to be on the payroll and Microsoft Google who are the ones that typically end
up buying a lot of these successful software vendors right so software firms that start off as venture
opportunities so I have a lot of contacts on those firms and therefore you know I think that if I find the
right one I could identify the right one I know what Google and Microsoft are looking for when they're
trying to buy software and therefore I backed the right one because I have that so all this to say purpose
the topic of discussion for today's class was how do you value and venture land it's not a mechanical
formula it's not an economic exercise you can't plug it in a financial model which by the way is the
exercise all these finance and these private refunds too is financial modeling right you're trying to solve
for what you're paying and how you drive return and what happens everything in between you're
putting in your top line revenues you're putting it on your cost they're coming up with effectively
perform a financial statements for your company right so you can't do that inventory scenario so that's
what I that's the only and we're gonna talk about adventure way more elaborately next week but that's
that's what you need to remember preventure very different exercise to try and figure out how you're
gonna value that opportunity just because it's not an economic and on any any in any other
circumstance I just want to keep hammering this home private investments no different than any other
investment asset class right I talked real estate a few terms ago people have a very difficult time grasping
this but what you're willing to pay for a piece of real estate if it's a piece of if it's an investment it's very
very intuitive how much income will this investment drive would I think it'll be worth when I wanna sell
it that's it that's all it is same thing with any private company same thing with a stock or any investment
that you make has that exact same so now where there's variations to what assumptions you make
about what somebody might be willing to pay along the way or what my cost of debt might be along this
you plug in different assumptions but all of these private equity funds are doing the same exercise and
modeling out what these different outcomes are and all of these inputs all these assumptions you have
to make you can sensitize them right or run sensitivities or I don't know how how other people articulate
this but essentially you can flex them right you can make different assumptions to see what range of
price you might be willing to pay but that's all you're doing you're trying to take a view on what these
different assumptions are but eventually I'm incapable of doing that so we talked about venture we
talked about buy out one topic I haven't talked much about is distressed by how do they sort something
and the reason I waited up until now the textbook talks a lot about distress I saved it for now because it's
the most intuitive time trying to explain it sourcing if I'm trying to find an opportunity to invest in
distressed private equity investment first of all what is distress what is a company that's distressed that's
right so so you have a view on a difficult financial circumstances there they have maybe going concern
they have trouble servicing their debt potential so we can use a some real life examples where we can
use like a hypothetical example but it's like staples it's probably a lot of these retailers probably shouldn't
exist or like discount like there's no reason for anybody work at staples at super offensive that was like
my first job is like after I delivered papers for a number of years and 1:51 so I have a lot of affinity for the
company but yeah so like as a company probably not a great investment opportunity today right so but if
I have a view on I could run staples really efficiently right like I think I can cut a bunch of costs they're
really sweet footprint is probably something that's crazy right they only huge big box stores I think I can
you know consolidate that and run it in a third of the real estate I'm making these examples up but like I
think I can do this really well and oh by the way staples has a bunch of debt that's trading so that publicly
traded debt and they're servicing that debt right and what's happening with interest rates right now
really high relative to what they were appears ago so they have to refinance any of that yet they have
bullet bonds which they probably do that are coming due in the near term and I think staples and by the
way this is not I'm making all this up staples not that I know of so like maybe they are but they probably
are but so if I take the view I'm a private equity fund that's been very a private equity fund manager
that's very good at retail operations I I'm very efficient I I know how to do this I think staples has debt
that's where I know staples has publicly traded debt but it's a private company but has dead that's
publicly traded still they have a lot of debt that's coming due in the coming years that debt is gonna cost
a lot more for them to service that debt is gonna be is not gonna be feasible if I want to take over staples
should I go to the owner of staples and say hey but to sell me your equity today they're gonna say hey
well retail operations trade on the multiple of 10/12/13 times whatever it is right profitability isn't this
$10 is $130.00 but if I think in a few within a year or two their debts gonna start coming due and they
won't be able to refinance they won't be able to afford that debt by more efficient patch taking control
of staples for people bold is to go buy at that depth because when a company doesn't service their debt
what's the consequence goes back to the credit yeah it goes back to the creditors in fact we'll just knock
this out really quickly what's the order of who you have to pay for go bankrupt if you're if you're a
company if you're a private company before but you're on the right track because that's what we're
talking about but really quickly if you have anything due to the government if you withheld so generally
