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Private Equity Private Equity

Prof. Dr. Dr. Dietmar Ernst

Prof. Dr. Dr. Dietmar Ernst

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Contents

1. 2. 3. 4. 5. 6. 7.

What is private equity all about? Who drives private equity? How are private equity companies organised? How is private equity done? What makes acquisition-financing special? Main goals of investors European finance leveraged finance market

Prof. Dr. Dr. Dietmar Ernst

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Contents
1. 1.1 1.2 1.3 1.4 What is private equity all about? Definitions Case Study: Private Equity Ltd. acquires Packaging Group Occasions for private equity financing Types of investments

2. 3. 4. 5. 6. 7.

Who drives private equity? How are private equity companies organised? How is private equity done? What makes acquisition-financing special? Main goals of investors European finance leveraged finance market

Prof. Dr. Dr. Dietmar Ernst

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1. Definitions

Private Equity Financing

Private equity financing is the financing of companies via equity that is brought in from outside the organized capital market, i.e. from outside the stock exchanges. The investment involves considerable monitoring, information sharing, and co-determination rights as well as management support.

Private Equity

Private equity is defined as direct investments in the form of shares in companies and equity-related funds, the so-called mezzanine, as far as they grant the above-mentioned co-determination and cooperation rights. Mezzanine is defined as a financing form which either includes equity-related elements (such as co-determination rights, profitlinked payment) or debt elements (such as limited maturity, fixed payments etc.).

Prof. Dr. Dr. Dietmar Ernst

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1. Definitions

Private Equity Company

A private equity company is a corporate entity providing equity to other companies in exchange for shares of equity in these firms. So, private equity companies can participate in the performance of these companies in the medium term. A private equity company is responsible for managing the investors (funders) capital.This implies the following activities: Selection of investment targets Investments Monitoring of existing participations Disinvestments

Funder

A funder is the source of investment capital for the private equity company.

Fund

A fund is a designated pool of investment capital that the private equity company is responsible for advising and/or managing on behalf of the funder.

Prof. Dr. Dr. Dietmar Ernst

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1. Definitions

Portfolio Company

A portfolio company is an organisation, which is in receipt of private equity from a fund advised or managed by a private equity company.

Venture Capital / Private Equity

Private equity and venture capital are two different topics. Venture Capital is primarily used for transactions in the high technology sector as well as in early stage financing. Private Equity evolves into the generic term for all types of equity investments in non-listed companies. The term differs from the term public equity that characterises the shares of publicly traded companies.

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1. Definitions

Exhibit 1: The players of a private equity financing at a glance


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Case Study: Private Equity Ltd. acquires Packaging Group

What does the press say ?

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Case Study: Private Equity Ltd. acquires Packaging Group

Sale of 100% stake in Packaging Group to Private Equity Ltd. Transaction Overview Purchase price of 445m (enterprise value) Signing on October 19th, 2006 Closing expected December 14th, 2006 subject to extraordinary general meeting approval and competition authorities clearance

Private Equity Ltds Role

In summary, the role of Private Equity Ltds management includes financial advice on all aspects of the transaction, including the following: Scrutinise the investment opportunity Valuation of Packaging Group Run due diligence process including data room, site visits and Q&A-sessions with management Structure the deal Conduct negotiation of share purchase agreement Secure financing of the transaction Carry out negotiations with acquisition finance departments of banks involved in the transaction.

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Case Study: Private Equity Ltd. acquires Packaging Group

Prof. Dr. Dr. Dietmar Ernst

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Case Study: Private Equity Ltd. acquires Packaging Group

Prof. Dr. Dr. Dietmar Ernst

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Types of Investment Financing

Overview

Concerning chronological phases of the financing, the private equity financings are divided into early stage financings (venture capital financings) and later Stage financings (private equity financings)

Early Stage Financings = Venture Capital Financings

The financing of a company in an early stage occurs in three phases:

Seed financing Start up financing First stage financing

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Types of Investment Financing

Seed Financing

The seed financing phase stretches across the period of the preparation of the company formation. It aims at developing the company concept, for example formulating the company objectives, analysing the target markets via market research, and developing production plans etc.). In most formation phases, the equity financing is not yet carried out via venture capital. The company founder normally has to inject a certain amount of his own capital in the companys equity base. Moreover, so-called business angels (i.e., private persons participating in young companies with parts of their assets) often participate as investors in this phase. Additionally, the company founder can use funds from public development companies (ffentliche Frdergesellschaften). The seed money is characterized by the fact that it should represent an investment with an above-average return and a high risk for the investor. The return depends on the success of the companys start up.
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Types of Investment Financing

Seed financing is followed by start-up financing. Start-up Financing It is the companys development phase; characterized by the technological maturing of the product up to the production of the prototype. During this period, the creation of an extensive business plan also takes place, together with a detailed company strategy (planning), a competition and product analysis as well as a marketing concept. The formal and juridical company formation is normally carried out during this phase. A business angel or first-stage venture capital financings is used at the start-up financing phase. However, in both cases, a sophisticated and rigorously detailed business plan is required. The business plan reflects the quality of the company and of the entrepreneur. Based on the business plan, the venture capital investors evaluate the economic success opportunities of the business model on the one hand but also the professional and managerial competence of the management on the other hand.

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Types of Investment Financing

The focus of the analysis for the evaluation is not only on the technical feasibility but especially on the market opportunities as well. In this phase, founders of an enterprise are in fierce competition with other venture capital seekers. This is why it is advisable for company founders to invest much time and effort in the start-up phase.

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Types of Investment Financing


In the first-stage financing phase, the newly formed company starts to produce its products, based on the prototypes. The products are launched in the market, and the first sales are made. In addition to the venture capital provided in the first and second financing phases, the production commencement leads to additional, (often considerable) needs for capital, depending on the results of the sales. The early-stage financing is completed after the end of the first three phases. These can also be specified as the critical keep-up period for the venture capital investor. Usually, this period is characterised by initially increasing company losses. Problems concerning the search for qualified managers and skilled employees often arise as well. At this stage, it will become evident if the (often technologically oriented) company founders are qualified to manage an expanding business. Conflicts can arise if different ideas in this matter exist between the company founders and the venture capital investors.
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First-stage Financing

Types of Investment Financing


The risk taken by the venture capital investors, especially the default risk for the invested capital, is reflected by the level of the required return on the invested capital (IRR = internal rate of return) which mainly results from a later sale of the investment. From a private venture capital companys point of view, the calculation is based on a return expectation of 30% - 50% p.a. The target return for each single exposure is rather 50% in order to reach a return of 25% for the whole exposure, considering the defaults. Venture capital companies under public law aim at the same IRR for single exposures, but because of the higher amount of investments, their total return target is lower than that of private venture capital companies.

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Types of Investment Financing

Later Stage Financings = Private Equity Financings

As soon as the company breaks even (starts being profitable following a successful launch in the market), the later-stage financing period begins. Prerequisites for the entry of private equity companies traditionally are: The company has already existed for at least five years. The business model of the company is accepted by the market. The company is profitable. The organisational and personnel structures are sound.

In addition, in late-stage financing period, one can distinguish between the following three phases (at least in the ideal cases): Second-stage financing Third-stage financing Fourth-stage financing

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Types of Investment Financing

Second-stage Financing

After a successful market entry, the company reaches a strong growth phase. Sales develop above-average in the growth phase. In order to make growth possible, capital needs to be provided. This defines the type of financing needed.

What is meant by the statement that the above-average growth strongly depends on the sector in which the company operates? Above-average growth can refer to a comparison with the market or with the competition. Sometimes, above-average growth is defined as a double-digit growth rate.

On the production side, the emphasis is on the expansion and optimisation of the production capacities, on the sales side, one of the main tasks is the development of distribution channels. As strong growth is often connected with increasing costs because of a higher working capital need, despite the expansion, the management has to take measures for cost control and cost cutting.

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Types of Investment Financing

Here, the establishment of an enterprise resource planning system (ERP system) as the basis for an efficient controlling, reporting and risk management may be considered. In order to fulfil the business management requirements of fast growth, organisational structures have to be created which are tailor-made to the adequate size.

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Types of Investment Financing

Third-stage Financing

In this phase of competition growth, the main emphasis is on the strategic exhaustion of market potential. In this phase, the company achieves a sustainable profit. In addition, for the first time longer-term loan financings are carried out which go along with the expansive business turnover process.

Fourth-stage Financing

This phase reflects the economic expansion phase of the company. Once a firm reaches this phase of development, then, the private equity provider has fulfilled its special financing role. Therefore, at this phase, the investors prepare an exit strategy. Their disinvestment can be completed by the following methods: Going Public = IPO Trade sale = sale to a strategic investor Buy back = buyback of the shares by the existing shareholders Secondary purchase = sale to another financial investor

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Types of Investment Financing

Exhibit 2: Exit channels first half 2005 in Germany Source: BVK

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3. Types of

Expansion Overview Bridge-financing Public-to-private Solving the succession problem Spin-offs Private Placement Turn Around Buy-and-build Strategy

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3. Occasions for Private Equity Financing

Growth financings serve the financing of expansion plans Expansion via internal growth (additional production capacities, additional working capital, market share increase, product diversification etc.) or via external growth (acquisitions which cannot be financed with debt). Private equity companies usually finance a companys growth via direct investments (majority or minority interests) or indirect investments (mezzanine). In business practice, minority interests are usually preferred. Unlike early-stage financings, this is done, mainly due to the existing shareholders desire to limit the influence of the private equity company. Moreover, the cash inflow which is generated by a minority interest usually is sufficient for the financing of the expansion plans.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

A bridge financing serves for the preparation of an IPO. Bridge Financing Here, additional equity is provided for bridging the period until the launch of the company at the stock market. Bridge financings can also be found in the venture capital area between different stages of financing. Bridge financing is defined as the interim financing for the IPO of young technology companies immediately after the venture capital financing.

