Private Equity 101 - Entrepreneur's Guide to Private Equity Capital Raising | John Colley | Skillshare

Private Equity 101 - Entrepreneur's Guide to Private Equity Capital Raising

John Colley, Digital Entrepreneurship jbdcolley.com

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14 Lessons (1h 8m)
    • 1. Private Equity 101 Promotional Lecture

      1:56
    • 2. Private Equity 101 Course Introduction

      3:20
    • 3. Overview of Private Equity

      4:45
    • 4. Deal Stages The Difference between Private Equity and Venture Capital

      2:56
    • 5. What is EBITDA?

      4:35
    • 6. How Do Private Equity Firms Create Value?

      6:08
    • 7. Categorising Private Equity Firms

      9:30
    • 8. Private Equity Deal Screening

      8:40
    • 9. Private Equity Firm Lifecycle

      3:51
    • 10. Private Equity Measurement and Compensation

      5:32
    • 11. Private Equity Deal Funnel

      4:30
    • 12. What is a Mangement Buyout?

      5:28
    • 13. What is a Leveraged Buyout?

      3:32
    • 14. Private Equity 101 Summary and Wrap Up

      3:21

About This Class

12755397

At the core of Investment Banking Finance Fundamentals is the world of Private Equity

This is how many on Wall Street and CEO's of companies make millions of dollars every year.

If you seeking to master Entrepreneurship Fundamentals or considering a career in Investment Banking, then this is a topic you need to master!

I have been working with Private Equity firms since 1988 and have done dozens of deals raising millions of dollars.  I have been involved in deals where the principles walked away with hundreds of millions of dollars - each!

The objective of this Investment Banking: Private Equity course is to share that insight into what Private Equity is all about!

In this course:

  • Discover the core concepts in Private Equity, a core Investment Banking skill required by any Wall Street analyst

  • Understand how Private Equity Funds are raised and financed

  • Understand what is meant by EBITDA and how to calculate it - Finance Fundamentals 

  • Gain an Investment Banking perspective on Value Creation in Private Equity investing

  • Understand the difference between a Leveraged Buyout ( LBO ) and a Management Buyout ( MBO )

  • Discover Private Equity Business Strategy through a Categorisation of Private Equity Firms

  • Understand the difference between Private Equity and Venture Capital

  • I share with you my Banking and Finance perspective on Private Equity Deal Screening

  • Understand the importance of Private Equity Firms' Fund Lifecycle to Fund Raising

  • Find out how the Private Equity Business measures their results and earns their compensation

  • Understand a Private Equity Deal Funnel

Don't walk into that interview under prepared!  Do you homework on Private Equity first by enrolling and completing this course.  Plus if you have any questions - post them in the course - I always do my best to answer them.

With 30 years experience of Investment Banking, you won't find a better qualified instructor to help you!

Not sure yet? Scroll down and watch the Free Preview Lectures!

Enroll with Confidence! 

See you inside the Course!

