PRIVATE EQUITY

[SUBJECT: PROJECT FINANCE]

Learning Objectives:
 Get a brief overview on the Private Equity Market, its history,
performance and trends
 Get a list of top 10 private equity companies in India
 Understanding Venture Capital
 Shed light on the stages of Venture Capital Financing
 Learn about Venture Capital Process
 Learn about steps in Venture Capital Process

Chapter 11 Private Equity 1

 11.1 Introduction

 Many young companies are unable to raise capital in public equity markets because

they are not large enough to attract investor’s interests.

 A company having a very promising product or service but not sufficient track

record.

 This also holds true for companies that are in financial distress.

 Such companies can get funding from Private Equity investments.

 Venture represents financial investment in a risky proposition made in the hope of

earning a high rate of return.

Chapter 11 Private Equity 2

 11.2 Private Equity Market

 The Private Equity Market is dominated by private equity companies that represent large
institutional investors.

 The private equity market is crucial for both start-up companies and established publicly traded
companies.

 For example, a public company in financial difficulty will generally not be able to raise public equity
or public debt.

 Private equity companies invest private money in businesses they consider attractive.

 Private equity companies are usually structured as partnerships, with general partners (GP)
presiding over limited partners.

 The partners tend to be high net-worth individuals, public and private pension funds, endowments,
foundations and sovereign wealth funds.

 According to PEI Media's 2008 ranking of the top 50 private equity companies worldwide, the top
four were United States-based. These were The Carlyle Group, Goldman Sachs Principal Investment
Area,TPG Capital, and Kohlberg Kravis Roberts.

Chapter 11 Private Equity 3

 History
 From obscure beginnings as boutique investment houses, through the junkbond
leveraged buyout debacle of the 1980s, to the thousands in existence today, private
equity companies have become an important source of capital.
 According to the trade industry association, Private Equity Growth Capital Council
(PEGCC), in 2009, private equity companies raised close to $250 billion and made
more than 900 transactions with a total value over $76 billion.

Facts
 Private equity companies typically manage funds on behalf of their investors.
 They look for businesses with higher-than-average growth potential over the long
term.
 They often provide senior management direction to the companies in which they
invest.
 This is especially true in cases of majority control, because bigger returns mean
bigger carried interest payouts for the GPs.
 Carried interest is the portion of the funds that remains with the company after
paying the limited partners and other investors their paid-in capital plus a
minimum rate of return, known as the hurdle rate, and transaction expenses.

Chapter 11 Private Equity 4

 Strategies

 In 2009, private equity companies invested mainly in five sectors: business services,
consumer products, healthcare, industrial products and services, and information
technology.

 The most common types of investment structures are:

1) Leveraged buyouts, or LBOs; LBOs use both equity and borrowed capital to
invest in companies, hence the term "leveraged”.

2) Venture capital funds focus on new companies, mainly in the technology,

biotechnology and green energy sectors.

3) Growth capital invests in mature companies deemed to be undervalued.

4) Turnaround capital, also known as distressed capital or vulture funds, looks

for financially-troubled companies to buy inexpensively; potentially restructured,
often through layoffs and asset sales; and then sold for a healthy profit.

Chapter 11 Private Equity 5

 Performance

5) Bank Guarantee:
 It is difficult, from the outside, to judge the performance of a private equity firm.
 Unlike public companies that trade on the stock exchanges, subject to regulatory
disclosure requirements, private equity companies do not typically disclose their
financial statements.
 Private equity companies that trade publicly, like Kohlberg Kravis Roberts, do provide
information on realized and unrealized profits from their investments.
 The realized profits are significant.
 According to PEGCC, through 2009, private equity companies have returned close to
$400 billion in cumulative net profits to their investors.

Chapter 11 Private Equity 6

 Top 10 Private Equity Companies in India

 Private equity funds--investment funding made without stock being issued--have raised
over $17 billion since the year 2000, according to the research agency Preqin.
 The private equity sector in India declined about 60 percent in 2009 due to recession in
overseas markets, but as of 2010, the Indian markets have stabilized despite volatility
and uncertainty in global finances.
 When determining the top 10 private equity companies in India, one measure of
success is the amount of funds raised.
1) ICICI Venture
o ICICI Venture Fund management, headquartered in Mumbai, has raised funds to the
tune of $3 billion over the last decade.
o As one of the largest funds, it is a subsidiary of ICICI bank, the largest private sector
bank in India.
2) ChrysCapital
o This New Delhi-based fund launched in 1999 and has raised $1.9 billion in private
equity funds.
o It has made more than 45 investments since its inception, according its website.
3) Sequoia Capital
o Sequoia Capital India, formerly known as WestBridge Capital Partners, mainly
invests in consumer, energy and financial services in India.
o Headquartered in Bangalore, it focuses on investment in the seed, early and growth
stages of industry.
Chapter 11 Private Equity 7
4) India Value Fund
o India Value Fund, a Mumbai-based fund, was established in 1999 and boasts more
than $1.4 billion distributed across four funds.
o It was formerly known as GW Capital.
5) Kotak Private Equity Group
o This company stands as one of the early investors in Indian private equity, launched
in 1997.
o Kotak pumped $1.4 billion into the Indian market mainly in the infrastructure and
health care sectors.
6) Baring Private Equity Partners
o Established in 1998, Gurgaon-based BPEP has over $3 billion invested mainly in the
American, Latin and Indian markets.
o It generally invests in manufacturing, pharmaceutical and information technology.
7) Ascent Capital
o Ascent Capital, as one of India largest private equity funds, has invested $600 million
across three funds, helping more than 40 entrepreneurs access its funds.

