Introduction to Private Equity

233 Pages·3.165 MB·English

by  Cyril Demaria(auth.)

Introduction to Private Equity
ForothertitlesintheWileyFinanceseries
pleaseseewww.wiley.com/finance
Introduction to Private Equity
Cyril Demaria
A John Wiley and Sons, Ltd., Publication
Thiseditionfirstpublished2010
(cid:2)C 2010CyrilDemaria
Registeredoffice
JohnWiley&SonsLtd,TheAtrium,SouthernGate,Chichester,WestSussex,PO198SQ,UnitedKingdom
Fordetailsofourglobaleditorialoffices,forcustomerservicesandforinformationabouthowtoapplyfor
permissiontoreusethecopyrightmaterialinthisbookpleaseseeourwebsiteatwww.wiley.com.
Therightoftheauthortobeidentifiedastheauthorofthisworkhasbeenassertedinaccordancewiththe
Copyright,DesignsandPatentsAct1988.
Allrightsreserved.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmitted,in
anyformorbyanymeans,electronic,mechanical,photocopying,recordingorotherwise,exceptaspermittedbythe
UKCopyright,DesignsandPatentsAct1988,withoutthepriorpermissionofthepublisher.
Wileyalsopublishesitsbooksinavarietyofelectronicformats.Somecontentthatappearsinprintmaynotbe
availableinelectronicbooks.
Designationsusedbycompaniestodistinguishtheirproductsareoftenclaimedastrademarks.Allbrandnamesand
productnamesusedinthisbookaretradenames,servicemarks,trademarksorregisteredtrademarksoftheir
respectiveowners.Thepublisherisnotassociatedwithanyproductorvendormentionedinthisbook.This
publicationisdesignedtoprovideaccurateandauthoritativeinformationinregardtothesubjectmattercovered.It
issoldontheunderstandingthatthepublisherisnotengagedinrenderingprofessionalservices.Ifprofessional
adviceorotherexpertassistanceisrequired,theservicesofacompetentprofessionalshouldbesought.
LibraryofCongressCataloging-in-PublicationData
Demaria,Cyril.
Introductiontoprivateequity/CyrilDemaria.
p.cm.
Includesbibliographicalreferencesandindex.
ISBN978-0-470-74596-0(cloth)
1.Privateequity. I.Title.
HG4751.D462010
332.6—dc22
2010005161
AcataloguerecordforthisbookisavailablefromtheBritishLibrary.
ISBN 978-0-470-74596-0
Setin10/12ptTimesbyAptaraInc.,NewDelhi,India
PrintedinGreatBritainbyAntonyRoweLtd,Chippenham,Wiltshire
Tomyfamilyandmyfriends
Contents
Foreword xi
Acknowledgements xiii
AbouttheAuthor xv
Introduction xvii
Amovingtarget xviii
Aconsubstantiallackofinformation xviii
Benignneglect,malignconsequences xix
Knowingthedeviltocircumventit xx
PARTI WHATISPRIVATEEQUITY? 1
1 PrivateEquityasanEconomicDriver:AnHistoricalPerspective 3
1. Poolingintereststoidentifyandexploitsourcesofwealth 5
(a) Identify,controlandexploitresources 6
(b) Leveragepublicpoliciesandafavourablebusinessenvironment 8
2. Championingentrepreneurship 9
(a) Noprivateequitywithoutentrepreneurs 10
(b) Convertventuresintobusinesssuccesses 12
(c) Entrepreneurshipandprivateequityformaspecificecosystem 14
Conclusion:anattemptatdefinition 15
(a) Anegotiatedinvestmentinequityorquasi-equity 15
(b) Afixedmaximumterm 16
(c) Implyingspecificrisks 16
(d) Withhighexpectedreturns 16
(e) Undertakenonbehalfofqualifiedinvestors 16
2 ModernPrivateEquity–AFrenchInvention? 19
1. USA:thefoundryofmodernprivateequity 20
Thestrictseparationofpublicpoliciesandpublicfinancing 20
viii Contents
Theseparationofpublicendeavoursandprivateefforts;thesubsequent
supportoftheformerforthelatter 20
(a) Governmentalinput:SBA,DARPAandERISA 21
(b) Universities,defenceanddisruptiveinnovation 22
(c) Challenges 23
2. Europe:adaptingasuccessfulmodelorcreatingitsown? 24
(a) Governmentalinput:legalchanges,taxrebates,infrastructures
andEUmarket 25
(b) Nationalchampions,informationtechnologiesandincremental
innovation 28
(c) Challenges 33
Conclusion:Emergingmarkets,buildingcastlesonsand? 38
PARTII THEPRIVATEEQUITYECOSYSTEM 41
3 PrivateEquity:ABusinessSystemPerspective 43
1. Weareallinvestorsinprivateequity 43
(a) Sourcesofcapital 43
(b) Privateequityinvestmentrationale 47
2. Organisationandgovernanceofprivateequityfunds 53
(a) Privateequityfundmanagersarefinancialintermediaries 53
(b) Incentivesandfees 54
(c) Conflictsofinterest 57
(d) Power,checksandbalances 60
3. Measuringperformance,managingrisksandoptimisingreturns 61
(a) Measuringperformanceinanuncertaincontext 61
(b) Managingrisksandoptimisingreturns 66
4. Pitfallsandchallenges 71
Conclusion 74
4 TheUniverseofInvestment 75
1. Venturecapital:financingcompanycreation 77
(a) Venturecapitalinvestmenttargets 78
(b) Actorsandstructures 78
(c) Operationalactivities 80
(d) Challenges 81
(e) Limits 84
2. Growthcapital:financingcompanies’expansion 84
(a) Growthcapitalinvestmenttargets 84
(b) Actorsandstructures 85