During this period, the company may take advantage of its non public status to gain experience regarding the expected particularities and requirements of a listed public limited company (plc). Especially the adaptation of the accounting, reporting and controlling standards to the requirements of the capital market make a good preparation necessary. In this context, it is important that the private equity firm provides management support as a feature of its involvement. This support also extends to the so far not necessary investor relations task.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

Another important advantage of the bridge financing is that it provides flexibility to the companies in terms of when to do an IPO. The right moment for the IPO can be adapted by the additional capital without exposing the company to the financial pressure of executing the IPO in an unfavourable stock market environment. A bridge financing usually is carried out through an open (direct) equity investment. Thus, a private equity company can directly participate in the increase of the companys value which is partially already realised via the IPO.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

Public-to-Private

The term going private describes the transformation of a listed company (public company) to a private company. This implies that the shares of the private company are not traded at stock markets anymore as well as the free float of shares is abolished and the number of the new shareholders is very limited

Very often the private equitys intention is to fully control a listed company. Having terminated the delisting process the acquirer tries to increase the targets value by developing it further. After a limited period of time (in business practice 5 years 7 years) the private equity company tries to exit via IPO or via trade sale to a strategic or financial investor.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

Succession Planning and Displacement of Existing Shareholders

A generation change in the companys management as well as restructuring of a company caused by other reasons including the restructuring or exchange of its shareholder circle are the most common reasons for modern solutions which have become known under technical terms such as Management Buy-Out (MBO) or Management Buy-In (MBI). MBOs and MBIs are normally linked to leveraged constructions and therefore represent a variety of the leveraged company acquisition (LBOs). There are a number of reasons for including MBO and MBI in the area of private equity: In most cases, buyouts involve a risk-bearing equity position. For buyouts, equity-similar or equity-close funds mezzanine capital are used differently and on a case-by-case basis within the other private equity business. A buyout is a entrepreneurial challenge which requires techniques used in the private equity business such as controlling, reporting, monitoring, and risk management.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

As prerequisites for a successful leveraged acquisition, the target company to be bought should possess the following prerequisites: Save market position High profitability Low leverage / debt ratio / leveraging Low need for capital expenditures in the near future A company with those characteristics normally has a high company value. The buyout then is based on the following further thoughts: The purchase price will be raised mostly by debt. In the end, this puts a burden on the target company. More interest has to be paid due to higher leverage. Usually, this will be financed based on the targets cash flow. In contrast to the nominal value, the high company value leads to the revealing and activation of hidden reserves (for example, goodwill) in the target companys balance sheet. The additional interest for debt as well as the additional depreciation of the activated indirect reserves lower the profit of the target company and therewith its tax burden.

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3. Occasions for Private Equity Financing

Spin-off

In the context of the buyout topic, the so-called spin-off procedures should be mentioned. These transactions concern the spin-off of a department or a division out of a company or a group. The reason for spin-offs often is a change in the strategic focus of the parent company, according to which certain businesses no longer belong to the groups core competencies. But also newly developed activities and products which after maturing are not to be run according to the group managements decision can be considered for a spin-off. As a general rule, those managers who have so far been responsible for the division to be spun-off are the ones who leave the group together with their business unit or division. So they get the chance to keep their former job as an independent manager. Again this is a case, in which the new entrepreneurs normally do not possess sufficient funds to bring up the purchase price for the division to be spun off. According to financing techniques, one can take into consideration constructions for the spin-off which are similar to those for the MBO.
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3. Occasions for Private Equity Financing

However, the business planning for such a project includes a higher risk because the business unit to be taken over had not been subject to separate reporting prior to spin-off (in most cases). Thats why significant uncertainties may occur in terms of the cost and revenue projections actually attributed to this business unit, so that a spin-off can be quite similar to a start-up in terms of its risk structure. On the other hand, it bears the opportunity for the independent management to develop significant creative impulses with its business programme - due to the recently gained freedom from the group in order to achieve market success.

Prof. Dr. Dr. Dietmar Ernst

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3. Occasions for Private Equity Financing

Private Placement

Private Placement is defined as the placement of securities that are not publicly sold and traded, and that normally remain in the portfolio of the first investor after their issue. Apart from the off-market issue of shares, a Private Placement comprises further investment instruments at which the investment capital of private investors is placed as non-voting, wide-spread investor capital (= equity replacement according to accounting standards). A private placement can for example be used for restructuring purposes or for the displacement of a minority shareholder, and it is usually connected with a leverage component.

The advantage of a private placement from the companys point of view consists in limiting the investors influence through contract clauses and directing it according to the company philosophy. The spectrum of investment possibilities that can be offered within the scope of a private issue is much broader and much more interesting than a public security issue at the stock market, and it covers the whole area of mezzanine financing instruments.

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3. Occasions for Private Equity Financing

Especially, the non-public capital market can offer no-certificate (and therefore cheaper) and non-voting investments (partially with significant tax advantages for companies and investors). In Germany, for a long time only little attention was paid to the alternative possibility of raising equity via private placement on the non-public/OTC (= over the counter) capital market. Against the background of Basel II and the common restraint of banks regarding the granting of loans as a result of the restructuring of the credit business, more and more companies make use of the advantages of a private placement.

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3. Occasions for Private Equity Financing

Turnaround

Turnaround financings provide private equity for companies, which are either in a restructuring phase or have just completed one. Analysing potential investment opportunities, the private equity company focuses on sustainable future profits. Especially the issue of reaching the profit zone and sustaining that level of profit is subject of the private equity companys examination.

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3. Occasions for Private Equity Financing

Platform strategy or buy and build strategy

With a platform strategy or a buy and build strategy, companies are consolidated out of a polypolistic market environment in order to benefit from synergies which can arise from e.g. a stronger purchasing or distribution power or from reduced administrative expenses. Initiators of a platform strategy often are the investment companies themselves which with their own teams - analyse sectors as to their suitability for a platform strategy and integrate adequate market participants into a company. A bigger market participant thereby serves as a nucleus which then, with appropriate financial strength, acquires competitors and therefore makes the realisation of economies of scale possible. With an increasing company size and the connected growing market power, the attractiveness of the platform strategy increases for foreign industrial investors who want to extend their market position. This development results in an exit alternative for the private equity company, and the possibility of realising the value added that resulted from consolidating the companies.

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4. Types of Investments
With an direct investment, the private equity company acquires shares in the subscribed capital of the company with all rights and duties linked to it. Direct investments are connected with voting and co-determination rights. Direct investments make the owner participate in the hidden reserves of the company and so in the company goodwill and opens up the opportunity to realize a profit from the sale of the investment. This profit results from the difference between the sale proceeds and the purchase price. For existing companies, the purchase of the shares takes place within the context of a capital increase or through the purchase of existing shares. The entry via a capital increase can only be realised if the existing shareholders do not exercise their purchase right. Details from the cooperation between the private equity company and the shareholders are regulated in a shareholder agreement which however is legally effective only internally. Externally, the investment company appears with the unlimited rights and duties of an open shareholder.
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Direct Investment

4. Types of Investments

The duration of an open investment is not limited by contract, but persists until it is sold to another shareholder. But as a financial investor the private equity company has a limited investment horizon which normally can be depending on the investment purpose ca. 5 years - 7 years. Because of this time limitation, the disinvestment perspective is already an important decision criterion for the private equity company if it makes the investment. The sale (the so-called exit) of the open investment can be carried out through different ways. Crucial for the position of the investment company within the shareholder circle is the amount of the open share. Hereby, the spectrum stretches across minority interests without blocking minority to the complete takeover of the company. Investment companies that only have a minority interest in a company often request a contractual guarantee that they take over the majority and therewith the management of the company if the profitability of the company develops significantly negative and if risks that concern the further existence of the company are connected with this development.
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4. Types of Investments
Direct Investments

Advantages

Disadvantages

Company maintains independence and responsibility for business operations Higher level of equity capital to finance growth and investments Little or no interim interest or dividend payments required

Acquisition price depends on value of the company (company valuation required) Lower value and price for minority interest (no strategic premium) Financial investor receives higher value for shares at time of exit (exit opportunities must be demonstrated) Co-determination of major business decisions with financial investor

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4. Types of Investments

Indirect Investment

Via indirect investments the company receives equity but the private equity company does not get any shares in the company. That is why the private equity company does not appear externally, i.e. it is not registered in the commercial register. The investment remains anonymous. Public limited companies are an exception. The private equity company has the obligation to place in its shareholder deposit, and after the termination of the stipulated shareholder relationship, it can claim the redemption of the deposit. Unlike a borrower, the indirect shareholder participates in the companys profit. Another term for indirect investment is mezzanine.

Prof. Dr. Dr. Dietmar Ernst

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4. Types of Investments
Indirect Investments

Advantages

Disadvantages

Company maintains independence and responsibility for business operations Higher level of equity capital to finance growth and investments Collateral is typically not required No principal payments on investment funds; original shareholders retain full value should value of the company increase

High required return on investment Most financial investors prefer direct investments with potential to realize higher value at time of exit

Prof. Dr. Dr. Dietmar Ernst

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Contents
1. What is private equity all about?

2. 2.1 2.2 2.3

Who drives private equity? Bidder groups for equity capital The role of banks in the private equity business Investors in private equity

3. 4. 5. 6. 7.

How are private equity companies organised? How is private equity done? What makes acquisition-financing special? Main goals of investors European finance leveraged finance market

Prof. Dr. Dr. Dietmar Ernst

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1. Bidder Groups for Equity Capital

Overview

The bidder groups mainly differ by the characteristics of their sponsorship, i.e. by their shareholder background. Captive funds Public funds Independent funds

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1. Bidder Groups for Equity Capital

Captive Funds

For captive private equity companies, the funder is the parent organisation. Generally, private equity companies intent to maximise the internal rate of return. If corporations (not private equity companies) invest in a target and the investment is not only financial but also strategic driven, the companies are called captive private equity companies (or captive funds). These captive funds are very often technology oriented acting as window of technology for their parent companies. They take up new trends early in single technology areas and benefit from them. Captive funds can apart from a profit orientation also pursue other company objectives with more or less strong specification.

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1. Bidder Groups for Equity Capital

Public Funds

Public private equity firms usually conduct the investment financing with the purpose of promotion of the economic development in order to e.g. help structurally weak regions attract young companies or to settle high technology companies in a region. They often have a regional or sector-specific orientation. The responsible bodies are normally corporations under public law.