Chapter 11 Private Equity 8

8) CX Partners
o CX Partners promoted by former Citigroup Venture Capital Investment made "a
final close of its debut fund in excess of $500 million," according to a July 7, 2010,
report from Reuters.
9) Everstone Capital
o Everstone Capital, the equity subsidiary of Future Holdings, raised its first fund in
2006, for $425 million, and set its sights on a $550-million fund in 2010, reports
AltAssets.com.
o Everstone invested in engineering companies, a renowned children clothing
producer and other industries.
10) Blackstone Group
o Blackstone, a U.S.-based firm, remains an emerging player, announcing plans to
invest as much as $1.5 billion in Indian infrastructure. In April 2010, it invested $50
million in a regional Indian newspaper, "Jagran Prakashan."

Chapter 11 Private Equity 9

 11.3 Venture Capital

 Venture Capital is part of the private equity market.

 In return for the venture capital, companies have to offer a share in their ownership.

 Venture capital investments can be in different stages of business.

 However, it is usually made in the early stages because those investments are more

likely to yield high returns.

 To compensate for some likely venture failures, high returns on some of these

investments are required for venture capitalists to be willing to take on the risks

associated with these high growth businesses.

Chapter 11 Private Equity 10

11.4 Stages of Venture Capital Financing

Seed
Money
Start-up

1st Round

2nd Round

3rd Round

4th Round

Chapter 11 Private Equity 11

1) Seed-money stage
 Seed money is the initial equity capital needed to start a new business.
 The initial capital money is used to develop a product or prove a concept.
 It is usually a small amount of financing and does not include marketing.
2) Start-up
 Financing for companies that were started within the past year.
 The funds usually include marketing and product development expenditures.
3) First-round funding
 After the company has spent the start-up funds, additional capital is provided to
begin sales and manufacturing.
4) Second-round funding
 Funds provided for the working capital needs of a company whose product is selling
but still losing money.
5) Third-round funding
 Financing for a company that is at least breaking even and is considering expansion.
 This is also known as mezzanine funding.
6) Fourth-round funding
 Funds provided to companies that are likely to go public within half a year. This is
also called bridge financing.

Chapter 11 Private Equity 12

 An IPO is the next stage after venture capital financing.

 As mentioned before, venture capital funds are significant players in the IPOs.

 It is the norm that venture capitalists do not sell their shares when one of their
portfolio companies goes through an IPO.

 Instead, they usually sell out in subsequent public offerings.

 The maximum number of companies need seed capital.

 Then as they progressively move up the pyramid, number of companies requiring

funding reduces.

 And they move up the pyramid, the investment size increases.

 An informal survey shows that most of the companies die off in the seed financing
stage itself.

 Current trends indicate that only 27% of companies that are seed funded actually
raise the required angel round.

 16% of the companies shut down at the Seed stage.

Chapter 11 Private Equity 13

 11.5 Venture Capital Process

 Venture Capitalists invest in private businesses to make profit.

 They attract most of their financial resources from sophisticated institutional investors.
 Venture capitalists try to create value by monitoring the companies and making sound
business decisions about follow-on (staged) investments.
 Venture capital financing can be thought of as a joint product of both investment capital
and consulting services.
 The venture capital process can be analyzed in following five steps.
 Step 1: Getting the attention of private equity investors
o Many young businesses are interested in raising capital from the limited supply of
private equity investors.
o These investors are interested in specific types of businesses that include
biotechnology, internet and technology.
o In order for any of the companies to be able to attract these investors, their
management must have a vision for converting their private company into a public
company in the future.

Chapter 11 Private Equity 14

 Step 2: Performing the valuation and rate of return
o Once the private equity investors are interested in a particular company, they will
attempt to estimate its value.
o In addition to the conventional valuation methods, venture capitalists use another
method to value private companies.
o In this method, the future earnings of the company i.e., when it is expected to go
public, are forecasted.
o With the use of price-earnings multiples for similar public traded companies, the
value of this particular company is assessed at the time of the contemplated IPO.
o This value is called the exit, or terminal value because the IPO is an exit strategy for
venture capitalists.
 Step 3: Structuring the deal
o In structuring the deal, private equity investors and the owners of the company
negotiate through the ownership proportion.
o Private equity investors need to determine what proportion of the company they
want in return for their investment. On the other hand, the company needs to
determine the ownership proportion that they are willing to give up in return for the
capital.
 Step 4: Post-deal management
o After the investment, it is usual for the private equity investors to have an active role
in the investment of the company.
o Sometimes, they also seek out new business opportunities and try to raise more
capital for the company. Chapter 11 Private Equity 15
 Step 5: Exit
o Private equity investors and venture capitalists invest in private businesses because they are
interested in high return on their investment.
o There are different ways of realizing targeted returns such as an IPO which can be an exit strategy
for venture capitalists.
o However, as mentioned before, these companies usually do not sell their shares at the IPO, but
after the securities have traded for some time.
o Alternatively, investors may exit by selling the business to another company.
o Quite often, private equity investors prefer to liquidate a company, if it is not generating
sufficiently high returns.

Chapter 11 Private Equity 16

 Preparing a Business Plan for Venture Capitalist

 Preparing a Business Plan for Venture Capitalist

o If you are approaching a venture capitalist to finance your project, how
should you your business plan? Here are some guidelines:
o Use simple and clear language. Avoid bombastic presentation and
technical language
o Focus on four basic elements, viz. people, product, market, and
competition.
o Give projections for about two to five years with emphasis on cash flows.
o Identify risks and develop a strategy to cope with the same.
o Convince them that the management team is talented, experienced,
committed and determined.

Chapter 11 Private Equity 17