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Transcripts

1. Private Equity 101 Promotional Lecture: Welcome to Private Equity 11 Let me ask you a couple of questions. Are you confused by the whole world off Private equity, Maybe your on entrepreneur or you're a CEO of a company and you want to organize a buyout, but you don't know where to start. Or perhaps your potential Wall Street analysts. You want to go and get a job on Wall Street or in an investment firm, and you need to swat up for your interview when you're in the right place. Congratulations. My name is John Colley. Now I'm a best selling online course instructor, but over 57,000 students I've been on you to me for five years. But I'm also an ambassador investment banker with over 30 years of experience, including dozens of private equity deals. So I really know this subject back to front. When you've taken this course, you're going to be able to hold a conversation about private equity with anybody. You're not going to know all the answers, but you're no a lot of the jargon. You'll understand the concept, and you'll be able to hold your own in the conversation. Make sure you are so lots of questions. Now I want you to be comfortable with the purchase this course. So I've enabled a significant number off the lectures as preview lectures so you can actually see them before you dive in. Now, private equity is a major part off the international finance market, and it's here to stay. And you need to understand what it's all about, how it works, and that is what this course is all about. This is an investment in your future. This is an investment in you, and it's probably the quickest and easiest way to get up to speed on private equity. So what are your next steps? Enroll in the course. Get motivated. Make sure you watch every lecture on, then asked me any questions you've got because I love getting questions from you. So Private Equity 101 Welcome to the course. I look forward to seeing you inside, and I can't wait to hear your questions. 2. Private Equity 101 Course Introduction: welcome to this. Private equity 101 cause this is an introductory course to introduce you to the world off private equity. Now I stress this course is introductory. The whole idea is to try in about an hour to cover a lot of the ideas and concepts and principles behind private equity. But it's not going to turn you into a private equity expert overnight. It should give you enough command of the detail and of the jargon to at least have a conversation with a potential investor on not look like a complete idiot. So I hope you're going to find this helpful. The idea, then, is to provide a basic understanding off private equity. In a short course on, I've done my best to put in lots and lots of detail, lots of examples and lots off presentation materials you can download and study afterwards to make it as helpful as possible. Now, my name's John Colley. I've got 30 years investment banking experience, and I've done literally dozens off private equity deals, so I know my way around this subject really quite comprehensively, probably more comprehensively than many people teaching the subject on you to meet today. So what are you gonna find in this course? Well, first of all, I'm going to give you an introductory overview to private equity and what it looks like and how it works and who the principal players are. Then we're going to look at the different deal stages. We're going to look at what e bit d a is earnings before interest, tax, depreciation and amortization on, I'm gonna show you or try to explain to you how value is created in a private equity deal. Then we're going to look at the categorization off different private equity firms. This is important. If you are looking to put a deal together, you've got to go and find the firms that match the sort of deal you want to put together. We're going to look a deal screaming. So if you putting this deal together, how are the privately firms going to screen you on? Most of its gonna be screening you out, and you really need to be ready for that. We're going to look at the life cycle of a private equity fund, so you'll understand when you approach of a private equity firm. You can evaluate whether they're fund is at the right stage for you or are you going to go and have a long conversation and meetings with somebody who doesn't isn't ready to invest again for several years? We're going to look at how private equity firms measure their returns on their deals on August. Also going to have a look at how they're compensated. I'm going to take you through a deal funnel, which looks a bit of the process on. Then I'm going to explain the difference between a management buyout. Onda Leverage buyout at least explain what the two deals look like and then contrast their differences, particularly leveraged buyout. I want to show you how leverage creates the Valium, so this is not the last word on the subject of private equity by any means. But I am very interested to hear your questions about private equity because it'll give me a fantastic example or opportunity to create more content for the course. So definitely message me. I can share. You can share your questions in the course is one in the Q and A and I will do my best to answer your questions. So that's the course. Private equity 101 I have. You gonna find this really stimulating Really great fun. And thank you very much for enrolling in the course. 3. Overview of Private Equity: in this lecture, I'm going to present you with an overview off private equity. To put it simply, a private equity fund generally buys or invests in a company with the intention that it will improve its earnings or value by providing capital and expertise, and then sell the investment at a profit. The prophet is eventually distributed to the people who have invested in The fund Fund is jargon for a unit trust. The investors in a private equity fund are mainly institutional investors, such as life insurance companies and superannuation funds. The funds are called private equity funds because they invest in nonpublic, unlisted IE private companies. They are called equity funds because they invest in equity, the jargon for an investment in shares as distinct from property or financial instruments. The funds are run my managers, usually on the terms of an investment management agreement and subject to the terms of the trust deed forming the fund. The fund manager receives a fee from the fund, which typically includes a performance fee based on the return achieved by the fund on its investments. The decision to make an investment is usually made by the fund manager subject to approval from its investment committee. Private equity funding is used by companies of all sizes to provide the funds for startups , where the funding is sometimes referred to as venture capital expansion, capital management buyouts and public to private deals. Where a company requires expansion or development capital, the private equity fund will subscribe directly for shares in the company in a management buyout. The private equity fund were typically team up with two or three off. The existing senior managers off the target company on those senior managers themselves participate in the purchase. The private equity fund on the managers will invest in a new company. The fund will typically subscribe for about 95% on the management team will subscribe for about 5% off the equity on the new company, will then acquire the target company. The acquisitions are usually completed using borrowed funds together with private equity investment funds, to increase the potential return for investors where borrowed funds were used. This is referred to as leveraging the transaction. Most of the borrowed funds will be provided by a bank senior debt. Further loans, known as mezzanine or junior debt, may be provided by a different financier. These loans are subordinated to the seamy a day but rank ahead of any funds provided by the private equity investors. The private equity fund may also make part of its investment by way of loan funds called subordinated debt, which will rank below all other loan funds. Subordinated debt may also be convertible into equity, for example, by way of a convertible loan note on the occurrence off certain events. On Exit is a transaction where the private equity fund sells its investment. The exit usually takes the form off either a sale of the company to 1/3 party buyer or a flotation of the company on the stock exchange on AIPO, together with a shared by My and I PO, involves the raising of money from applicants subscribing for shares under prospectors, where some or all of the money raised is then used to buy back the shares held by the private equity fund. In