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1. Bidder Groups for Equity Capital

Independent Funds

Independent funds are private equity firms with independent shareholder teams. Independent funds usually are exclusively orientated towards profit maximization which is reflected among others in the specific design of these private equity firms organisation, such as the choice- and investment decision process as well as the degree of investment support and control. The management of the independent funds usually is controlled via incentives (especially variable and performance-based remuneration agreements), whereas captive funds, in their relation to their investors, i.e. their parent companies, are more characterised by authoritarian performance features (rules or prohibitions). Because of the competition for qualified management personnel, one can notice an increasing importance of the performance-based remuneration.

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2. The Role of Banks in the Private Equity Business


Viewing the origin of funds, one can distinguish between two types of private equity business performed by banks: Investment of own funds Management and investment of foreign investors funds Bank-related private equity firms belonged to the pioneers of the European private equity financing business because of their parent companies traditional role as intermediaries in the financing process. The banks role as the strongest group by the volume of the funds provided is unchanged. Banks mainly pursue the following objectives in the private equity financing business: Return targets: By entering equity investments, returns can be achieved which are not reachable in the classical credit business. According to BVK statistics, average returns of 15% 19% p.a. were achieved in the past. Current dicidend payments usually play a minor role. The return is mainly achieved through the capital gain from the sale of the shareholdings. Customer loyalty: Universal banks consider private equity capital to be a financing module in an integrated corporate finance strategy in order to achieve customer loyalty by covering the customers financing needs.
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Business Model

Objectives

2. The Role of Banks in the Private Equity Business

Equity Investments

Looking into the balance sheet of banks, the participation in other companies are reflected by various positions, which can be divided into the following categories: Shares and other trading investments: purpose of this exposure is short-term profit through trading Shares and other equity financing investments: predominant motive is profit in the medium-term after further development of the portfolio company. Realisation of profit through sale of the investment. Strategic investments: Long-term intentions based on strategy, in order to secure the markets, know how etc. The sale of the investment is not intended. Subsidiaries: A worldwide banking group typically consists of a multitude of companies and strategic investments which are all formally investments of the parent company. It shall be understood, that in this case one cannot talk about investment companies in the sense of this chapter. Only the second point (shares and other equity financing investments) can be referred as to private equity business.

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3. Investors in Private Equity

Different investors

The majority of private equity investors differs from the typical capital market investor. Originally, i.e. in the 50s, in the US, mainly funds of private investors (family money) were invested. Over the years, banks, industrial companies, insurances, pension funds, mutual funds and even the government (in the context of the Small business programme) have participated. In 2000, the following investor groups primarily contributed to the fund raising in the US (almost 93 billion $): pension funds with at least 40 %, insurances and other financial institutions with more than 23 %, mutual funds with at least 21 %, private investors with almost 12 % and companies with 4 %. In Germany the development proceeded in a different way. Here, the first development phase was almost exclusively financed by credit institutions. However, recently their share has decreased. In 2004, their share was only 20 %.
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3. Investors in Private Equity

New funds raised according to capital sources

The largest proportions of new funds raised in 2005 in Germany were accounted for by pension funds with 37.4 % and with 14.4 % for funds of funds. Credit institutions provided 11.6 % and public capital sources 7.7% of the new funds. This area also accounts for - apart from the activities of the Mittelstndische Beteiligungsgesellschaften - the public coinvestment and refinancing programmes as well as the public private equity firms. Furthermore, insurance companies (8.1%), private investors (5.7%), capital markets (5.2%), reinvested capital gains (4.9 %) and other capital sources (4.7%) were of importance.

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3. Investors in Private Equity

Exhibit 3: New funds raised according to capital sources in Germany Source: BVK

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3. Investors in Private Equity

Geographical distribution in Germany

The first half of the year 2005 shows the following ranking of nation-wide investment: Baden-Wurttemberg (41.7%), Bavaria (20.0%), Thuringia (8.0%), Lower Saxony (6.4%) and Rhineland-Palatinate (5.8%).

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3. Investors in Private Equity

Exhibit 4: Geographical distribution of investment first half 2005 in Germany Source: BVK
Prof. Dr. Dr. Dietmar Ernst page 51

3. Investors in Private Equity

New funds raised according to financing phases

The biggest fund-raising proportion in 2005 was accounted for by buyout transactions with 65.2%. Other important sources were expansions (15%) as well as significant high tech expansions and high tech early stages.

Exhibit 5: New funds raised according to financing phases in Germany Source: BVK
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3. Investors in Private Equity

Sectoral distribution of investment

In the first half 2005, funds were distributed to the sectors as follows: consumer goods (20.7%), mechanical engineering (16.2%), computer (8.5%) and medical (8.1%).

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3. Investors in Private Equity

Exhibit 6: Sectoral distribution of investment first half 2005 in Germany Source: BVK
Prof. Dr. Dr. Dietmar Ernst page 54

Contents
1. 2. What is private equity all about? Who drives private equity?

3. 3.1 3.2

How are private equity companies organised? Separation of fund and management Subsidiaries

4. 5. 6. 7.

How is private equity done? What makes acquisition-financing special? Main goals of investors European finance leveraged finance market

Prof. Dr. Dr. Dietmar Ernst

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1. Separation of Fund and Management

Overview

The general rule is a separation of fund and management company, i.e. the private equity capital and its management are within different companies.

Investment Company

A fund is founded, where the available investors capital is brought in. The fund acquires the investments.

A management company that manages the fund is elected. Management Company It therefore receives 1.5% 2% p.a. of the subscribed fund volume and participates in the funds performance only after a minimum return is provided to the investors capital. The minimum rate of return (hurdle rate) lies between 8% and 10% p.a. IRR (internal rate of return). The profit share of the management company lies between 15% and 20 % (carried interest) of the profit earned. A management company can simultaneously manage several (subsequent or theme) funds. Decision criterion for or against the separation of management company and investment company is the choice between openend fund and closed-end fund.
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1. Separation of Fund and Management

Open End Fund

Definition: A open end fund represents a permanently running investment business. An open end fund operates similar to a bank, which permanently borrows money and relends it in the form of loans without facing a temporary limitation on its activities. In principle this kind of business can also be formed by agreeing to separate the management company and investment assets, as the example of DBG, DBAG shows. With an open end fund however, this separation is not obligatory. Definition: In a closed end fund a certain fixed investment sum is invested in private equity projects. The objective is the sale of possibly all projects with a high value added within a previously arranged fixed time horizon. The entire task from fund raising trough to the exit (and achievement of possibly high capital gains) is usually done by a team of private equity professionals. The private equity professionals present their qualifications to the investors on the basis of their track records and their prior performance, i.e. their previously achieved successes in private equity projects.
Prof. Dr. Dr. Dietmar Ernst

Closed End Fund

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1. Separation of Fund and Management

The purpose of closed fund businesses is the flexible perception of investment opportunities: Private equity experts are able to recognize cheap market opportunities for private equity capital investments, e.g. in certain growth processes, and to successfully take advantage of these up to a certain amount. They commit themselves only to promising capital investments that are within this defined amount, a defined time period and possibly a defined kind of entrepreneurial undertaking. They also want to benefit from the undertaking through (differently structured) success premiums (carried interest). The capital for such an undertaking is therefore brought into a closed fund which is settled and returned as a whole to its investors. If new market opportunities occur, new closed funds are formed to take advantage of these opportunities. The only permanent aspect of this business principle is success given the management company.

Prof. Dr. Dr. Dietmar Ernst

page 58

2. Subsidiaries

The organisation of captive funds

Captive funds, on the other hand, are mostly managed by staff divisions or subsidiaries, i.e. the investment and management company are identical. The outsourcing of the investment financing business to an independent subsidiary has, among others, the following reasons: Loss separation: separation of the managing entity from losses which the investment financing business might cause. Admission of partners: easier admission of partners. Profile-building: establishment of an independent profile of the PE firm, independent from the image and profile of the managing entity. Liability according to 32 a GmbH: In case that a bank provides direct investment financing and debt financing to a company (if it provides debt to the portfolio company in addition to private equity), it may face the problem that, in the event of portfolio firms bankruptcy, the debt can be considered by court to have equity replacing character. The consequence would be that the assets which originally should serve as collateral of the debt cannot be drawn, i.e. the debt provided by the bank would be assessed like being equity (which usually is an unsecured claim).

Prof. Dr. Dr. Dietmar Ernst

page 59

2. Subsidiaries

Through adequate measures, such as the group-owned private equity firms orientation according to the UBGG (Law of private equity firms) or the legal involvement of partners (according to company law) who hold the majority of the, in this case only group-related private equity firm, such risks can be avoided. The UBGG thus opens up the exemption from the risks of 32 a GmbH law for so-called captive private equity firms, i.e. private equity firms whose shares are mainly held by a bank.

Prof. Dr. Dr. Dietmar Ernst

page 60

3. Management-, control- and advisory organs

Operative management organs

The operative management organ can be the company executives board (private limited company (Ltd. = GmbH)) or the board of directors (public limited company (plc = AG)). As to the operative business, the management tasks mainly cover the acquisition, current support and sale of investments the fund raising the inner organisation, the human resource management, the controlling the development of the strategy of the private equity firm

Depending on the scope of tasks and business volume, the number of people involved can vary from one-person-management to five- or six-head committees with one chairman/president or speaker.

Prof. Dr. Dr. Dietmar Ernst

page 61

3. Management-, control- and advisory organs

Control- and advisory organs

Almost all German private equity companies posses a control- and advisory organ, no matter if the legal form specifies this, like the supervisory board of a public limited company, or not. As long as it is not a public limited company, the committee is not called supervisory board, but advisory board or administrative board. Concerning the tasks, they are quite identical to those of the supervisory board of a public limited company and normally involve: decisions on proposals of the executive board regarding the purchase or sale of investment projects, as long as these do not fall into the managements own competency which is mostly depending on the size of the investment the decision on proposals of the executive board regarding fund raising (e.g. capital increase, borrowing of a loan) the decision on the executive boards strategy proposals the examination and, if need be, the approval of the annual report, possibly also the decision on proposals of the executive board regarding the choice of the auditor

Prof. Dr. Dr. Dietmar Ernst

page 62

3. Management-, control- and advisory organs

Control- and advisory organs

significant personnel decisions such as the appointment and dismissal of executives (or board members) and the clarification of their material contract conditions, normally also the application of a full power of attorney, possibly also the application of a power of procurement (in case the latter does not fall into the executive boards competency).

Single tasks are often transferred to a kind of preliminary committee (e.g. investment committee) in order to reduce the burden of the supervisory board. This is usually applied to decisions on investments with a fixedlimited amount.