when you buy something and you pay them the price of the item plus GST QST you're paying sales tax
you withhold that tax you hold that on behalf of the government you have to pay all of that right away so
at any any proceeds you've retained for for sales tax for instance or if you own the government passed
the income tax that that was the first dollars that are owed second is your wages so if your employees
are owed any wages they have to be paid before anybody else so once you've knocked those two things
out what's left what's the next thing Maggie just said so if you borrowed money and you can no longer
pay it before you even have to pay your rent you have to pay your senior level and so if I think that
staples won't be able to pay their debt and I wanna take over staples so that they can do a really good
job of it uncle buy up their debt so that when they default unless somebody's willing to take a leap of
faith and write them a massive check because they have the same conviction that they can run staples
efficiently staples will end up having to turn over the keys to me right I'm using exchange scenario there's
a lot of things that happened before test company ends up in the hands of its debt holders but that's
what distressed private equity fund managers do they identify companies that they believe will be that
that have tipped over so they'll buy debt of a already bankrupt company and take the keys over and run
the company more efficiently or they'll buy debt of a company they foresee being in financial trouble in
the near future and then that's their path to generating a return now what's the upside in doing this so if
I'm in distressed debt and I have really strong conviction on my my ability to serve to to run staples
better what's the other upside of me buying up their debt what are staples is really successful and they
just crushed over the next few years the worst that can happen is I'll get paid back for the debt right like I
still own that debt instrument I get paid a return not that return isn't gonna be as what I promised my
investors it may not hit my hurdle but I won't lose money I won't go to 0 if staples succeeds if I'm a
distressed debt master if my debt holder ultimately makes it out alive yeah I didn't get to take over the
company and I don't think I won't generate the 2030% returns that I want to generate but my downside
is pretty damn good right like I'm gonna get my debt paid back so that's one tidbit to keep it but to bring
it back to today's topic which was how do you source these opportunities distressed companies they're
private equity fund managers whose expertise is identifying companies that they believe are
mismanaged and have debt that's available to them to make sense any question everybody's wondering
why like how come dead man distress upon man you may think that you can run staples very efficiently
when you actually take over staples you find out it's a much bigger to that and so distressed private
equity fund managers are not don't all crush it the one that you would have heard of or the ones that
you probably familiar with Aries Apollo you guys are I guess one of their founders was all other story but
you know they're publicly traded as well that's right I bring them up because they also sorry so that's our
distress fund managers and so when they underwrite their investment opportunities they do the same
exercise which what am I willing to pay I'll buy the debt but I have that cost what does it cost me to buy
that debt how long will it take before I could take over the company you have to factor all those things in
how long till I turn it around and sell it all those are that's how you how you come up with the value so
we talk about venture we talked about distress we talked about buyout we'll we'll we'll tackle one last
one which is grown this one's a bit tricky right so bio we understand well it generates a profit I pay a
multiple of profit venture doesn't generate focus I take a view on what this thing is working growth
equity is somewhere in between as we've discussed in the past so how do you come up with what you're
willing to pay for growth for a for a company that's in growth if I'm private equity fund if I'm private
equity fund manager who makes growth investments I may have that expertise which is I can grow these
companies generally like I I'll go back to the same examples I can expand them internationally I can I can
expand them through acquisitions I might have a view on how we can grow those operations so all those
other toolkits that exist are just kind of cost running them institutionally running them as an institution
would those are all still in place so whether you're out or whatnot but how do I come for the price I
won't because the guy that's selling the company in a growing company they know just by way of
background if I if I'm the owner of a company that's growing I know that I shouldn't be selling it for 10
times more revenue stabilized company is selling for 10 times why is that if I think my revenues are
doubling or my profitability is doubling up every year I sell for the same multiple as this table and I'm not
using it or anything just because like I want profitability to be like the thought process like so why would I
not be willing to sell for the same multiple stable from a growing company why do I not want to sell at
the same rate as stabilized company at the same multiple because you see growth in your company it is
going to change that means absolutely so I see growth in my company so if I allow somebody to pay the
same price for the same the same multiple for my company next year when I doubled the profitability of
the paid half the multiple essentially right if I was told if I was generating $10 in profit and I sold for $100
I sold the 10 times but next year I know I'm gonna generate $20 in profit because I'm in growth mode
like if I look forward to hear right away that extra year but I may need capital to be able to get to $20.00