the company, private equity funds air usually set up with a lifespan off 10 years. This means that investments are cyclical, with an initial set of investments after the fund is set up, then several exits after three or four years, followed by another set of investments. As the market matures, many of the entries and exits are secondary buyouts, which is where one fund buys the shares. Theo Equity off another fund. 4. Deal Stages The Difference between Private Equity and Venture Capital: One of the key questions we need to understand very early on in this course is the difference between venture capital and private equity. And it's essentially a question off deal stage. This is an important distinction because depending on the stage of your business, you need to understand which sorts of firms you should be speaking to, because different firms do different deals in different ways. We're gonna understand this as we go through the course. But this course, remember, is primarily focused on private equity rather than venture capital. So the question is, what's the difference on the simple answer is the deal stage the stage off the maturity off the company at which a firm will invest on this diagram, I think simplifies it. But also summarize it, I think quite distinctly. The center line you can see is taking a business maturity from idea through start up through growth to maturity. On the dotted line. In the middle is the point at which the company is generating profits, and it's generating historic profits. On the type of profits it's generating is what they call in the industry. E bit d a. Now we'll look a T B D A. In a bit more detail, but a bit d a is earnings before interest, tax, depreciation and amortization. It's short hand for operational cash flow, but I don't want to get into the detailed accounting of it. But it's the key profits number that both venture capitalists, when they have companies with profits on private equity, look at so that the point is that when a firm gets to a point in its development where it could look back 12 months, 18 months, two years and it can show a track record off historic a bit d a. Then it is moved. It has moved. It has matured into the private equity space from the venture capital space on. That's the most succinct way I can think off to actually differentiate the two. We could talk an awful lot about the types of deals they do. But if you think of it purely in terms of e bit D, A earnings before interest, tax, depreciation and amortization, and ask yourself the question. Has this firm got a track record off historic, trailing a bit d A. And if the answer is yes, then it's suitable for private equity. If the answer is no, you're gonna have to look to venture capital. And I think that sums up in a nutshell, the difference between private equity and venture capital. So if you hold that idea in your head, I guess the next question we need to ask ourselves is what is a bit D A. 5. What is EBITDA?: So let's ask the key question. What is e bit d? A. EBITDA is this proxy number for profitability, which is prevalent. Lee, used by venture capitalists and by private equity. So is really important that we would have a clear understanding of what it is, why it's used and how we calculated so a bit. D A is earnings before interest, tax, depreciation and amortization. Essentially, its net income with interest, tax, depreciation and amortization added back. So you, depending on where you start, don't you understand where you end up? That's fine. The reason it's very useful is because it enables financiers and indeed entrepreneurs to compare profitability between companies irrespective off their balance sheets, structure or financing situation. It effectively eliminates because you're taking out the interest on the tax and the depreciation and amortization. It eliminates the effects off, financing off some of the key financing and accounting decisions. It's use prevalent Lian valuation ratios. And it's also on critically for private equity firms, a proxy for the company's ability to service debt on because this is the interest, or this is the earnings level at which you would then start to pay interest because that's the first number that comes off, then you are measuring how much the company can actually measure. Don't forget, Depreciation and amortisation are non cash items, so they affect the reported number you need to add them back, but they don't affect the cash flow. Interest is a cache item, and tax is a cash item. But because interest is tax sheltered, so you reduce your profits with interest before you calculate your tax, Therefore means that when you get to the earnings before interest line, you're at that point where the companies can pay interest on. That's what private equity firms are interested to know. How much cash is the company producing? How much profitability is the company producing to service the debt they want put into the deal into the leverage off the deal? So it should be added that this is this is not a good metric for evaluating cash flow, right? There are other accounting, um, conventions, which very much affect cash flow, particularly a Krul's. I won't go into all the detail of accounting, but don't use e bit D A as a proxy for cash flow, and it also doesn't help you to calculate a measure. Theo the cash requirements for working capital. So it's very distinct from cash. It's a profitability measure, and you must keep clear in your mind that profits and cash are two very separate things. Let's go through a very simple example, so you can see exactly how it's arrived out. Let's take a company. Doesn't matter. It's a fictitious company, and it generates $200 million in revenue. In doing so, it incurs $80 million of profit product cost. That's what it costs a manufactured product. And then it's got $40 million of operating expenses. This means that after depreciation and amortization expenses of $20 million its operating profit is $60 million. Its interest expenses are $10 million on its earnings before tax are therefore $50 million on with a 20% tax rate. His net income is $40 million. So now to get to a bit d A. We need to work back. So the EBA dia is $80 million because what we do is we and back 40 million. You take the 40 million of off net income when we add back 10 million interest, 10 million off tax on 20 million off depreciation and amortization. So I hope that makes clear what a bit D A is, why it's important and how you calculate it. It is a core number when you come to dealing with buyout firms with private equity and looking at deals. It's really important you've got a very clear understanding of what it is very early on. 6. How Do Private Equity Firms Create Value?: I want to take a look now at how private equity firms create value. Andi. If you can understand this, then you go some way to understanding how they structure their deals. There are three essential ways that private equity firms create value. Andi. There are only three on def. They'll for each deal. They'll do a combination of these to create the every will return and result. But you don't need to look beyond these three core principles to understand how private equity deals work. The three methods are operational improvement, multiple arbitrage and leverage. So the operational improvement speaks for itself. They are basically improving the operations of the business to make them more profitable. That may mean that they'll increase the product range. They'll enter new markets, they'll increase prices, they'll cut costs. Whatever it is, they may make acquisitions, and they may make efficiencies. They mace, restructure whatever it is they are actively or the management is actively getting into the business on making it a more profitable business and growing the business. Multiple arbitrage is financial engineering. At its most basic on all this means is that when they come to buy the business, they buy it on a multiple of letters, say, four or five times a bit d A. But when they sell the business, they make sure that they sell the business on no less than maybe 67 or eight times ebitda EA. And the consequence of that is that for every pound of profit the business has got on Day one, they get more value regardless of the performance of the business. As long as there's that pound of profit. At the end of the day, they're getting mawr brandy you back for that pound of profit than they paid for it. So if the company has got letters, say £100 of profit or $100 of profit on they pay spend, they buy that four times they sped. They pay £400 for it on in five years. Time is still only got £100 of profit, but they said it the eight times they set up £800. And in the in the meantime, the business is done Nothing. But they have