Prof. Dr. Dr. Dietmar Ernst

page 63

4. Inner organisation

Functional departments

The inner organisation is determined by two functional employee groups. the group of the employees who are responsible for the active investment business, i.e. the project managers and the project professionals the group of the employees responsible for all other functions: finance and controlling, human resource and organisation, administration, altogether also called services.

Prof. Dr. Dr. Dietmar Ernst

page 64

4. Inner organisation

Additional departments

TIn better organised and usually larger companies, one can additionally find the following institutions as organised structures: investment controlling: this function is crucial for current monitoring of the development of the single portfolio companies, especially through current comparisons of actual figures with plan figures. If certain business target figures are involved (such as return on sales, equity ratio, leverage, liquidity, etc.) the controlling then evolves to an early warning system; decision finding committee: the decision finding committee, where the executives and certain leading employees such as the head of investment controlling and the head of accounting as well as those directly responsible for a certain investment project, debate on propositions regarding the purchase or sale of certain investments, with the objective to make decisions in its own competence or present the project to the responsible committee with a certain recommendation; treasury: the treasury as special institution apart from the finance and controlling, if the fund raising is fully developed as an independent function.

Prof. Dr. Dr. Dietmar Ernst

page 65

Contents
1. 2. 3. What is private equity all about? Who drives private equity? How are private equity companies organised?

4. 4.1 4.2 4.3 4.4

Investment contract Basic types and significant parts of the contract Adoption of existing contracts, important side contracts and covenants Project-oriented milestones Participation in advisory and control organs

5. 6. 7. 8.

How is private equity done? What makes acquisition-financing special? Main goals of investors European finance leveraged finance market
Prof. Dr. Dr. Dietmar Ernst page 66

1. Basic types and significant parts of the contract

Common types of investment contracts

The contract which regulates the investment relationship can describe completely different types of relationships. Common types of investment relationships are: purchase of existing company shares (from current shareholders) by the private equity firm, thus displacement of the existing owners increase of the companys equity within the existing legal form and raising of the additional amount or participation in the raising by the private equity firm; investment of equity by the private equity firm in a special legal construction, independent from the companys legal form; in Germany this often takes place in different forms of silent partnerships; investing funds by the private equity firm in hybrid forms between liable equity and loan (mezzanine capital), e.g. as a subordinated loan and an interest rate which is increased by a risk premium; partially connected with call options like a convertible etc.; Between these different basic types, all various combinations are possible and common.

Prof. Dr. Dr. Dietmar Ernst

page 67

1. Basic types and significant parts of the contract

As far as the purchase of existing shares or shares to be created via capital increase are concerned, according to German law, especially the shares in limited partnerships, shares in private limited companies stocks are considered. It shall be understood that private equity firms usually only participate in legal forms with limited liability, thus for e.g. they do not become partner in a partnership or a partner with unlimited liability in a limited partnership. The risk of the investment must remain limited to the paid-in capital or the purchase price for the shares, at best increased by consents with fixed amounts of a participation in further recapitalisations. Through the purchase of shares in a company in the existing legal form, a private equity firm would only be one shareholder among others. But in fact, it mostly is a shareholder sui generis. The cooperation with a private equity firm brings elements into the company agreement, the operation method, and the objectives of the company, which often do not exist in this form prior to the entry of the private equity firm.

Prof. Dr. Dr. Dietmar Ernst

page 68

1. Basic types and significant parts of the contract

These new elements are reflected in significant parts of the agreement and important covenants / side agreements on which the private equity firm has to place value. The significant parts of the agreement concern 1. transactions that require an approval, i.e. a catalogue of measures which only can be executed with the approval of the private equity firm or of a committee in which the private equity firm is represented; 2. information rights, i.e. a catalogue in which the kind and scope of information according to a matter-of-fact content and time rhythm is described; 3. the private equity firms claim to be represented in a supervisory or advisory organ (advisory board, supervisory board, administrative board) with its own employee or a person of their confidence (they trust in)

Prof. Dr. Dr. Dietmar Ernst

page 69

1. Basic types and significant parts of the contract

In some cases, such a regulative structure already exists. Then, special negotiations are not necessary. However, most often the decision-finding and decision-making process in medium-sized companies (family-owned companies) is not yet organised in the way required by private equity firms, prior to the entry of the private equity firm. The executives or the entrepreneur are/is in that case not used to dealing with business policy, its objectives and significant other business issues with a third party in a critical way.

Prof. Dr. Dr. Dietmar Ernst

page 70

1. Basic types and significant parts of the contract

Measures that require an approval

In order to illustrate the content and meaning of the approval and information rights of a private equity firm, the following examples shall serve: measures which would make something different out of the company than it was in the beginning of the investment (change of the business programme) measures which mean significant financial expenses (investment intentions) or which change the financial structure (leverage) measures which have a significant influence on the management structure (appointment of executives and similar measures) measures, which could lead to conflict of interest with shareholders, leading employees, etc. measures which could lead to significant risk exposures (large loans to customers, unsecured foreign exchange and stock transactions).

Prof. Dr. Dr. Dietmar Ernst

page 71

1. Basic types and significant parts of the contract

Measures which require a current briefing (providing information)

Procedures and facts that must be know for a current assessment of the situation and development of the company must be provided to the private equity firm and therefore require a current briefing. The current effect of this development in figures is especially important. The current briefing is at the same time a significant prerequisite for a reasonable use of the approval rights. Being confronted with these requirements of the private equity firm towards the contractual form of the cooperation, the entrepreneurial negotiation partners are regularly divided into two groups: a group who feels such restrictions on their entrepreneurial freedom of decision-making as unacceptable, a group who is not scared by such requirements, because they feel confident and they do not dare to convince competent negotiation partners of their ideas, or to yield to their stronger arguments, in this case willingly and with a profit.

Prof. Dr. Dr. Dietmar Ernst

page 72

2. Adoption of existing contracts, important side contracts and covenants

Company statute

Regardless of whether the acquired investment is an open or silent investment, the project manager must carefully scrutinize the effective company statute, i.e. the company agreement and possible regulations among the existing shareholders. Subject of the examination is if the statute contains clauses which are incompatible with the private equity firms interests. The following examples can be named: If the silent partnership contract with a limited partnership for example stipulates that a cancellation on the part of the private equity firm is only possible after for example, 8 years at the earliest, then it should be considered that the limited partners are not allowed to cancel their own company relationship at an earlier date. If the private equity firm commits to leave its share of the profits partially or completely within the company in order to strengthen the companies financial profile, then the limited partners should not be allowed to withdraw their dividends completely.

Prof. Dr. Dr. Dietmar Ernst

page 73

2. Adoption of existing contracts, important side contracts and covenants

Also loans granted by the existing shareholders to the company which have equity character or serve as a replacement for equity, should be, according to interest rate and withdrawal rights, and shall be explicitly regulated in a way that the interests of the private equity firm will not be injured.

Prof. Dr. Dr. Dietmar Ernst

page 74

2. Adoption of existing contracts, important side contracts and covenants

Additional agreements

Not all rights and circumstances that are essential for the investment relationship from the private equity firms point of view emanate from the company agreement. Partially, they do not even belong there. If need be, information have to be gathered or additional agreements have to be made. Here, one particularly has to think of: Commitments to execute important measures that are necessary for the realization of the objectives named in the business plan, e.g. capital expenditure programmes or personnel measures. If need be, the whole business plan has to be mutually declared as business basis of the investment relationship. Intended or guaranteed arrangements regarding marital property regime (such as separation of property between shareholders and their spouses) or testament and succession arrangements. Due to their very personal character respective clauses should contain the possibility of being changed. This fact should be known at the beginning of the investment and a commitment should be obtained that the private equity firm will be informed of any changes.

Prof. Dr. Dr. Dietmar Ernst

page 75

2. Adoption of existing contracts, important side contracts and covenants

Contracts with or among shareholders, especially concerning the exchange of goods and services against payment, e.g. the purchase of certain good and services at shareholders, moreover employment and pension contracts with shareholders. It should be understood that the profitability of a company could be hollowed out by such regulations. Agreements on possible exit, for example what is to be done if one shareholder group especially the private equity firm wants to sell its shares, while the other group of shareholders tries to block the exit? Especially here, significant interests of both parties can be at risk and therefore, mandatory, enforceable agreements are difficult. It is clear that one can not make it mandatory that the company has to do an IPO after (for example, five years at latest). However, this can be defined as an objective, and certain steps towards it can be set in stone. Such steps could be the conversion of the company into a public limited company, personnel pre-decisions on composition of the board of directors as well as the supervisory board, agreements on the prospective consortium and the start of pre-negotiations with the potential lead-arranging bank. Naturally, all this does not guarantee the success of the IPO, but it provides the private equity firm with certain rights in case the other party might block their planned path, e.g. because of a change in their interests.
Prof. Dr. Dr. Dietmar Ernst page 76

2. Adoption of existing contracts, important side contracts and covenants

Moreover, agreements on buyback rights or shareholder options can be important, as well as mutual offer commitments in case of displacement, as long as such rights are not already included in the company agreements.

Prof. Dr. Dr. Dietmar Ernst

page 77

3. Combined investment contracts

Example

How can an investment negotiation be terminated successfully even if there is no mutual consent between the entrepreneur and the private equity firm as to the company evaluation, but nevertheless, both parties still believe in a successful company development? Lets assume that the company needs an equity increase of 5 million to implement its business plan and both parties agree on that need. We further assume that both parties wish to avoid giving a majority of voting rights to the private equity firm. Thus, the investment ratio to be reached with an equity increase of 5 million must not exceed 49.9 % of the shares. This can be realised if the enterprise value as capitalised earnings value after the equity increase of 5 million - at least amounts to 10 million . This presumes that both parties either agree on the profit expectations as to the projections (e.g. 1.5 million p.a.) and subsequently might agree on the discount rate (e.g. 15 % p.a. as to the current income), or that mutual consent is given on the discount rate and the projections actually lead to mutually accepted profit expectations which result in the target enterprise value with the assumed interest rate.

