足ることを知らず

Data Science, global business, management and MBA

Top > finance > Day 128 MIT Sloan Fellows Class 2023, M&A and PE 8 "Private Equity"

Day 128 MIT Sloan Fellows Class 2023, M&A and PE 8 "Private Equity"

finance M&A MBA MIT SFMBA

Fund setup

Private Equity is a group of investors pools their money together to purchase ownership stakes in companies that are not publicly traded (i.e., not listed on a stock exchange). The group of investors is typically organized as a private equity fund, which is managed by an investment professional called a sponsor. The sponsor is responsible for identifying potential investment opportunities, conducting due diligence on those opportunities, negotiating the terms of the investment, and managing the investment once it has been made. The sponsor typically charges a management fee and a share of the profits (called carried interest) for its services.

 

There are several stakeholders and they interact with each other.

  1. LLC Sponsor: The LLC sponsor is the investment firm that sets up the private equity fund. The sponsor typically raises capital from institutional investors (such as pension funds and endowments) and high net worth individuals, and uses that capital to make investments on behalf of the fund.
  2. General Partner (GP): The general partner is the entity that manages the private equity fund on behalf of the investors. The GP is responsible for making investment decisions, conducting due diligence on potential investments, negotiating the terms of investments, and managing the portfolio of investments over time.
  3. Limited Partners (LP): The limited partners are the investors who provide the capital for the private equity fund. LPs typically have limited liability, meaning that they are only liable for the amount of capital they have invested in the fund.
  4. Investing Partnerships: Investing partnerships are formed between the private equity fund and other investors, such as other private equity funds, to co-invest in larger transactions. This allows the private equity fund to spread its risk and leverage the expertise of other investors.
  5. Investment Professionals: Investment professionals are the individuals employed by the GP to source, evaluate, and manage investments. They typically have expertise in a specific industry or sector and are responsible for conducting due diligence on potential investments, negotiating deal terms, and monitoring the performance of the portfolio companies.

 

In a private equity set up, the LLC sponsor raises capital from limited partners and uses that capital to form a private equity fund, managed by the general partner. The general partner then invests the capital in a portfolio of companies, with the help of investment professionals who source, evaluate, and manage the investments. The limited partners receive periodic reports on the performance of the portfolio and may have some input on investment decisions, but they generally have limited involvement in the day-to-day operations of the fund. The GP typically charges a management fee and a share of the profits (called carried interest) for its services. The goal of the private equity fund is to generate a return on investment for the limited partners by buying and improving companies, then selling them for a higher price.

 

PE fund cashflows

  • Deal Level Multiple:
    The deal level multiple measures the return generated by an individual investment within a private equity fund. It is calculated by dividing the total distributions (i.e., cash returns) received from the investment by the total capital invested in the investment. For example, if an investment generates $10 million in distributions and $5 million was invested, the deal level multiple would be 2x ($10 million / $5 million).
  • Fund Level Gross Multiple:
    The fund level gross multiple measures the overall return generated by a private equity fund before accounting for any fees or expenses. It is calculated by adding up the total distributions received from all of the investments made by the fund and dividing that by the total amount of capital invested in the fund. For example, if a fund has invested $100 million and has received $200 million in distributions, the fund level gross multiple would be 2x ($200 million / $100 million).
  • Fund Level Net Multiple:
    The fund level net multiple measures the overall return generated by a private equity fund after accounting for fees and expenses. It is calculated by subtracting the total fees and expenses charged by the general partner from the total distributions received by the limited partners, and then dividing that by the total amount of capital invested in the fund. For example, if a fund has invested $100 million, has received $200 million in distributions, and has paid $20 million in fees and expenses, the fund level net multiple would be 1.8x (($200 million - $20 million) / $100 million).
  • Deal Level IRR:
    The deal level internal rate of return (IRR) measures the annualized return generated by an individual investment within a private equity fund. It takes into account the timing and size of all cash flows associated with the investment. It is calculated by solving for the discount rate that makes the present value of the cash flows from the investment equal to zero.
  • Fund Level Gross IRR:
    The fund level gross IRR measures the overall annualized return generated by a private equity fund before accounting for fees or expenses. It is calculated by taking the cash flows received by the fund and discounting them back to their present value using the fund's initial investment as the starting point.
  • Fund Level Net IRR:
    The fund level net IRR measures the overall annualized return generated by a private equity fund after accounting for fees and expenses. It is calculated by taking the cash flows received by the limited partners, subtracting out the fees and expenses charged by the general partner, and discounting the remaining cash flows back to their present value using the fund's initial investment as the starting point.
  • PME (Public Market Equivalent):
    The PME measures the performance of a private equity fund relative to the performance of a comparable investment in a public market index. It is calculated by dividing the total value of the private equity fund's investments by the total value of a hypothetical investment in the public market index at the same time and using the same amount of capital. A PME greater than 1 indicates that the private equity fund outperformed the public market index, while a PME less than 1 indicates underperformance.

PE buyout drives

PE deal breakdown

  1. Transaction Strategy: how to buy and sell companies
  2. Business & Operations: how to add value to companies
  3. Financial Engineering: how to exploit finance knowledge to maximize returns
  4. Approach to governance: how to run companies

 

Transaction strategy

Value drivers 

  • Good acquisition price
  • Deal flow/Sourcing ideas
  • Industry knowledge
  • management connections
  • timing

Risks

  • Too high price
  • auction vs negotiation process
  • uncertain exist opportunities

Business and operations

Value drivers 

  • Enable good management
  • Capitalize on optionality
  • Legerage due diligence
  • cost reductions
  • Breakups and divestitures
  • Bolt-on acquisition

Risks

  • Backing bad management
  • Debt limits opportunity
  • cutting meat vs fat
  • Poor business opportunity
  • not enough long-term focus

Financial Engineering

Value drivers 

  • Minimize equity ticket(minimize stakeholders)
  • Debt sourcing and flexibility
  • Lender and covenant managment
  • minimize taxes

Risks

  • Too much debt
  • short-term covenant issues
  • short-term liquidity issues

 

Approach to governance

Value drivers

  • Change the culture
  • Employee inventives
  • Hands-on oversight

Risks

  • Not in the right culture
  • Too much finance focus