doubled their their return on the business. They've bought for 400 sold for 800 multiple arbitrage, really simple and leverage is basically using debt to part fund the deal, which means that they use the cash flow off the business during the their period of ownership to pay down that debt. Which means that when they sell the business, if they bought it on 50 50 debt equity and in the period of ownership they pay back all the debt, they basically double the value off the equity. So operational improvement, multiple arbitrage on leverage. Now, over the decades, the influence on the combination of these three factors has changed as much because off market conditions but also because, off these smarts off owners. Now I've tried to summarize in this very simple graph four decades off buyout deals of private equity deals to try and show you how these basically have changed Now. In the eighties, leverage was what it was all about. In the nineties, it was more about multiple Arba charge in the two thousands. It's Bean Mawr about trying to grow earnings but without being particularly sophisticated about it. And in the last of eight years in the 2000 tens, there's been a lot more hands on work to do with the specific improvement in the business in order to improve the value off the business through high profitability and higher earnings. Let's look at these in a bit more detail. So in the 19 nineties, most value was created by private equity firms through leverage on a classic example of this is K K R Kobo Krabat Roberts, who bought R J R Nabisco heavily leveraged, particularly using junk bonds on junk bonds with the flavor of the month. They were very subordinated instruments of quite high yields. But they enabled by out firms, particularly buyout firms, concentrating on very large deals to fund these otherwise unfunded herbal deals. In the 19 nineties, junk bonds have been discredited. On the game was all about buying low and selling high. It was about valuation and multiple Albert charge in the two thousands. There was much more focus on growing earnings, but only by doing simple things like cost cutting. Making acquisitions maybe die vestiges to to reduce the leverage in the business those sorts of things. But it wasn't anything particularly sophisticated, and it's only really be in the last 10 years that buyout firms have had to work a lot harder on This is primarily because the leverage that the banks particular since 2008 have been able to provide as being very limited sellers and buyers are much smarter now about selling to private equity and buying from pile equity. And as a consequence of this, they've gotta roll their sleeves up on work harder to improve the business and improve the operations of the business in automate the business is more valuable, so that is a summary. It is quite high level off private equity value creation. I hope you find that helpful and interesting, and I hope it goes some way to understanding. Or it will go some way to understanding how private equity firms basically structure their deals on why they structure them the way they do. And now we're gonna take a look. And I'm trying to understand the different types off private equity firms on the types of deals that these firms do 7. Categorising Private Equity Firms: Let's talk now about how we can categorise private equity firms, because if you can understand how this categorization works, you'll have a much better understanding off the layout off the private equity market. The easiest ways of classifying this is by the types of firms on the scale and types off deals that they're doing. So bear in mind, this is actually quite a complex matrix. But if I give you a few pointers towards thes criteria, then when you look at a firm, you'll be able to say it doesn't do this, doesn't do that and get some idea of what where it fits. In the universe of private equity firms, there are essentially three types off private equity oblique venture capital firms. Those are the leverage buyout firms, the venture capital firms and so sitting in between them, the growth equity firms. So if you bear that in mind as a starting point, let's look at leverage. Buyout firms, first of all, they normally take controlling stakes in businesses on their looking for larger businesses with mature, ideally growing cash flow because they need the cash flow to fund the debt repayments that they're going to fund the acquisition of business with, and they're typically financed with a mix off debt and equity. And the balance between the debt and the equity does vary an awful lot, depending on the business and on market conditions. And indeed on the firm. Some examples of big leverage about firms Kohlberg Kravis Roberts, Roberts, K, K, R. Carlisle, TPG and Blackstone. So these are names that you're here in the industry. Venture capital firms are very different. They tend to take minority stakes in a startup or an early stage off the business. So you're typically hear about in a round to be around to see around a D round. And these are ways off categorizing of naming different funding rounds. The A round being the first, and you'll also find that as these rounds happen, the mix of investors changes, so they'll be firms that like to invest earlier in higher risk. A smaller amounts for more return, and there are somewhat more risk averse companies who will only come in. And maybe the sea or the D round there typically invest probably larger amounts. But the companies would have bean great deal. De risk will be better established on larger and have better financial characteristics. Essentially, venture capital firms are picking winners. They're looking for talent, intellectual property technology that has the potential for giving them a very high returns . It's a very different business. Examples of off VC firms Kleiner Perkins, Sick Wire, Excel, August Capital and Dress In more ways, growth equity firms sort of sit in the middle. They are looking for more mature businesses, but what they're looking to do is to come in at the point at which these businesses want to scale. So it's really after the VC rounds. But they're not mature enough businesses for the normal private equity firms, so they're in a certain sense of sort of bridge between the two and again. They'll bring in a mix off debt and equity, but they the debt will be limited to the extent that the businesses can carry the debt. They'll probably be more equity in these deals because they are looking to grow the business rather than trying to create a financial engine. Financially engineered return examples Summit Partners jam I TA associates. So let's look at another way of looking at these firms is to ask what size of company Do they like to acquire on? Essentially, we're talking about large, mid market or small on. By that, I mean revenues of more than a $1,000,000,000 revenues of more than $150 million on revenues of less $150 million. So if you look at the deals that they've done in the companies that a particular private equity firm has bought and you look at the revenue lines, you'll get some idea about what part of the market that playing in many of these firms also come in with a sector specialization. This is because a lot of these sectors are very complex, and if you're really going to understand what you're investing in, you need that sector expertise to understand whether the business you're buying is really going to exceed the return expectations you want for it in that particular market. So examples typically healthcare technology, fast moving consumer goods of M C, G retail financial services and pretty well, just about every sector you can think off eso sets a specialization is a particularly strong theme, and you'll see within private equity firms. Many off them will say that we invest in this sector, that sector. On the other side, there are a few generalists around, but for the most part, more and more firms of becoming specialists. So let's look at some of the deal types that they can do because it is a little bit more sophisticated than just the 1st 3 headlines I gave you. Tipple kill leverage. Buyout firms will look at a car about deals. These air basically where they acquire a non core where they acquire a subsidiary or division of a much larger business, which they then take and invest in and grow. They are looking to put leverage into these, although want them to have strong cash flow characteristics so that they can actually get some growth from the financial leverage. Buy and build platforms are slightly different. This is where growth equity comes in and the firm will acquire a platform business on then make acquisitions off smaller companies to scale it up and grow it. Using a combination of equity and debt public to private