Prof. Dr. Dr. Dietmar Ernst

page 78

3. Combined investment contracts

Assuming that in our case, the private equity firm only considers an enterprise earnings value of 8 million (instead of 10 million ) to be justifiable (e.g. because it assesses the annual profit expectation more carefully to be 1.2 million ). In that case, with an investment ratio of not more than 49.9 %, it could only cause an equity increase of 4 million . However this would be less than the desirable level of the liable funds for strengthening of the business planning. The solution could look like this: the private equity firm acquires for 4 million a share of near 50 % in the increased voting capital. Moreover it makes a silent investment of 1 million for which a fixed annual interest rate - that is independent from the actual gained annual profits - is paid as a pre-profit sharing. In the end, the total return of the private equity firm will be slightly below their desired return, but therefore be a bit more secured at the lower end.

Prof. Dr. Dr. Dietmar Ernst

page 79

4. Participation in advisory and control organs

Significant participation and information rights of the private equity firm have to be realised in many cases via the participation in an advisory or control organ. In most companies outside the stock market this institution is called advisory board. If important managerial measures are tied to the approval of such a committee, it is possible that the representative of the private equity firm will be overruled. This can be considered to be a risk which could be avoided if the respective approval rights were all in the hands of the private equity firm. In practice however, the solution normally looks different: it depends on the personnel composition of the committee. If it is a matter of independent, qualified, competent personalities, then the best guarantee for an appropriate decision is given. Majority decisions and crucial votes are not common in such qualified staffed committees, independent from the regulations of the statute or the rules of internal procedure of the committee unless in extremely urgent cases.

Prof. Dr. Dr. Dietmar Ernst

page 80

4. Participation in advisory and control organs

A disputable point is usually discussed until the doubts of single members are cleared out. If necessary however the single member must accept being overruled by respected and qualified colleagues. But how does it really look like with the qualification of the members of an existing company advisory board in the practical case? Or: If the advisory board really should be only just established because of the investment intention: Which members can be won for it that possess the necessary qualifications and are accepted by the shareholders of the company? The experience shows: cooperation in a competent advisory board should usually be preferred over other solutions, but: if existing advisory boards are missing the requirements, or a competent replacement is difficult, then the project managers of the private equity firm should insist that they can realize their participation rights outside of a committee. There are plenty of propositions, e.g. by consultants, on the right composition of a medium-sized company advisory board.

Prof. Dr. Dr. Dietmar Ernst

page 81

4. Participation in advisory and control organs

Usually it is explained, that due to expected interest conflicts all those are not taken into consideration as members who are already advising the company on other issues, especially against payment: the auditor/accountant who audits the company, the legal advisor and the tax advisor, the consultant, the representative of the house bank. Instead, members of the advisory board should be persons who have their own experience with managerial tasks and managerial responsibility. However, they should of course not belong to the companys customers, suppliers, and especially not to the competitors of the company. And they should not come from big companies where a completely different company culture prevails. Finally, they should still be active in their jobs and not be retired. If one bases these ideal standards, the real possibilities to choose from are often running towards zero. As a matter of fact, the advisory boards nearly always come at least partially from the forbidden camp. If they are competent personalities, they will cope with possible interest conflicts.
Prof. Dr. Dr. Dietmar Ernst page 82

Contents
1. 2. 3. 4. What is private equity all about? Who drives private equity? How are private equity companies organised? Investment contract

5. 5.1 5.2 5.3 5.4

How is private equity done? Milestones of a private equity process Organisational milestones Project-oriented milestones Case Study: Private Equity Ltd. acquires Packaging Group

6. 7. 8.

What makes acquisition-financing special? Main goals of investors European finance leveraged finance market
Prof. Dr. Dr. Dietmar Ernst page 83

1. Milestones of a Private Equity Process

ORGANISATIONAL MILESTONES

Recruiting

Fund Raising

PROJECT-ORIENTED MILESTONES

Deal Flow

Due Diligence

Business Plan

Investment Negotiations

Investment Support

Exit

Exhibit 2: Milestones of a private equity process

Prof. Dr. Dr. Dietmar Ernst

page 84

2. Organisational Milestones

Recruiting

The management team of a private equity firm has a crucial impact on the private equity firms success. The management team must be in a position to filter promising business concept out of a multitude of investment opportunities with a manageable effort, and in the further course, to provide management support to the advised investment companies (that means to create added-value).

Apart from financial expertise, investment managers should, possess sector-specific knowledge which makes it possible for them to achieve the expected added-value. They need to possess the experience and the background to handle complex situations in efficient and effective ways. Moreover, the investment manager has to possess communication skills necessary for dealing with the information processes of the portfolio companies. An investment manager should be able to operate effectively, despite the conflicts of different professional requirements and perform the important role of an intermediary between the stakeholders.

Prof. Dr. Dr. Dietmar Ernst

page 85

2. Organisational Milestones

Investment managers are in charge of an average of 5-8 company investments, whereas they normally accompany each project from the beginning until the exit stage. On average the managers spend about 40 % of their work time on the choice and the closing of new projects, another 40 % on the supervision of portfolio companies and about 20 % on other tasks such as the less frequent investment sales or private equity firm internal measures (such as, marketing, reporting etc.).

The extent of the investment managers contribution in the investment project depends among others on the private equity firms strategy (specialisation vs. diversification strategy) and on its phase-specific orientation (early-stage vs. later-stage). Early-stage projects are generally more support-intense. Broadly diversified private equity firms can only contribute a less profound support. In times of crisis, the complexity of the support role from a portfolio company increases significantly.

Prof. Dr. Dr. Dietmar Ernst

page 86

2. Organisational Milestones

The spectrum of support hereby rather stretches across from passive accompanying and supervision measures (handsoff support, initiation of business contacts, presence in advisory board committees) to active intervention in the operating business of the portfolio company (hands-on support, intervention in or takeover of the company management)

Prof. Dr. Dr. Dietmar Ernst

page 87

2. Organisational Milestones

Fund Raising

The source of investment funds is directly linked to the shareholder identity and the background of the private equity firm. Captive funds or corporate ventures are usually financed either fully or partially by a parent company that provides the funds. These parent companies take into consideration profitability targets as well as other targets in their investment policy. Public funds are allocated from public budgets according to budgetary conditions. Independent funds are received from external investors. These can be institutional investors or private persons, domestic or abroad. Given, the principle of the freedom of contract, there are no special legal regulations for the recruiting of investors. For the recruiting of investors, in the market however, a more or less standardised procedure has evolved including following steps: Memorandum Distribution Closing Paying-in of the capital

Prof. Dr. Dr. Dietmar Ernst

page 88

2. Organisational Milestones

Memorandum As a first step in fund raising, a private placement memorandum is created. This memorandum is a prospectus that explains the planned investment policy of the fund and in particular specifies the criteria for the investment decisions. In addition, the structure of the fund is explained from a legal and tax perspective. In this case, there is no prospectus liability, as with the liability that is an important factor in public offers.

Prof. Dr. Dr. Dietmar Ernst

page 89

2. Organisational Milestones

Distribution After the preparation of the memorandum, potential customers are approached. It is common to approach customers either directly using in house contacts or to out source this activity by engaging distribution companies and specialised fund raisers. Private equity firms of large banks often attract investors via the branch network of the parent company; smaller private equity firms usually engage fundraisers for this purpose. For the procurement of investors, a fundraiser charges a placement fee of about 2 %.

Prof. Dr. Dr. Dietmar Ernst

page 90

2. Organisational Milestones

Closing Once the management company has reached its acquired capital volume, it declares the final closing of the fund. After closing, additional investor participation in the fund are not accepted. The closing process can be carried out gradually in several steps.

Prof. Dr. Dr. Dietmar Ernst

page 91

2. Organisational Milestones

Paying-in of the capital Investors do not mostly pay the fund capital in one lump sum amount. The funds are paid in trenches (drawdowns), depending on how the management company succeeds in finding projects in which the capital should flow. That is, the management companys aim is not to manage liquid funds in order to minimize administrative expenses, and avoid low margins. Furthermore, investment in trenches provides control and retention of some funds by the investors, thereby providing them the possibility to control the proper fund management. That is, in the case of irregularities, investors can reject the next drawdown, for example.

Prof. Dr. Dr. Dietmar Ernst

page 92

3. Project-oriented Milestones

Deal-flow

How does a private equity firm acquire projects which are worth being financed? Deal-flow: Deal-flow is defined as the flow of project propositions that reach a private equity company. => passive approach Screening: Screening is the systematic process of finding and identifying projects among those in the deal-flow that are worthy of being financed. => active approach The deal-flow is in general fed from the following sources: Direct contact: entrepreneurs and companies often directly contact a private equity firm with their proposed deals. This process is dependent on the reputation of the private equity firm. The private equity firm remains passive, apart from the measures to build up a reputation. Network: Indirect contacts via the network of the private equity firm (multiples, other Private Equity firms, parent company etc.).

Prof. Dr. Dr. Dietmar Ernst

page 93

3. Project-oriented Milestones

Acquisition: The capital investment firm contacts an entrepreneur or a company after conducting research that identifies a capital need or an investment opportunity for that entity. Auction: The private equity firm participates in an auction procedures where investment projects are presented to interested parties who are participating in the bidding process. The generation of a high-quality deal-flow is of significant importance and is a strategic success factor. That is, a high-quality deal-flow process can significantly reduce the expense of the screening (project choice) and the later examination (due diligence) of investment-worthy projects. Private equity companies often announce their basic strategic orientation to the market by advertising in professional magazines or through information events and thus signal what kinds of investment projects are interesting to them. In this context, (sector) specialisation provides competitive advantages over a broadly diversified investment strategy in the acquisition of interesting projects.

Prof. Dr. Dr. Dietmar Ernst

page 94

3. Project-oriented Milestones
Apart from sector specialization, forming a network of so-called multiples (consultants, accountants, banks, other private equity firms etc.) facilitates benefit from the deal flow of the network participants. Private equity companies attempt to avoid direct competition for investment projects with other equity investors because the resulting competitive pressure usually has a negative impact on the negotiated investment conditions (price, co-determination rights etc.). Therefore, it is important to get in contact with investment-worthy companies before other private equity companies by an adequate signalling (e.g. image, pointing out the value-added trough the private equity firm). With speeches at Chambers of Industry and Commerce or through a participation in business plan competitions one can try to monitor the market regarding investment-worthy projects systematically in order to know more about interesting projects as early as possible.