of profitability versus 10 so I do need to get some I do need a capital injection I need equity to be
invested into my company but I don't want to be dilutive to my ownership too much because I'm giving
away profits that I think will happen in the very short term so if I'm a private equity investor now going
back into the shoes of the person making the investment growth company how do I come up with the
value I've just made you realize that they may not want to sell on on the base on the multiple other
possibility what other metrics can we possibly use and I heard one earlier on the class so like what other
what other metrics can we use revenue multiple or you can do DCF maybe yeah so because that's how
they do on all of on any opportunity but I told you in the bio context the multiple wasn't output right the
multiple profitability that I'm willing to pay for the company is not something I've decided from the
moment from the moment I came up with the price I'm willing to pay I came up with the price that I'm
willing to pay and that led to a multiple right I have to solve for 2020 like 30% return whatever it is I have
to come up with what I believe my capsules will be so you guys are if you're visualizing this it's a
discounted cash flow I came up with the person in the end I can derive what multiple that implies in the
context of growth investments I have to do some of the same exercise I still need to get to that return
that I promised my investors but I can't just apply multiples to my to their to the profitability because
they won't sell to me based on any profitability multiple so the revenue multiple is kind of the the more
accepted or the more go to metric that growing companies are willing to sell that

Yes can you use the PEG ratio PO yeah absolutely so you can but in private equity land the norm for
growth has been by large revenue and I'll and I'll get into it once because we're gonna talk about growth
and buyout sorry growth investments specifically as well in separate and separate class um so we'll walk
through it in more detail but by and large I think for now what I'd like for you to retain is the revenue
multiple system is is the the metric that's most often used why is that and by the way the revenue
multiples are much higher so like generally you think of paying for a stabilized business maybe 8 to 12
times of their profitability and revenue multiple land people are often willing to pay in the 20s range and
I'm over generalized because it varies by sector but generate revenue multiples are quite generous so if
you think about it if you want to think about it from a moment well why would you be willing to pay a
revenue multiple first of all and why would that multiple the number itself of the revenue be higher then
then a stabilized off the building any thoughts in growth land there is going to be generally and like if we
if we oversimplified if you think of this scale as you continue to grow your cost base shouldn't grow
linearly right so if I double up my profitability or if I double up my top line revenues in a in a growth in a
in a company that's growth oriented very likely that my cost basis will go up that'll go up right so you're
willing to eat the fact that you're paying more just for the revenues ignoring profitability because there is
room in for that profitability to grow very meaningfully over time we talk about growth companies often
being break even or just barely profitable but the line of sight is if you think you can double triple up
quadruple up your customer base then you're doubling up tripling quadrupling up your top line but your
bottom line because you're stabilized because if you were developing the software it's not developed it's
functional that's proof the proof of concept is behind you you are now you have a software that works
people will be willing to pay for it it's not gonna cost me as much to develop it it's not gonna cost me the
same as it did to develop that software to go from scratch to have something that's fully baked in
everybody fall in line with revenue multiples last ticket in terms of the ownership states you end up
taking in these companies and as I said in ventral and it's very nuanced and I and I want to spend a
meaningful amount of time on that when we get to that class next week not because of impact how you
think about your trump project in file quite intuitive right what do you end up taking is control of the
company you take generally 100% or maybe you need some management you might but in either case
you have a majority control over the company and buy it so your ability to influence the outcome of your
investment is in your hands right if I'm a violent investor and my pie shop were really good at cutting
costs to to use like the the most basic example there's nothing that gets in the way when I decide I
wanna cut a bunch of costs that don't have other stakeholders I don't have forward to report to I am the
board company would control the board so I have no one to report to to rationalize when your growth
mode one of the things we discussed earlier on the term is typically you end up with a minority position
or the owners of companies that are going to want to give up majority ownership how do you then
ensure that you can help them in that growth if you believe you can help them say for instance grow
from being a North American company to company that sells soft how are you supposed to ensure as
one of the equity investors at this point because you're buying into the equity of the company then you
have some sort of say on on how the company is on the direction of the company help manage because
you don't take over management but you take over some level of direction you sit on the board yeah so
you sit on the board so board of directors again I didn't wanna I think I spent a bit of time on this earlier
on in the second class but what does every company have whether private public they have board of
directors right so the people that are responsible for the direction of the company and it's on the