transactions are where a typically a LBO firm will come in and make an offer for a public company that is listed on a stock exchange to take it private so that they can take control off normally 100% off the equity , they very rarely leave minorities in there. They'll give management and incentive with some equity. But the idea, then, is to grow that business privately and then to exit it, sometimes by relisting it in 3 to 5 years. Time management buyouts and management buy ins are so founder exit deals where a founder of the business will sell to a private equity firm, enabling the management to take over. But the management without the financiers won't have the resources to give the founder the exit. It once on a management buy in, is where an external management team comes into a business that's a high risk deal and more difficult to do. In addition, you'll also see some of the following. You'll see specialist funds who invest in in difficult situations and specialist arrangements of specialist deals, distressed deals, turnaround deals, those sorts of things. There are funds that specialize in real estate. There are funds who specialize in mezzanine finance. This is a debt, normally a debt instrument, paying quite a high coupon subordinated behind the senior debt. But with the ability in certain circumstances says to convert into equity or it comes along with a warrant or some sort of coupon to give them an equity carry as well. There are funds of funds, and these are firms and funds that basically invest in other firms so that they are allowing those firms to make the investment risk. But they're providing some of the equity that there are secondary investors. And these are firms who by deals from private equity firms so they don't go and originate their own deal. But very often, towards the end of the life of a fund, they get funds of 10 years in life. There may be one of two businesses left in the fund. They will need to wrap the found up they need to exit. So the secondary found will come in and buy those businesses for them on then last see as another example. There are pre I P O funds, where the company needs a little bit of finance before it actually gets to the I p o Onda. Without that, they won't be ableto Waipio, so the pre I P o funds provides that finance the specialist situations turnaround funds. Recapitalizations are also very unique types of funds who deal with those particular types of very difficult transactions. So I hope this gives you an overview off the different types of private equity firms out there. I think it's really important to get this grounding or on this overview of private equity, feel privately before we dive into leverage buyout firms and management buyout firms. To understand those deals, we've got an understanding of what the private equity landscape looks like. 8. Private Equity Deal Screening: want to take a look now on private equity deals Screening. What I'm trying to do here is take you into the ground between private equity firms and companies were seeking finance to help you understand some of the dynamics, some of the criteria that every is always looking at to see how deals might fit together. Andi indeed, how if you're either an investor or a company, how do you go about finding the fit? There's quite a lot going on here, and I'm going to use some of the examples from my own investment banking presentations. The starting point is having very, very solid sector expertise and understanding. So I picked out a few key words here from the theme the technology and telecoms and media sector. But having that understanding and having a clear understanding of the competes constituent parts of the sector is a critical starting point. So here's an image, and each square is a company off one of my databases from the UK software business, and you can see different types of software companies. And you can see that that there are some very large, concentrated sexual lots of competitors in, and then there are some other, more specialised sex like security. So that just goes to show how complex it can be, but also that the deeper you dig down, the more niche businesses can get. So although you on the face of it, in tech, you've got these five main sectors, you can break them down into these sub sectors. And if you take even one of these software, you can end up with all these different sub sub sectors. It shows you how complex the picture really can be. So when you're putting together your understanding off the sector, you need to have a very good idea not only of who the companies are, but also of what their background is, because you need to understand whether they are public companies where they're privately owned, whether they're venture capital or private equity backed, where their subsidiaries of larger companies, whether they're foreign owned companies or, indeed, whether they're early stage disruptors. These are just some of the clarifications and classifications that you need to think about because clearly, and it does depend on whether your an equity investor or whether you're a company looking for targets or or indeed you're one of these particular companies, you need to make sure that you understand. You know where you fit into this hierarchy now, even then, at any one time in the market, there are a lot of complex dynamics going on. And again, let's stay with the UK software company and in the UK software market. There's a lots of things going on. So you have US software companies who are always seeking cross border deals. Normal. Looking at this Of the top 500 companies, you have European software companies seeking cross border deals into the UK, and these are also looking at this of the top 500 companies. So these are big cross border deals. You have venture capital and private equity phones who are looking for deals including secondary deals and tertiary deals, and these might be for the top 100 firms. All these might be you may have to look at the top 100 b, C and P firms to get an idea of you know who these players are. Then you're gonna potentially have Indian or Asian software companies seeking cross border deals into the UK These could be financially strong, but they're more limited in number on. Then you can get UK domestic technology companies who could seeking to consolidate their own market. So again, you get all these different dynamics competing for potential deals within the market. And when you come to a deal, there's still quite a lot of hurdles to overcome. And one of the biggest of these A are the financial hurdles, and the finances are not always available. But every deal requires detailed financial analysis. You need to understand the cash flow, the balance sheet, but the profit and loss account. You need to understand the cash flow and the break even characteristics what the funding requirements off the business, our the funding requirements off the deal is andi. For early stage companies, you need to understand what their financial runway is. I how much money have they got? And how long is that money going to last that Ben rate? So there's lots of different terms going on here, lots of different financial aspects to the deal that you need to get your mind around. Now let's take a look. A geography geography is important are from both the perspective of the company and off the investor as a rule of thumb this the earlier stage, the deal. The close of the investors like to be to the businesses so very large light leveraged buyout deals of billions of dollars can be done by a firm in California, and they could be buying a bit business in Europe. That's not an issue. But if it's a Siri's, a round of BC firm, you really wanna have your investor, if not in the same city than certainly definitely in the same country. Um, this is a map I've got off UK self software companies with revenues during 5,000,100 million, and I could immediately see where the geography is. And it means that when it comes to me trying to put a deal together and finding investors, I can start with a geographic approach. Then investors and companies need to be mindful off the business model. So you know how how did they make money? Is the key question. You know, what is to what extent are they relying on intellectual property or technology? What is their pricing strategy? Do they have market leadership? Are they in niche player? Do they have a unique selling point all these talks of jargon ist IC terms, trying to identify what makes the business special strategically on. Therefore, why is there an expectation that's good, outperforming its market management team? Quality is off course critical. You need to look at their experience. Have they got a history of dealmaking? Do they have interesting relationships