Prof. Dr. Dr. Dietmar Ernst

page 95

3. Project-oriented Milestones
After identification of investment-worthy projects, now the real investment process of the private equity company starts. The investment process will now enter a more crucial stage. The private equity company has now the chance to have a look at more sensitive information during a due diligence. This will enable the private equity company to determine a more accurate value for the target company. Consequently, the interested private equity company can refine their ideas about how to structure the deal and what financing is needed to complete the process. The due diligence will reveal all material issues concerning the business of the target company. A due diligence in the private equity business includes two stages: rough analysis detailed analysis

Due Dilgence

Prof. Dr. Dr. Dietmar Ernst

page 96

3. Project-oriented Milestones

Rough Analysis In the rough analysis, investment projects are examined real-time in terms of their investment worthiness against the selection criteria set by the investment strategy or policy. In this analysis, the non-fulfilment of only one criterion (especially the return expectation) can lead to a rejection of the project. Typical criteria for choice of projects during the rough analysis are: industry-/sector-specific orientation region-/country-specific orientation phase-specific orientation (e.g. specialisation on early-stage projects) targeted investment volume (absolute and relative to percentage of the shareholders capital, minority or majority interest) investment type (direct / indirect investment) expected return economic development and perspective targeted influence on the business development

Prof. Dr. Dr. Dietmar Ernst

page 97

3. Project-oriented Milestones
Detailed Analysis The detailed analysis is significantly costly. In this analysis the investee company is examined in detail and in all different segments at the company level. This analysis involves participation of external specialists. Normally, the due diligence process is divided in the following areas: legal due diligence: analysis of the company contracts, patents, possible liability or warranty claims insurance due diligence: analysis of possible insurance-technical risks management due diligence: analysis of the relation between organs of the target company technical due diligence: examination of the technical feasibility of the developed technology or the developed product. market due diligence: examination of the competitive environment and market environment tax due diligence: analysis of the tax situation; tax statements, latent taxes, tax credits etc. financial due diligence: analysis of the annual reports, business projection figures.

Prof. Dr. Dr. Dietmar Ernst

page 98

3. Project-oriented Milestones

Business Plan

In order to get an impression of the potential of the private equity company, the investment manager will always request a business plan. A business plan should contain information on the following issues: company (internal procedures, information systems, controlling) product and applied technology entrepreneur and management team and market and competitive situation economic development (actual / planning) Apart from verbal explanations, the business plan has to contain an appendix which consists of the profit and loss statements, balance sheets as well as cash flow projections for 3 to 5 plan years. The plan figures of the business plan are the basis for the first valuation by the private equity firms. The planning assumptions are therefore examined thoroughly by the investment managers in terms of plausibility.

Prof. Dr. Dr. Dietmar Ernst

page 99

3. Project-oriented Milestones

Company Valuation

The following methods are applied in order to calculate the enterprise value: Internal Rate of Return Net Asset Value Multiples method Earnings Value method and Discounted Cash Flow method It has to be mentioned that the expected profits from the sale significantly influence the value of the portfolio company. The detailed examination of the exit possibilities is therefore an indispensable analysis step in the early valuation phase. In order to include risk into the analysis, very often different valuation methods are applied (mostly different multiples plus DCF) and therewith an average value is calculated scenario analysis are created and the based projection assumptions are changed into best, real and worst case simulations.

Prof. Dr. Dr. Dietmar Ernst

page 100

3. Project-oriented Milestones

Investment Negotiations

Although the private equity company has the possibility to thoroughly examine the portfolio, uncertainties still remain. They have an impact on the feasibility of the financial planning. For example there is the incentive for the entrepreneur to present its company in a better state than it really is, or to hide risks and weaknesses in order to achieve a higher purchase price. In order to counteract this behaviour and so at least to obtain subjectively honest information by the investee company, the private equity firm has to create incentives for a fair behaviour. In this context, rules can be implemented in the contract, which turn a potential disadvantage for the private equity firm caused by the investee into a disadvantage for the investee.

Prof. Dr. Dr. Dietmar Ernst

page 101

3. Project-oriented Milestones

The following measures are common: Financial commitment of the seller in form of a sellers note Performance-dependent correction of shares Milestone financing Combination of direct investment and mezzanine capital Financial commitment of the management Monitoring and influencing the business development

Prof. Dr. Dr. Dietmar Ernst

page 102

3. Project-oriented Milestones

Investment Support

The investment financing concept links the provision of funds to the management support component. Hereby, the investment capital financing stands out from the classical service of a passive finance intermediary. In terms of intensity of the support activity, one distinguishes between: Hands-on: The private equity firm supports the whole spectrum of managerial activity with advisory and know-how transfer in the areas of product development, strategy/planning, financing, marketing, distribution, human resource development. Hands-off: no management support Semi-active support: medium support intensity, often only in single chosen business functions

Prof. Dr. Dr. Dietmar Ernst

page 103

3. Project-oriented Milestones

The degree of intensity depends on the problems and the support needed by the portfolio company; furthermore, the cost-benefitconsiderations play a role. Overall aim of the support is the acceleration of the company development. Through supporting and attending to the companies invested in, the private equity company tries to reduce the risk of its investment through the involvement in the information flow and to contribute to the value-adding e.g. via the activation of business contacts of the company. The scope of the involvement and of the influence is based on the strategic orientation of the private equity company. The spectrum stretches across from the presence in the advisory board committees to the active participation in the companys management.

Prof. Dr. Dr. Dietmar Ernst

page 104

3. Project-oriented Milestones

Exit

The profit from the sale of the investment plays a decisive role in determining the return in the investment financing business. Basically, the following exit types exist: Going public: Through a placement of the company at the institutionalised capital market, the fungibility of the so far hardly liquid investment is increased. Hereby, the possibility exists for the private equity firm to sell its investment completely or partially in the course of or as a result of the IPO. Trade Sale: In this case the private equity firm has the possibility to sell its investment in parts or as a whole to an industrial or strategic investor. Buy back: This means the sale of the private equity firms investment to the other shareholders, usually to the main shareholder. In comparison to the other exit channels, the lowest profits can be expected here due to the usually limited financing possibilities of the shareholders. Secondary purchase: In this case, the private equity firms investment is sold to another private equity firm / financial investor. Thus, a private equity firm that specialises in earlystage financings can sell a company to a private equity firm specialised on later-stage financings.

Prof. Dr. Dr. Dietmar Ernst

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4. Case Study: Private Equity Ltd. acquires Packaging Group

Key Success Factors of Private Equity Ltd.

Mastered competition between strategic buyers and other financial investors Clear and consistent communication of sellers selection criteria: price speed secure financing Careful preparation of the purchase process significantly increased transaction certainty Selection criteria of Packaging Group: Experience of Private Equity Ltd., its approach and strategy Private Equity Ltds financial strength Private Equity Ltds strong link to the financial institutions financing the transaction Test and analyse financing of transaction at an early stage in the process Private Equity Ltd. was always on top of latest development Detailed preparation of negotiation process A large transaction team including full senior level involvement at all stages of the process
Prof. Dr. Dr. Dietmar Ernst page 106

4. Case Study: Private Equity Ltd. acquires Packaging Group

Transaction timetable for Private Equity Ltd.


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4. Case Study: Private Equity Ltd. acquires Packaging Group

Key Phases of the Sales Process set up by Packaging Groups M&A adviser
Prof. Dr. Dr. Dietmar Ernst page 108

4. Case Study: Private Equity Ltd. acquires Packaging Group

Key Financing Factors of Private Equity Ltd.

Confirmation of financing facilities and financing approval requested early in the process (to be included in the binding offer) Competition between financing banks as bidders involved 2 - 4 banks each Banks are willing to provide finance for an enterprise value based on EBITDA of up to 4 - 5x.

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4. Case Study: Private Equity Ltd. acquires Packaging Group

Due Diligence
Prof. Dr. Dr. Dietmar Ernst

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4. Case Study: Private Equity Ltd. acquires Packaging Group

Data room schedule set up by Packaging Groups M&A adviser


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4. Case Study: Private Equity Ltd. acquires Packaging Group

Management presentation of Packaging Group for Private Equity Ltd.

Provide Private Equity Ltd. with an opportunity to gain a positive impression of Packaging Groups management Answer any questions arising from the data room visits Complement the due diligence process Clarify and explain the information provided in the data room: Explain the assumptions behind the business plan Provide background information on strategy and future development of the Packaging Group Present managements view of competition and the positioning of Packaging Group Provide additional information on suppliers, products and customers

Prof. Dr. Dr. Dietmar Ernst

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4. Case Study: Private Equity Ltd. acquires Packaging Group

Negotiation Process
Prof. Dr. Dr. Dietmar Ernst

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4. Case Study: Private Equity Ltd. acquires Packaging Group

Development of bid price for Packaging Group


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4. Case Study: Private Equity Ltd. acquires Packaging Group

Private Equity Ltd. concerns and Share Purchase Agreement


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Contents
1. 2. 3. 4. What is private equity all about? Who drives private equity? How are private equity companies organised? How is private equity done?

5. 5.1 5.2

What makes acquisition-financing special? Definition and challenges Case Study: Acquisition Financing of Packaging Group

6. 7.

Main goals of investors How does acquisition financing work?

Prof. Dr. Dr. Dietmar Ernst

page 116

1. Definition and challenges


The successful purchase of a company always depends on the availability of funds to finance the transaction. In practice, despite a consensual purchase price agreement between buyer and seller, a large number of transactions fail, because no bank agrees to finance the transaction. Definition 1: The term acquisition financing is understood as the process of financing the purchase of a company or an affiliated group of companies. In this process, the buyer of a company may combine sources of equity capital and debt capital to finance the purchase. Debt capital, as a partial tool for acquisition-financing, is most of the time provided by banks as a term bank loan. Another form of debt financing is called high yield bonds (highinterest-bearing bond issues at the capital market). The transaction volume of this form of financing is increasing.