governance class so I don't we don't need to get into the nitty gritty of it but the general structure of of
companies whether public or private you have a board apartment directors and then you have
management and then everybody else right and so the board of directors are responsible for nominating
management hiring management firing management if they want to including executive management
sorry including the the chief executive officer of the company right so that's what the board does now
we just said in the buyout scenario you take over the board if you're a private equity company you now
own the company and therefore you can appoint whoever you want to the board generally what you end
up doing is you hire a couple of independents that are very good at what they do and at that time the
company so if you buy a software company you may wanna find some ex Google guy who was very well
renowned and all that person doesn't he's old and retired but he sits on board you get him to be
involved you have your investment team people because they're the ones that came up with what they
believe the financial projections the company would be along the way so you want one of them on the
board to make sure that they're have oversight of management as well you might appoint another
partner from the firm some analysts decide but all people that are by and large under your purview so
they're gonna do what you say is as private equity provide they I mean by by you I mean you private
equity fund right you want to direct the company in a growth scenario you're having to rely on not
necessarily your appointments to that board if you made an equity investment to take say 1020% of the
company and there are say 5 board seats maybe if you bought 20% you've got one board seat right it's
not always that clear like it's just broke down every 20% shareholder has onboard oversimplifying that's
not always the case but in the end you have one vote out of box right if you wanna house the founder or
the CEO of the company not the founder but the CEO of the company the guy was running the company
but he owns all 80% US growth equity fund manager made an investment into a company that you have
no direction in right you may have all these ambitious plans to grow this firm you wanna take them
internationally you wanna do all these you may have ideas on how they should do card how they
optimize their operations to become a real company but you have no say 4 million that company so as a
growth investor private equity fund investment growth opportunities how do you tackle that yeah I
guess when you reach out the company like part of your your pitch to them is absolutely so that's I think
that's that's a really astute like way of pointing out because we think of all this as economics and we see
as an investment opportunity the founder of the business ultimately wanted needs equity investment
and they have a desire for growth so it is human beings that interact with one another so it's a CEO or
founder of the of a of a company that's now breaking even or semi profitable their idea when they went
out to get to get a growth equity investor was to find somebody who was willing to work with them to
grow the company so like hopefully they'll have you here but the reality is and This is why growth
investments are a little bit riskier is that they may not operate ultimately like founders again like I I'm
using the joke the joke but the the example that I did in last week Class A lot of these founders happened
to be true people right in ventureland it's extra it's extra egregious because you have an idea and you're
being paid for this idea and growth it's a less of a a sexy story because it's still like a semi profitable
company so it doesn't sound as crazy when somebody says I don't want your ideas I wanna run it myself
you go OK well at least you have a semi profitable company but how do you formalize beyond the notion
that you'll work in consortium with existing ownership of the company how do you how do you formalize
that arrangement the notion that you'll be working hand in hand with the the remaining shareholders of
the company which would in often cases the founder or the existing management of that company in a
growth remembrance so voting rights you you're you're very close to what I want to get to so you can
have control necessarily over the world but you can't have what often people call negative people does
anybody does everybody know what negative control

OK so again it's not a government governance class so I don't wanna spend a ton of time on this but for
any company generally the board has a say over certain decisions they'll call them reserved matters you
might hear these terms and like this isn't unique to private equity it's really common in all in any in any
given context but companies have things like reserve matters but they're often called reserve matters
what what are they how much can your company borrow at any given moment if the company wants to
borrow any more than if you're a very big company this threshold could be very big if they're a small
company that threshold might be very small but you'll say hey if you if you wanna borrow if you're a
company that generates $10 in profits if you want to borrow $3 you have to come to the board and
everybody has to be there has to be everybody everybody has to agree on that or you have to have at
least four out of five votes for instance so if I'm a minority owner in this company that has one board
seat if it's unanimous if it has to be unanimous agreement to borrow 3 bucks then when that founder
CEO decides hey I wanna go borrow 3 bucks right now that generated 22 extra dollars in profit or three
extra dollars in profit I wanna go borrow 3 bucks I have negative control of this company because ISP
fund manager ensured that my governance terms said that hey if you want to go borrow money I get to
have a say in that now borrowing seems pretty benign right hey you generate more profit you wanna
borrow more money you presume you want to put that money back into the company and and and grow