both within the industry and also within the finance community? So the quality of the management team is court any buyout deal? Because, in essence, financiers would always tell you that they're not investing in the business. They're investing in the management team with owners and fire founders. There are a number of issues which need to be addressed and understood. How old are they? What is their? Except, I mean, what are their price expectations? Are they suffering from the implications of the three D's death, divorce and disease, which very often provide triggers for deals? Is there a succession issue or succession plan? So addressing founders of businesses, you need to be very mindful off their personal circumstances. We've talked about deal types in a previous lecture. I've included this in case you're watching this video on a standalone basis, but the different deal Times, venture capital deals, growth deals, management, buyouts, management buy ins, public to private deals, secondary buyouts, leverage buyouts, pre I P O. Deals, etcetera. So different firms will do different deals. Different companies need different types of deals that the different stages in their lifecycle. The need for a deal is one of the critical factors. Is there a real motivation within the company to get a deal done on? This can be down to timing. This could be down to the need for capital. It could be down to the desire to exit or retire. It could be down to financial stress or distress within the business. They need a deal to sort that out. They might be facing a cash flow screen squeeze. And from the investor point of view, the fund may be coming to an end. They may need to do a deal in order to complete and clean clothes their fund up. So finally, in your screening, just being mindful and we're going to talk a lot more about this in the whole area around buyouts, but off the process that there is a time implication to the complex process involved in terms of screening and approaching targets, having discussions, arranging meetings, putting forward terms, negotiating them gang through due diligence and closing the deal. So these are all factors which you'll need to bear in mind in terms of understanding the complexity off what private equity involves. So that is a again, fairly high level. But we're hopefully you'll understand, with some specific examples, some A an introduction to private equity deals screening giving you some idea of what on how complex the whole per private equity process ecosystem environment really can be like. 9. Private Equity Firm Lifecycle: I want to take a look now at the private equity life cycle, and this is the life cycle of a private equity fund within a firm. We've already established that private equity firms raise funds for buyouts. Simple statement. Each fund is in itself a what is called an SPB, a special purpose vehicle. It's a company which has specific groups of investors, very specific terms on it is designed to be the investment vehicle for the company and its investment partners. These are normally limited to a 10 year life so that at the end of 10 years the fund has repaid or repays all its investors their returns and hopefully makes a profit for them. Of course, it's possible they make make a loss. So the cycle is that the private equity fund goes out and raises its fund. It's it's a special purpose vehicle and get since $100 million. It then goes to a phase off investing. That money on growing the business is during which and at the end of which it sells the companies and harvests the money that it's made, which it returns to shareholders. After taking its return on its commissions and things and towards the end of that 10 year period, normally starting from about year eight, because this process takes about 18 months and then starts to raise the next fund, and it uses its track record in the first fund to attract new investors into the second fund. This is an illustration off what that process might look like and about this of beer. Seven point. And what you can see is the investment phase. On the harvesting phase, you can see the blue arrow in the bottom right hand corner, which shows you when they start to raise them. You fund the red in the bottom half. Is the negative cash flow going out to make their investments, and you can see they've made 10 investments from A to J. And the green is when they sell the investments and they make a positive cash return. Although you're noticed that let's take a couple of examples and you see how this might bury in the case of their first sale company, see, they buy it for relatively small amount of money and they triple their money broadly speaking. But with Company B, they've done almost the opposite. They bought it for quite a lot of money, but they haven't made a very big return on it. And that is fairly typical off an investment profile. Not every deal is going to be successful on what they're hoping for is over the portfolio that they invest in that they will get an overall return of around 20 to 30% for their investors. So that's what the office of the cash flows look like. And that's how you can picture fund. Now you'll notice we've still got companies G, H, I and J to be sold, and it may be that as they approach the 10 year point, if these companies haven't mean so, then they will be looking to a secondary fund to perhaps help them exit those companies so that they could close off this fund and return the proceeds to investors. So that's a little look into the firm's life cycle, the lifecycle off a fund, and I hope it gives you some idea about how private equity investors think about their investments as a portfolio and how the time cycle, the time frame on the lifecycle affects their behavior. 10. Private Equity Measurement and Compensation: Let's take a look now at private equity measurement Onda compensation by measurement, I mean, how do private equity firms measure their performance? What are their expectations off returns for their investors? How much money are they trying to make in? How do they measure it? Broadly speaking, then forget they're running a portfolio and broadly speaking there, looking to get a range of returns across that before your portfolio. They know that not every deal is going to knock it out the park. So let's say they get 10 deals in their fund in a port failure. They would hope, sincerely that at least two of them are going to be. Blockbusters are going to be fantastic deals, relatively low investment and fantastic return. And here we're talking 345 times the money back. So big deals. When we're talking private equity venture capital. Expect to get even higher returns. They sometimes look for 10 times returns. The investing in an earlier stage. They're looking, taking greater risk. They expect greater returns, stay on private equity the moment so 10 deals to blockbusters. Then they're looking for one deal that will triple their money. One couple of deals that will double their money and three deals that will give them a single figure, single money. They basically get their money back, a single return on their money. So that's the sort. Poor failure and then the last two deals are duds. The bank took the keys. They expect to lose their money, and that's the sort of spread that they look for. Investors met measure their returns in two ways. By the internal rate of return or the cash return. Now the internal rate of return is a calculation that basically says, by how much the money has to grow over a period of time to get to that return. Put another way, if you take your starting point and you take your ending point and you discount that back to get from the end to the start, you need to discount by 30% to get to the figure. So it's a statement of how much the money has grown over time. It's a financial calculation. The trouble is that I are ours, are very sensitive to the time period, so if you but I have a deal and you invest 10 and you get out 100 and you do it over 10 years, you're going to get a reasonable IR. I again it basically 10 times in 10 years, which is basically not doubling your money every eight. But you're basically going up in a steady, steady fashion. If you do that in 10 minutes, then you're given a 10 times return in 10 minutes and the I R O will be astronomic. It's very sensitive to the time period off the return. So what proud equity firms more and more talk about is their cash returns. And they talk about doubling their money and tripling their money on this basically says that if they put in, they say they do a deal for 100 they put in 30 of their own equity and they finance the rest with debt. And there's other things. Then they'll be looking to get equity value back in the period. In the investment off 60 or 90 orm or