Definition 1

Prof. Dr. Dr. Dietmar Ernst

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1. Definition and challenges


The term Leveraged Buy-Out (LBO) is predominantly used in the case of acquisitions of companies (or parts of companies) where the debt ratio exceeds 50% in the acquisition financing structure. The idea behind LBOs lies in the gearing or the leverage effect of debt. This leverage effect enables the buyer to finance acquisitions of high valued target companies and to undertake large-scale transactions with a relatively low equity investment. At the same time, the yield on equity rises disproportionally, as long as the total return on capital exceeds the debt service liabilities. This criterion plays a significant role in the development of LBOs. Financial investors primarily appear in form of private equity companies and hedge funds. Their general investment horizon is in a range of five to seven years, whereby the profit should be realized by exiting the project (primarily). Beside financial investors, the management also regularly holds shares in the company. The management participation is less due to a quantitative reduction in the investment risk of financial investors, than rather due to a high identification of the management with the company. Thus, a higher probability of success in realization of the desired increase in value can be achieved.
Prof. Dr. Dr. Dietmar Ernst page 118

Leveraged Buy-out

1. Definition and challenges

Differentiation of acquiring parties / vendees

Outside / third party investors

Management, poss. in combination with financial investors

Differentiation of financing ratios

Low debt capital ratio / Low leverage

Common Merger or Acquisition MBI

MBO

High debt capital ratio / High leverage

LBI / LMBI

LBO/LMBO

Buy-in

Buy-out

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1. Definition and challenges

Exit
market value of equity market value of debt
market value added (e.g. increase in company value)

LBO deal closing

30%

market value of equity (private equity investors and management)

original market value of equity (private equity investors and management)

100%

70%

market value of banks (banks) debt relief

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1. Definition and challenges


The debt capital necessary for an acquisition financing can come from a large number of providers of financing. Considering risk diversification and feasibility of high transaction volumes, it is common that a loan is not provided solely by one bank, but from a syndicate of banks. In this case, one speaks about "Syndicated Loan".

Syndicated Loan

Acquisition Financing as Corporate Finance Business

Acquisition financing has developed to an interesting and lucrative special product within the field of corporate finance. In comparison to standard credit products, acquisition financing is more complex and has a higher degree of risk. Professionals in this field need to have a broad and deep knowledge in financing-, planning-, valuation-, tax- and legal subjects. Acquisition financing is therefore handled by special departments, most of the time called structured- or leveraged finance department, within the corporate finance department of a bank or an investment bank.

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1. Definition and challenges


Acquisition financing normally leads to a high increase of the borrower's debt ratio. The different goals of the parties involved - the equity capital and the debt capital investors - causes a conflicting circumstance. equity capital investors strive for the highest portion of debt financing that is possible banks demand a high equity ratio of financing for the minimization of credit risk. To limit the personal liability of the buyer, in general, a single purpose company (SPC) also called single purpose vehicle (SPV) or NewCo is founded for acquisition purposes. Thus, the personal liability of the buyer can be limited to the paid in equity capital of the single purpose vehicle.

Debt Ratio

Liability

Collateral

Because of this structure, the collateral for the financing banks is limited. Therefore, the cash-flow of the target company is of crucial importance. One goal in acquisition financing is the economic and legal separation of cash-flow streams for exclusive bank financing use, as well as the fiscal optimisation of the financing structure in order to increase net cash-flows.
Prof. Dr. Dr. Dietmar Ernst page 122

1. Definition and challenges


This leads to specific consequences, which are characteristics of an acquisition financing: since the debt of the acquisition financing must be served by the target company, in spite of the fact that a special purpose vehicle is used for the acquisition, an acquisition financing essentially focuses on future cash-flows of the target company an acquisition financing has to be structured legally so that the interests of both parties involved (equity and debt capital investors) are preserved and at the same time a fiscal optimisation is obtained.

Target Company

Definition 2

Definition 2: In general acquisition financing refers to a cash-flow oriented, structured financing. Its task is to find optimum financing solutions for investors and banks based on an agreed purchase price using custom-made financing instruments and considering the legal and fiscal constraints. In acquisition, financing cash-flow analysis has a central role.

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2. Case Study: Acquisition Financing of Packaging Group


Packaging Group is put up for sale by its parent company Packaging AG based on strategic decisions Packaging Group is sold to its former management and a financial investor - typical management-buy-out (in terms of an M&A project) The purchase price for Packaging Group is 340.0m, in addition the liabilities to the banks, which eventually must be met amount to 100.0m, plus transaction fees of 5.0m. This leads to a total investment and transaction volume of 445.0m. The challenge of the M&A project, in this case is to structure and arrange an acquisition financing which is able to cover the required investment.

Initial Situation

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Contents
1. 2. 3. 4. 5. What is private equity all about? Who drives private equity? How are private equity companies organised? How is private equity done? What makes acquisition-financing special?

6. 6.1 6.2

Main goals of investors Main goals of equity capital investors Main goals of debt capital investors

7.

How does acquisition financing work?

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page 125

1. Main goals of equity capital investors

Return on equity

The financial investors goal is to keep the portion of equity financing as small as possible. He would like to profit from the economical gearing effect of debt financing (leverage effect). This leverage effect implies that the debt ratio of a company should be increased as long as the total return of capital covers the required return on debt. From an economical point of view, this means that for the equity investor: The smaller the portion of equity used at the time of the investment, the higher the return on the invested equity after the exit. The debt financing portion is however limited by the maximum debt service ability of the target. Further it is not in the interest of the financial investor to encumber both, the single purpose company and the target, with debts higher than their maximum debt service ability. This would thereby endanger everything - the liquidity situation of the single purpose company and the target company and thus its paid-in equity.

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1. Main goals of equity capital investors

Limited liability

A further goal of the equity investor is to limit his personal liability and to make this risk as small as possible. Therefore, he will attempt to limit his economic risk to the invested equity and to transfer the liability to a single purpose company (NewCo or SPC) and the target company. This NewCo acts as a liability bumper and financing pot for and between the private equity company and the target company. This NewCo also holds all acquired shares of the target company. It further stands as a credit applicant for the acquisition loans, which are needed to finance the purchase price. The NewCo is held responsible with all its assets for the liability of debt financing; normally this exclusively consists of the interest in the target company.

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1. Main goals of equity capital investors

Contract flexibility

Financial investors also attempt to structure the whole financing in such a way that it offers the highest degree of flexibility as possible (to the investor). This flexibility is in particular desired in regards to the organization of the credit agreement. A perfect credit agreement for financial investors should be formulated in a way that the resulting rights and obligations are as favourable as possible to the investors. In detail this covers: flexibility concerning the credit availment (precedent period, minimum amount, currency option) minimization of the obligations in the context of the conditions precedent, the representations and warranties as well as the covenants (inclusive financial covenants) minimization of the enforced credit collateral

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2. Main goals of debt capital investors

Low debt capital ratio

The idea behind acquisition financing is based on the economical rationale of the leverage effect. Therefore, the equity capital investors will aim at a high debt ratio in the acquisition financing structure in order to increase their return on equity. On the other hand, it is in the best interest of the debt capital investors to endeavour to hold their credit risk at the smallest level possible. That is, the debtholders prefer a low debt ratio in the acquisition financing structure. In other words, debt providers demand from financial investors an equity investment that is as high as possible. Debt capital investors are aware of the fact that based on a predefined maturity and a fixed interest rate, an increase in debt ratio leads to a higher required debt service by the borrower. Therefore, considering this risk, debt capital investors attempt to limit their capital share in the acquisition financing to an extent that the repayment seems safe within the agreed maturity.

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2. Main goals of debt capital investors

Collateral

In an acquisition financing which uses a single purpose company structure, typically, the debt service of the acquisition financing is served by the acquired company. Thus it logical for the acquisition financing to essentially focus on structuring a claim on the future cash-flow streams of the acquired companies. Despite this cash-flow orientation of acquisition financings, credit collaterals play a substantial role in acquisitions and serve as a basis for a purchase price financing decision by the banks. Since, banks attempt to keep their credit risk as low as possible, they attempt to maximise the extent of and the access to credit collaterals. The collateral requirement, first focuses on the acquisition target. If there are not sufficient collaterals there, banks demand that the equity investors, place additional collateral. This request, however is contradictory to the equity investors goal of limiting their liability on the paid-in capital of the single purpose company.

Prof. Dr. Dr. Dietmar Ernst

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2. Main goals of debt capital investors

Marketability Loan Syndication

Since acquisition financings usually require a large credit volume together with a increased risk position, banks frequently attempt to diversify that risk through syndication. Syndication means that the risk of the financing is shared with several banks. Definition: Syndicated Loan Syndicated Loans are joint credit agreements between several banks and one credit applicant. A Syndicated Loan is not a standard type of a credit contract; all forms of credits and periods can be represented. Syndicated Loans have middle to long-term maturity and entered through a reciprocally binding, individually drafted master contract. Acquisition financing is normally arranged through a single bank (called an underwriter in the financing process). This bank (is also called the lead arranger in the syndication process) then pursues the goal of syndication.

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2. Main goals of debt capital investors

This means it allocates a part of the acquisition financing loan to other banks (called arranger) in order to reduce its own exposure to the financing risk. Lead arranger and various arrangers then make an offer to other banks to join the syndicate by offering them all rights and obligations of that contract (general syndication). Depending upon their risk estimates, price strategy, portfolio preferences etc. the invited banks (participants) join the syndicate. In order to ensure syndication, the underwriter must pay attention to the marketability of the credit. That is, it must negotiate typically acceptable credit conditions, in order to ensure a placement potential of portions of the loan with a syndicate of banks.

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2. Main goals of debt capital investors

Return on debt

The banks goal is to obtain an interest income commensurate with the riskiness of their loan. This required return is called the risk-adjusted return on capital. The debt capital investors goal of yield optimisation can be accommodated by a combination of arrangement fees and current interest charges over the maturity period of the loan. One has to pay attention to the fact that both the debt and equity capital investors want to obtain yield maximization from their commitment. This is only possible if the target can carry the high interest and the amortization payments stipulated in the acquisition financing. If the promised cash flows stipulated in the business-plan, is not realised, then all financing parties are likely to face losses. That is, when the business plan falls short of its goals, the financial investors loose as the expected increase in value of the enterprise does not occur and the net yield desired in form of the IRR (internal rate of return) is not achieved. If the debt service is not or cannot be fulfilled, then the financing expenses increase as costs are incurred to address the covenants, these costs lead to a net yield decrease.