it so like that's kind of a benign scenario but in companies that are making decisions about what
jurisdictions they want to grow in if I'm pregnant can you fund and I have investors that don't want
Chinese investments and my founders saying hey I want to go sell software in China and I say hey any
global expansion that occurs CapEx that incurs a spend of more than why dollars I have a safe I have
negative control over the company right you want to grow the company in a market if entrance into any
new market requires unanimous consent from the board I have one board seat so I can so in normal
circumstances I'm out voted right somebody there are four other votes on that board but because I
maintain negative control I've been sure that my interest in the interest of my investors are not
protected again not a crazy scenario like growing in in a market that I don't want but it gets trickier as
you move as you go down the types of scenarios you might encounter it becomes virtuous something
you said when you're about to invest yeah really good question so when you make the investment as
part of the investment you have to negotiate the shareholder agreement so incidentally when you buy a
private company the sellers will honor green all these terms before any transaction any any value is
exchanged and it's a really good question because it's not part of the content of like what you'll be
examined on or anything but if you're a seller of a private company if I own a private company then I'm
selling and if it's a growth it's a company that's growing I may want to avoid as many reserved matters as
possible I may be willing to take less money from another buyer who's willing to say effort like you go
ahead and do whatever you want I just want 20% of your company

I'll take one board too but I won't you know I don't care about your reserve matters right so that's like a a
separate issue if you will but all of this is agreed upon before in your sale and purchase agreement or
your PSA all these shareholder agreements are all agreed upon before the transaction is consummated
occurs so really good question now I've talked about like pretty benign scenarios but what can you think
of like some reasonably I don't want to say extreme scenarios but if I'm a growth equity fund manager
investment company what are the things that would be very fearful of once I've made that investment
and this is all comical circles because venture it's even more extreme like all these risks are like 10 times
higher but growth is like our growth equity investments are just a little bit less how would I say a little bit
less exotic in terms of how wild things could get because you can imagine eventually you're paying for
nothing you're paying for an idea at least in growth there's some company and there's some idea there's
some something that's proven behind it but what are the other scenarios that you wanna count for
because again just to bring it back to the content of the class you're a fiduciary for your investors right if
you're GP that manages growth equity capital they make growth equity investment how are you making
sure that you're protecting your well first of all your own carrying your your own your own living but also
the interest of your investors what other scenarios can occur from a company in which you don't have
majority control I mean if the company wants to release some more shares they can get potentially
diluted yeah so this is particularly with so you hit so the the most egregious thing that can happen and
Adventureland intervention is easier to visualize but in a growth and we'll talk about that next week but
in an opportunity where you invest for a company that's growing if the owner decides one day to sell to
you at a certain price and you're ground that price and and you you you can't make the transaction you
get that board seat but you exert no negative control over the company if the next day the founder says I
would like to sell to a friend of mine or even worse and this is a much more common scenario I'm getting
divorced I gotta sell this divorce this divorce let me sell my shares to somebody else and give somebody
else control on the company because the company right how do you avoid all those circumstances what
are the mechanisms that exist if you're in a P fund manager that's investing in growth opportunities how
do you dodge that other than having negative controls so that's just a you've now decided at the board
level I have a vote and I can redo some decisions some very specific decisions that are outlined but now
we have a scenario where you're you're one of your other shareholders who owns a majority is now
selling his company because he has to he needs funds for a divorce or he he turns out he has a gambling
problem and he needs to saddle up real up in the back of a back of the trailer somewhere so like how do
you how do you ensure that you don't end up in these circumstances as the GPU's who hasn't investors
to support negotiate specific terms of an agreement where they have to notify you of selling and you or
agree with the other yeah so you've you've come conceptually to the right idea which is there has to be
some sort of mechanism that ensures that if there's a sale process I'm involved from the onset so how
do you do that there are different ones the textbook doesn't go into this detail I think I don't know it
does not sorry but there are different mechanisms that you agreed upon among shareholders if one
shareholder wants to sell he has to first there are different like so you're gonna hear A tag right drag
rights roofers ropos right first offer right the first refusal these are concepts you might have explored in
other classes as well in governance classes but these are all mechanisms that have growth investor will
want to ensure exist in their agreement which is to say hey if you majority owner want to sell your
company you have to give me the option to buy it first now the contractual arrangement is actually it
doesn't matter as long as I have a first crack at it and as long as I have the ability to say for instance to