(c) Operationalactivities 86
(d) Challenges 86
(e) Limits 87
3. Leveragedbuy-out:financingcompanies’transmissions 87
(a) LBOinvestmenttargets 87
(b) Actors 87
(c) Operationalactivities 89
Contents ix
(d) Challenges 90
(e) Limits 92
4. Otherinterventionsinprivateequity 95
(a) Targetingthestockexchange 96
(b) Turn-aroundcapitalandspecialsituations 99
(c) Distresseddebt 99
(d) Quasi-equityinstruments(mezzanine)andsecondliendebt 105
(e) Merchantbanking,investmentbankingandprivateequityhouse
intervention 117
(f) Secondarymarket 118
(g) Realestate,infrastructureandexoticassets 120
Conclusion 122
5 TheProcessofInvestment:AMatterofTrustandMutualInterest 125
1. Step1:Preliminaryanalysis 126
2. Step2:Valuation 126
3. Step3:Negotiating 127
4. Step4:Structuring 129
5. Step5:Complementaryduediligences 131
6. Step6:Transaction 131
7. Step7:Monitoringandexit 132
Conclusion 133
PARTIII PRIVATE EQUITY IN TEENAGE TIME: TREND SETTING, FADS
ANDRESPONSIBILITIES 135
6 PrivateEquityEvolution:TrendsorBuzzes? 137
1. Isprivateequitygoingmainstream? 137
2. Isprivateequity(still)creatingvalue? 140
3. Privateequity:betweenbubblesandcrashes 144
Conclusion 148
Thereisnosuchthingas‘capitaloverhang’ 149
7 PrivateEquityandEthics:ACultureClash 153
1. Greed 153
2. Destruction 157
3. Philanthropy 162
4. Transparency 163
5. Confidentialityandself-regulation 164
Conclusion 167
GeneralConclusion–PrivateEquityTodayandTomorrow 169
1. Coretarget:managethevolatilityofperformance 169
2. Theonlyvalidleitmotiv:long-termthinking 172
3. Theimpactofthefairmarketvalue 174
4. Along-termtrend:theattractivenessofprivateequity 176
5. Privateequity:futurevictimofitsownsuccess? 179
x Contents
6. Theimpactofabetterknowledgeofprivateequity 184
(a) UnderstandingtheriskandmanagingtheJ-Curve 184
(b) Innovatingthroughstructuring 185
(c) Privateequityanduniversalowners 186
(d) Changeordie:thepressureongeneralpartners 188
(e) Regulation:Damocles’swordloomingoverprivateequity 189
Glossary 193
Bibliography 203
Index 207
Foreword
Private equity can be described as ‘investments in private companies in privately negotiated
transactions’.Thismeansthatprivateequityisanassetclassthatisnormallyopaque,illiquid
anddifficulttoanalyse.
However,privateequityinvestingoffersmanyadvantagescomparedtoinvestinginpublic
and more liquid asset classes. The underlying companies can be acquired ina private trans-
action, often in a specific process leading to attractive acquisition. The companies can be
developedprivatelyonthelongterm,hencemaximizingtheirchancestosucceed,whenmost
publiccompaniesareonlytargetingshorttermbenefits.Fundmanagersactiveinprivateeq-
uitynormallyhavemuchmoreinformationwhentheymakeinvestmentdecisionscomparedto
thoseinvestinginpubliccompanies.Incentivesforthemanagementcanbebetteralignedwith
theinvestors’interests.Fundmanagersexerciseahigherdegreeofcontrolonthecompanies
theyhaveinvestedin,anddevelopthemaggressivelywithouthavingtoworryabouthowevery
decisionisunderstoodbythepublic.Throughprivateequityinvestments,investorscantarget
industriesornicheswheretherearenopubliccompanies.
Privateequityisaverycomplexassetclass,moreofanartthanotherformsofinvestments
whichareanalyzedandcomparedquantitatively.Privateequityisanassetclasswheremanager
selectionplaysthehighestroleofallassetclasses.Therearenormallyseveralprivateequity
managersthatareinthesamestateofdevelopmentoftheirownactivities.Somehavedecades
of experience and some have worked as a team for a long time. Some have made several
investments in the same industry repetitively and some of them have sold their investments
atsignificantlevelsofprofit.Thismeansthatanalysingprivateequityinvestmentsandfund
managersrequiresskillandexperience.
Private equity is no longer as private as it used to be. Because of all the large leveraged
buyoutsduringtheendof1980sandthemegaleveragedbuyoutsduringthepastfewyears,
private equity transactions have been widely reported and followed. Private equity is a long
termassetclassandinvestorswillrealisethefinalreturnlongaftertheyhavemadedecisionto
invest.WarrenBuffettstatedoncethatitisextremelyimportanttounderstandwheretoinvest
in because eventually ‘only when the tide goes out do you discover who’s been swimming
naked’.
Despiteallthesementioneddifficultiesandhurdles,CyrilDemariahasbeenabletowrite
an interesting and extremely well formulated book about private equity. Cyril has seen and
experiencedprivateequityfrommanyanglesandindifferentroles.Cyrilhasbeenaninvestor
directlyinstart-upcompaniesandmoredevelopedandwellestablishedbusinesses.Cyrilhas