Andi, as we've already seen, that is achieved by operational improvements. Is she, by Financial leverage is achieved by growth. It's achieved by arbitrage on their entry value in their exit value, so cash returns is a better way off measuring returns for investment in private equity deals. The other question is, How did they? How do private equity firms get paid? What is their compensation structure? And it comes into two parts. The first part is a management fee, which is normally 2% off. The management raised the minute that the amount raised for the fund per year they do get deal fees when they arranged deal. They do get director's fees. But this money is relatively small in terms of what they hope to make, and it basically pays the salaries the rent and keeps the lights on. The other part off the return is their carried interest on this is normally something between 15 and 20% off. Profits on distribution, off returns over a hurdle rate. So what this means is that when the fund is being closed, the first of all the investors want to get their initial investment back on. Then they may have a built in rate of return that they want to get in addition to us. They want to profit on top of that on then 20% or 15% off. The remaining money goes to the private equity firm in terms of carried interest, and then the rest is distributed to the investors in the fund. So they there, they they do really well. They can make a great deal of money because that money principally goes to the leading directors, managing directors and directors in the private equity firm off which there tend to be relatively few. So that is private equity measurement and compensation. It gives you an idea off what sort of returns private equity you're trying to make. And it also gives you an idea of how the firms make their money on. This is helpful in understanding. When you go forward, you know how they're going to look at deals and also how they expect to get rewarded for the time and effort they put into deals. 11. Private Equity Deal Funnel: Let's take a look now at what a private equity firms deal funnel looks like. It's important to understand this because if you are in a private equity firm, you need to have some understanding an expectation off, how Maney deals you're going to look at and how many deals were actually going to do. But if your company looking for finance, you need to look at the sit around and say, Well, actually, what are my chances of getting funded by a particular firm, given what their deal funnel actually looks like? And if you look at that particular aspect of the thing, I'm afraid it's not going to look very good. Essentially, private equity firms are looking for a needle in a haystack. They are generally swamped with deal opportunities, and, frankly, they want to be swamped with. The options is they want to see as many deals as they possibly can. It's called being in the deal flow. If you're not seeing the good deals, if you're not seeing all the deals, you're certainly not going to see some of the good deals, so they're happy to see as many deals as they possibly can, but they want to do in a really efficient way so they don't want to sit down and have a meeting with you. They want to go and visit your company. They want to do in a very simplistic and straightforward when I'm going to show you how that is. But bear in mind that if a private equity firm does let us say 10 to 20 deals in its lifetime, it's gonna have to invest. In the 1st 5 years, we would have seen the life cycle. So if it's investing 10 deals in five years, that's two deals a year. That's not a lot. But in order to get to those two deals, there's quite a lot of work to be done. So in a particular year they will review typically anything between 300 to 500. What a cold teases deal summaries, possible deal, transactions one or two pages, which there have a quick look through and they'll eliminate a throwaway. Most of them, they may from that pile, ask for, receive and review, maybe 100 pitch books. But bear in mind that pitch BookScan B 20 page present power presentation. It could be a 50 page detailed written business plan that requires time, effort and consideration so they don't want to spend too much time doing those of the help have to. They then will have meetings with advisers and management teams from may be 20 companies. So they're getting into detailed discussions off that 3 to 500. They're down to 20 on off that 20. They're going to try to eliminate at least half and signed letters of intent otherwise with less than 10 because once they've signed the L. A. Y, then they actually doing an awful lot of due diligence work there, get they've got lawyers involved there but accountants involved and they don't want Teoh after you have to carry that cost cause that's cost for them, which they hate. They'll try and do further costs onto the other side, but they don't often get away with it so that basically be trying to really only sign otherwise with deals that absolutely serious about and off those deals. They're looking to close 1 to 4 deals a year, and that four might be optimistic, so you can see how this funnel really narrows down from 3 to 500 at the top toe wonder for the bottom, and that's in the process of just one year. So for them, for the private equity firm, the most efficient thing that they can do is to rule out a poor deal quickly. If it doesn't take absolutely every single one of their boxes, they're going to kill the deal and move onto the next transaction. So when you're presenting on putting together your pitch to private equity firms, you've really got to make sure you tick every single box for that for that firm. And don't forget, each firm has got it's only idiosyncrasies if you want to have any chance at all off getting your deal seriously considered by them. So that's why understanding a private equity firms deal funnel is so important. You really need to understand that you are at the top of a very wide funnel, and it gets extremely an hour at the bottom. And if you want to go from top to bottom, you've really got to do your homework and get your pitch absolutely spot on 12. What is a Mangement Buyout?: So what is a management buyout? This is a deal in which a business is bought from the owners off the business by a management team, which is financed externally Principe by a private e private equity firm. Now, opportunities for management buyouts occur all the time. But the most common circumstances for these are as follows in corporate restructurings, where a non core business is spun out on, the management had the opportunity to bring in third party finances and and basically by that from the main company where you have a founder or a controlling shareholder who decides to sell out or to retire to exit on. They want to sell the company to the people who have worked around them to the management team, and they give them the opportunity to do the buyout. Or it's the sale of a viable business or out of a business which has collapsed by a receiver administrator who managed to take a part of that business, which is still profitable and sell it out, thus creating value for the creditors to the collapse business. Now the parties to a management buyout can get quite complicated because you have obviously the seller. It's advisers and its own interests. You then have a special purpose vehicle, which is that the company which is formed. It's no me, a shelf company, which is formed to actually make the acquisition, the private equity and or the third party funders, which may include banks. And there can be more than one, which makes it even more complicated. And, of course, the buyout team comprised off different people within the team, so you actually get quite a lot of people sitting around the table. You then add to that, um, the complexities of the fact that each of these people and parties have their own agenda. They have their own priorities. They have their own personal parochial interests on. They have their own expectations off what they're going to get out of the deal. You can make it more complicated still, you then have financial advisors on both sides of the table. You'll have to diligence advisers advising the buyers to check that the basically the quality and the correctness off the business that they're buying, there'll be tax advisers tax plays, an important part in any of these deals, and obviously there Bill of Legal documentation, so you'll need more lawyers still to put all that together. The funding comes in the form principally of debt equity, and then you also need loans and overdrafts to cover working capital facilities so that s'more levels of complexity to put together the bank normally provides the debt funding. This might be 50% as I