Presented By
CA Swatantra Singh,
B.Com , FCA, MBA
Email ID: [email protected]
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
They buy companies…and then sell them
(hopefully) at a profit in a few years.
Rajput Jain & Associates.
Quick primer on industry jargon:
• Private equity firm = financial sponsor (e.g. The Blackstone
Group)
• Strategic investor = corporation (e.g. Walmart)
• LBO = leveraged buyout
The private equity process
• Private equity firms raise ‘funds’ – e.g. ABC Fund I, ABC Fund II
• Within each fund, the private equity firm is a General Partner (GP). GP
directly invests 1% of the fund
• All other investors are Limited Partners (LP) and they invest 99% of the
fund
• GP – LP is an important distinction both for legal purposes and also for
understanding how PE process works
• The fund itself is structured as a limited partnership
• Funds invest in multiple companies, acquire a controlling stake (usually
100% of equity)
• IRR threshold is 20-25% depending on size of the fund
• Lifetime of fund is ~ 5-10 years, this means that all companies in the fund
must be sold within this period
PE hiring
• Private Equity firms usually setup groups based on Industry and/or
Geography
• Many of the big firms are global
• Most firms are small with 50-100 investment professionals
• Some firms separate investment team from portfolio management team
• At entry level, most PE firms hire investment banking analysts with 2
years of experience
• Hard to break into industry, best way to do so is through contacts
• Lucrative and better hours than banking
• Culture tends to vary by firm – most PE guys are ex-bankers so some
similarities in culture
PE exits
• Exits can be of the following types:
• IPO
• Sale to another PE firm
• Sale to a strategic investor
“Any fool can buy a company. You should be congratulated when you
sell.”
-- Henry Kravis, founding partner of KKR
How do private equity firms make money?
• How do Limited Partners make money
• Periodic return on capital (e.g. dividends), 80% of profits
• Profit on exit, proportionate to investment
• How do General Partners make money
• Management fee of 2% per annum on raised fund
• Carry or Carried Interest, usually 20% of profits
• Profit on exit, proportionate to investment
What company makes a good target for a
buyout?
• Mature Industry
• Mature Company
• Strong Management Team
• Low Leverage
• Low CapEx Requirements
• Strong Cashflows
• Good Exit Options
3-step IRR calculation for PE deals
Step 1
•
Determine purchase price
•
Determine how much will be paid for using debt vs. equity
•
What is the entry multiple (i.e. EV/EBITDA of x)
Step 2
•
Project company’s cash flows over investment horizon (e.g. over 5 years)
•
Use any excess cash (after operating expenses and interest has been paid) to pay
down debt
•
Equity holders receive no cash during these years
Step 3
•
Assume an exit multiple (i.e. EV/EBITDA of x)
•
Multiply this with EBITDA in exit year (e.g. in year 5)
•
You now have EV. EV – outstanding debt = Value of Equity at Exit
•
Using Equity put in from Step 1 and Equity at exit from Step 3, you can calculate
IRR of equity investment
Barneys Case Study
•
Deal size ~ $950 million
•
Financed by 30% equity, 70% debt
•
GPs invest 1% of the equity, LPs invest 99%
•
Assume 5 year investment horizon
•
2% management fees per annum
•
Profit sharing among GPs & LPs is 20% and 80% respectively
•
Assume $120mm debt paid down each year & no cash distribution to equity
holders during years 1-5
•
Assume entry multiple (EV/EBITDA) of 8.0x and exit multiple (EV/EBITDA) of 8.5x
1. How much money did the General Partners invest initially?
2. How much money will the General Partners make in management fees on
this deal?
3. What is the IRR earned by GPs?
Barneys IRR (for LPs)
Deal value
Total Equity
Total Debt
30%
70%
Equity from GPs
Equity from LPS
950
285
665
2.85
282.15
Entry multiple
Exit multiple
8.0x
8.5x
Year
0
1
2
3
4
5
EBITDA
120
120
120
120
120
Debt begin
665
545
425
305
185
Debt end
545
425
305
185
65
EV at exit
1020
Debt at exit
65
LPs Equity value at exit
CF to LPs
IRR
945.45
-282.15
0
0
0
0
945.45
27%
Barneys IRR (for GPs)
Deal value
Total Equity
Total Debt
30%
70%
Equity from GPs
Equity from LPS
950
285
665
2.85
282.15
Entry multiple
Exit multiple
8.0x
8.5x
Year
0
1
2
3
4
5
EBITDA
120
120
120
120
120
Debt begin
665
545
425
305
185
Debt end
545
425
305
185
65
EV at exit
1020
Debt at exit
65
GPs Equity value at exit
9.55
Management fees
Total CF to GPs
IRR
-2.85
2
2
2
2
2
2
2
2
2
11.55
81%
Presented By
CA Swatantra Singh, B.Com , FCA, MBA
Email ID: [email protected]
New Delhi , 9811322785,
www.caindelhiindia.com,
www.carajput.com
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