match if you go out to the market and get an offer if I have the ability to match if I'm willing to pay up
what anybody else would to pay up then I have to have that right to buy your company right like I need
to retain all my governance rights to ensure that my investor that my investment is protected because if
you're not around well I can I can derive the same value that I had underwritten in my original case right
which is I'm gonna change this company international I'm gonna drive these profits if you sell this
company to some slept for a competitor I mean I'll be able to do those things so my investment might be
might end up so you wanna ensure you have all those protections which is contractually it's just tag
along if you if you guys want to look these up do it at your leisure but tagalongs drag along so tag along
is if you sell I could sell with you at the same price and if you're selling it should evaluation that I don't
wanna do that right so that that title long doesn't have any value drag along is hey I'm selling the
company I found a buyer that's willing to pay up you have to now sell your share alongside me even
though you're 80 percent 20% I drag you along write a first offer right of first refusal is hey you're gonna
sell you come to me first or write a first refusal as you come to me first I have the option to buy you out
before you go so if we agree on the price there might be a mechanism to come to a price but I get to buy
you out first before you go out to the market right of first offer I'm sorry that's right first offer right first
refusal is hey you've gone out you've gotten a price I can match that price so you've gone out
somebody's going to buy you for $100 well I'm I'm allowed to pay up that $100 and now you have to sell
to me and you have in a growth context super important why not just for the obvious reasons I stated
because you're protecting capital then from your investors but if this if your majority investor who you're
who you're along for the ride goes out to the market and gets a very high valuation do you want this
fund manager to be able to realize that giving yourself as well right like you wanna be able to to wash
your hands feel like you can monetize your investment early on if that's the outcome if it's a good If it's a
bad outcome what's the consequence for you so say the valuation comes up very low he goes to the
market and you can you know say they hired A banker and they went to the market and you're a
majority owner does not get some really ****** value and now you have the ability to buy it at that
price what was the problem with that process to begin with because you have that right if I'm selling a
company and I told him like hey what are you willing to pay but ohh by the way whatever price you come
up with after offered to to my other shareholder my my buy sorry my growth equity fund that's a part
owner in my in this company as well whatever price you're going to offer me they have to have the
option to buy at the same price what's gonna happen to that process that the investment bankers are
what what what do you guys think of it in Twitter this isn't like a think of it practically like what would
that do if I just told you that private equity firms spend millions of dollars in doing due diligence on every
company and now what they've realized is yeah just like come with the price that I'm going to pay for
your company but hey when I'm done you the next guy can just pay whatever price I came up with and I
don't get access to it what happens to that process that means I will not I probably won't get the optimal
price right the majority owner who is running this process to sell this state when he goes out to the
market we'll probably handicap this process now this is speculating a little because maybe somebody out
there is going to be willing to pay a price to the next guy won't I'll come up with the price but by and
large the reason growth equity fund managers make sure they have this contractual protections to make
sure that they protect returns because mechanically this does exactly that a either in the outcome will
be the the majority owner sells the company at a great valuation and I want to get out at that value or
they run a process and it comes out to the value isn't great and so now I get to buy their share on
initiative valuation but I still believe I can deliver what if I thought I could double up my money by
owning 20% of the company whether I want 20 or 100% of the company I could still double up but the
quantum that I will have double level just be larger right initially invested $20.00 for a 20% stake $4.00
but I've effectively doubled up 100 instead of just 20 so I've got $160 in actual incremental dollars out
the door that's the output right so I'm oversimplifying a lot of conceptually what happens but This is why
growth investors are so hyper focused on governance rights it's so critical because you're at the mercy of
not being in the driver's seat whereas in buyout land you are investing in distressed land we talked about
what the downside protection was hey I bought the debt they paid me the debt and I walked away I
didn't get a great return I didn't lose money right like that's that's the battle point in growth land and
Adventureland next class the bad outcome is if I didn't structure this correctly not just economically in
terms of the price that I paid if I didn't struck this correctly I can lose the company without doing
anything wrong right unless if I didn't think through some of these other arrangements whether it's
contractual arrangements whether it's negative rights negative control over the company at the board
level you have to think through these incremental considerations so i'll stop there i'm around if you guys
have any other questions there's a few more things to tell those topics but that kind of concludes what
may or may not what may or may not appear on the quiz next week next week as i said the first half of
the class will go over venture so we