have shown you already, the range of debt funding can be as little is an internal 20% and it could be as high as 70 rate. It does very in its unique to every deal the banks normally seek to get as much security as possible. Normally ever all the assets of the business. They get repaid through interest payments on through principal repayments, and they have the lowest risk the equity it forms into two parts. Firstly, is the private equity firm who puts up 40 to 50% letters, say off the consideration for the deal, and that's their money, and it goes in to the company's equity. Now they have ways of structuring this money as well, but I won't go into into that, but they constructor in a way that gives him a better position in terms of debt in and the the senior debt ranking in the event that the deal doesn't work out, so they have ways of protecting themselves. But let's just say keep it simple. They're putting up the equity on they put that up alongside management, and they control that relationship through a shareholder agreement, which gives them rights and beaters over the company, which gives them effective control of the business, even though they're working with the management team who have responsibility for the date day running of the business. Then you have the management equity, which is normally the smallest amount. It might be five or 10% of the total, but it's structured in a way so that they can make the highest personal potential capital gain from the deal. And the investors, the equity messes want to see the management make an investment off cash. They want them toe, have skin in the game. But they're very happy for them to be highly incentivized to make a very high return because that keeps them working very hard to make sure the deals as successful as it possibly can be. So a management buyout an embryo provides the management with the opportunity to make a substantial capital gain from a relatively modest investment. And that's why they're so popular on this deal. It's financed by banks and private equity firms and, of course, the company's own cash flow. So to summarize, a management buyout is a purchase of a company by its management, financed by banks and private equity firms, with management making a modest investment to potentially get very high return. And that is the crux off what a management buyout is all about. 13. What is a Leveraged Buyout?: Let's take a look now and ask the question. What is a leveraged buyout? The good news is, if you've got your mind around a management buyout than the core components of a leverage about are pretty, well the same. You got all the same sorts of players you've got the same principles you've gotten based on their financial structures in a management buyout. Simply the difference is that it's a process driven by a management team who are buying out the business, and therefore that's where the focus falls on. That's where they really talk about it in a leverage buyout. It's more the private equity fund driving the deal on. They've got their financial goals, and they're going to use debt to create the financial returns, and hence they refer to it as a leverage buyout. But in a management buyout, you're still going to get a private equity fund. You're still going to get the use off debt where appropriate, to leverage the returns. So much of it is very simple, simple and much of it is very similar. But I thought it would be worth focusing in on a leverage buyout just to explain how the leveraged part. How the use of debt in a leverage buyout works. Let's take a hypothetical example. Andi, let us say your private equity guy and you buy a business. It's a company with 10 bit D A, and you buy it for five times revenues, so you spend $50 million on it, and you finance that with 20 million off equity on 30 million off debt, which is a 60% leverage ratio, which is not crazy. Perfectly possible. So 3 to 5 years later, the company now has $15 million off a bit d. A. You've improved its operations on when you come to sell it. You sell it for eight times the BET D A. So you sell it for $120 million on because you've had some cash flow from the business and you'll be able to pay down debt. I mean, if it's checking off 10 million to be bit D A. You should probably clear all the debts. I've been quite conservative, so your debt is down to 10 million. You've being paying interest on the debt, obviously, and you've got working capital requirements and you had to invest in the business, but you've made some capital repayments, so the proceeds to the equity are 110 million. So let's go back and imagine for a minute that you didn't use leverage and you had simply bought this business for $50 million. You sold it for 110. You'd have made 2.2 times your money. That's a pretty good return. Not too bad. Relatively risk free cash on cash two times, However, with the leverage the equity out that you only spent $20 million a use 30 million off debt on the proceeds is still 110. So your return cash on cash is 5.5 times on. That's the difference. The difference during the 2.2 on the 5.5 has been created by the leverage by the debt you put into the business on. That is really what the basics off a leverage buyout is all about. Is using debt to leverage the power to multiply the power off your cash of your own equity so that when you sell, you've used the cash from the business to pay down the debt, greatly enhancing the value of your original equity investment 14. Private Equity 101 Summary and Wrap Up: what we've come to the end of this short course, and the first thing I would like to do is to congratulate you on completing it and also to thank you for taking the time to work with me and go through the course. I hope you found it really helpful. Don't forget, I'm always here to answer questions. You just have to message me or leave a Q and A in the course on I love answer questions. You often intrigued me with some of the things you guys come up with, but it's always great to get them, so that's fantastic. Let's have a quick run through. We've covered in this course because what I've tried to do is to give you an overview off private equity in a relatively short amount of time. It's a really very complex subject. I've been working with private equity firms now for over three up and getting on for 30 years. Since 1988. Andi, I've still got stuff to love, but it's an intriguing subject and they ain't going away. So let's take a quick look at what we looked at first when I gave you an overview off this of a key components off private equity on. Then we looked at deal stages, and that was really to try and get a split between venture capital and private equity e bit D. A. Earnings before interest, tax, depreciation and amortization is one of the key numbers that private equity firms work with , and I really wanted to make sure you got a detailed understanding of that. How value is created in private equity deals was important, and we went through that. I wanted to categorize the firm's for you so that you could understand the range on the different types of firms and why they had these categorizations. I hope you found that helpful and then took you through the serve the deal screening process to just show you what a needle in a haystack type exercise. The whole thing is. Andi then took you through the life cycle of a private equity fund, which is actually something very important to understand, because if you are pitching to have fund, you need to make absolutely sure that they're in in best mode and that they're not either fully invested harvesting or in the business of raising their new fund. Private equity measurement and compensation is a really key subject, you know? How did they get evaluated? How do they get paid? Very important. Looking at a deal funnel for a private equity, or was was, I think I hope they break constructive excise on. Then I've taken a quick look at management buyouts and leverage buyouts that this is going to be the subject of a much longer course. But I thought it be helpful to introduce these here because that's the sort of the main sort of deals that private equity firms do. And with a leverage buyout, I wanted to really show you how the leverage works and therefore why it's called a leveraged buyout. So this course is not the last word on private equity. I couldn't do that in such a short space of time. But if you've got a question, then please reach out, message me, put it into the course. I would love to do my best to answer it, and I say, I love getting questions from you guys. So that's it for this course. Private Equity 101 I hope you found it interesting insight into the world of private equity . I look forward to seeing you, of course, again very soon in another one of my courses