Prof. Dr. Dr. Dietmar Ernst

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2. Main goals of debt capital investors

In addition, the net yield of the financing banks depends on the economic success of the target. Based on their seniority and their contractual position, claims of debt capital investors are always served before those of equity capital investors. Nevertheless, an economic inclination of the target also has large effects for debt capital investors. In order to avoid insolvency, in such cases banks have to adapt their conditions to the ability of the borrower to service the debt. Since survival of the whole financing commitment is the centre of attention, debt covenants are only conditionally enforceable in such a case. Consequently, risk-adequate interest charges can no longer be obtained.

Prof. Dr. Dr. Dietmar Ernst

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2. Main goals of debt capital investors

financial investor

maximisation of internal rate of return (IRR)

acquirer / vendee

highest possible purchase price

debt to equity ratio


lowest possible purchase price maximisation of debt service ability

limitation of purchase price by cash-flows available for debt service

banks

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Contents
1. 2. 3. 4. 5. 6. What is private equity all about? Who drives private equity? How are private equity companies organised? How is private equity done? What makes acquisition-financing special? Main goals of investors

7. 7.1 7.2 7.3 7.4 7.5

How does acquisition financing work? Functionality of Leveraged Buy-Outs Exploiting the Leverage-Effect Improvement of Cash flows Improvement of Company Valuation Integral parts of successful Leveraged Buy-Outs

Prof. Dr. Dr. Dietmar Ernst

page 136

1. Functionality of Leveraged Buy-Outs

Increase in value

The fundamental procedure for a leveraged buy-out consists of equipping the NewCo, which acquires the target company, with a high debt ratio (60% to 70%) and repaying this in a relatively short period. The use of a high leverage effect, as described below, leads to a good return on equity for financial investors which is realized by reducing the company's indebtedness. LBO candidates typically possess additional potential for an increase in value. Financial investors pay particularly attention to utilizing all possibilities for an increase in value. These are: whole exploitation of the leverage effect, in order to finance the company with as low capital costs as possible improvement of the cash-flows, in order to reduce the company's burden of debts as fast as possible improvement of the valuation of the company, in order to realize a maximum increase in value with the later exit

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1. Functionality of Leveraged Buy-Outs


Exit
market value of equity market value of debt

market value added (e.g. increase in company value) LBO - deal closing

30%

market value of equity (private equity investors and management)

original market value of equity (private equity investors and management)

100%

70%

market value of debt (banks)

debt relief

Prof. Dr. Dr. Dietmar Ernst

page 138

2. Exploiting the Leverage-Effect

Leverage effect

In an LBO the buyer himself uses the leverage effect of debt to improve the return on his paid in equity (leverage effect = gearing). The leverage effect functions based on the following mechanism: The yield on equity (return on equity - ROE) and/or the internal rate of return (IRR) increases the debt ratio (gearing = debt/equity) improving ones return, as long as the total profitability (return on assets - ROA) is higher than the interest payments on debt (after taxes). Enterprises with a low operational leverage before the acquisition can afterwards profit from a high fiscal deductibility of interest payments in connection with a safe loan amortization to further increase the return on equity. This effect is realized because of the disciplinary effect of high indebtedness.

Prof. Dr. Dr. Dietmar Ernst

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2. Exploiting the Leverage-Effect

Despite the undisputed benefits of the leverage effect, it should always be kept in mind that the increased profitability of equity is obtained at the price of a higher risk based on the use of a high debt ratio (Modigliani & Miller). This higher risk also leads to a higher required interest rate on the acquisition financing loan. In practice, the leverage effect reaches its limit at a point where the exaggerated use of debt leads to a dependence on external sources of liquidity or even to a liquidity crisis in the event that operational result of the company fall short of expectations.

Prof. Dr. Dr. Dietmar Ernst

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3. Improvement of Cash flows

Cash flow optimisation

In an LBO, certain measures are used, in order to cause a balance sheet optimisation, which makes a sustainable improvement possible. These measures are necessary in order to meet the obligation of servicing a high level of debt. Here the following measures are possible: fixed assets and working capital optimisation strategic reorientation of the enterprise efficient capital allocation know-how transfer by financial investors improving performance (by elimination of underperformance) of the enterprise asset stripping

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3. Improvement of Cash flows

Cash flow optimisation

Fixed assets and working capital optimisation An improved management of fixed assets (e.g. leasing of equipment and facilities, sale and lease back of real estates) and working capital (e.g. optimisation of the accounts receivable management and exploitation of given dates of payment) may lead to improved results in a short time period. In particular, free cash flow optimisation is a suitable measure for improving the bottom line.

Know-how transfer by financial investors The inclusion of a financial investor in LBOs can lead to a reinforcement and a support for the management by the new managers and supervisors or advisers, who are selected by the financial investor. Furthermore, the improved enterprise management and control demanded by financial investors (corporate governance and corporate control) can cause an intensified transparency and efficiency of operations and likewise contribute to an improvement in the bottom line.

Prof. Dr. Dr. Dietmar Ernst

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3. Improvement of Cash flows

Cash flow optimisation

Elimination of underperformance in the enterprise Realizing a maximum increase in the company value is one of the highest LBO priorities. Therefore all inefficiencies that arise in typical LBO situations due to the "illusion of satisfactory underperformance" have to, and frequently really can, be reduced. As an additional source of increasing returns, the fiscal and regulatory benefits may also be exploited.

Asset Stripping A classical source for gaining additional liquidity after a LBO is the so-called asset stripping. It concerns the sale of property that is not necessary for operation and is a badly performing division, which no longer belongs to the core business of the company. Proceeds of the sale are used both for loan amortization and for investments into a more profitable core business operation.

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4. Improvement of Company Valuation

Increase of Company Valuation

A further important source for an increase in value and for later capital gains for private equity investors participating in LBOs is the improvement of the company value. In the private equity sector purchase price-multiples (e.g. EBITDA multiples and EBIT multiples) are used to measure these price improvements. The increase of the enterprise value can be achieved in two ways: increase purchase price-multiple by improving the return and profits increase purchase price-multiple by optimally adjusting the company size

Increase purchase price-multiple due to improved returns and profits If the investors, together with the management, succeed in improving the return and the profitability of their company, the new enterprise valuation (e.g. EBIT x EBIT multiple) will be influenced by an increased EBIT, and also by an improved EBIT-Multiple. The logic behind this fact is that the improved returns and profits of the company develop so positively that they are now above the sector average and therefore, have to be evaluated with a purchase price-multiple lying above the sector average.

Prof. Dr. Dr. Dietmar Ernst

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4. Improvement of Company Valuation

Increase of Company Valuation

Increase purchase price-multiple due to an optimised firm size The company's size also plays an important role in company valuation and is considered in the purchase price-multiple. To capture the interest of strategic or financial investors generally a critical company size has to be reached. As a rule of thumb, private equity investors consider a turnover size of approximately 50 millions. With enterprises of this assize, a certain market position and a minimum reporting compliance are assumed. The market position plays an important role in the eventual investment exit (harvest) and the reporting compliance and accuracy is needed for operational handling after the acquisition. Therefore, as the firm size rises, ceteris paribus, the purchase pricemultiple also rises. With a rising company size it is also adopted that the stability of the company and the associated rating of the company improves. The chance on valuation improvements by a size-conditioned rating is a substantial reason for conglomerate acquisitions referred to as LBU (leveraged build-up)- strategies.

Prof. Dr. Dr. Dietmar Ernst

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4. Improvement of Company Valuation

Increase of Company Valuation

Beside an improved rating, the primary goal of this strategy is to become the market leader in certain niche markets and to achieve a critical size which enables attractive exit opportunities like an IPO (initial public offering) or a sale to either strategic investors (trade sale) or financial investors (secondary buy out). In numerous empirical studies it had been shown that on average there is an increase in value with LBOs in practice. In particular, productivity increases are observed for nearly all MBOs and MBIs.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Success Factors

Despite the positive effects of buy-out financings there are also a significant number of less successful and/or failed leveraged buy-outs and acquisition financings. The challenge of acquisition financing is managing two different types of risk simultaneously. financial risk, which arises as a result of the high (dynamic) debt ratio operational risk, which consists of obtaining high cash-flows, necessary for the debt service In order to limit the above risks, some success factors must be carefully fulfilled within LBO transactions.

Attractive LBO market environment An attractive market for LBO financing exists, if we have a verifiable economical and technological stable and highly developed market, in which only a few competitors are operating (oligopoly markets). Typically these markets have gone through a strong growth phase in which only the strongest enterprises have won out over others. Due to existing market entry barriers, less substitution possibilities, and dependence of the customer and/or supplier side enterprises, in such markets it is possible to obtain the necessary high and stable cash-flows for a LBO financing.

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5. Integral parts of successful Leveraged Buy-Outs

In the ideal case, these markets are independent largely from the economic situation as well as not exposed to substantial regulations risks - like for instance a liberalisation pressure in strongly regimented markets. A monopolistic market position is in most cases analysed very critical by investors, because the exit possibilities are viewed as difficult. A generally accepted management tool for evaluating the market position is "Porter's Five Forces".

LBO proficient company In an attractive market the company should be ideally the market leader with an outstanding name (branding). The market leadership towards competitors should be justified based on so called USP's (unique selling propositions). Furthermore, the enterprise should have ultramodern business equipment and/or facilities, which do not enforce capital expenditures or replacement investments over the horizon of the planning period. Such capital expenditures would weigh down the company's cash flows and endanger the company's debt service.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

In addition, a small operational leverage, i.e. small effects of regressive sales on the operating results, are of great importance. This can be achieved if the ratio of the fixed costs in relation to the total costs is relatively low. In this case, frequently the possibilities of outsourcing the none strategically relevant tasks is considered. Moreover, the minimization of the operational leverage contributes to gaining a bilateral (sales and purchases) pricing and negotiation power. This standing crucially contributes to the maintenance of the gross profit margin in difficult market conditions. In this context also the business size plays an important role.

Exit possibilities and increase in company value A substantial portion of the financial investors' demanded net yield with a LBO financing is generated by the increase in value and the exit potential. During the interest's maturity, cash flows are predominantly used for debt amortization and not for dividends. This is the reason that the exit (harvest potential) has a crucial role in the investment decision.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Only by the successful sale of the company, after years of successful increase in value, the financial investors and the management can obtain a risk-adjusted net yield on their paid-in capital. A suitable LBO target should therefore be interesting for a large number of potential investors (strategic and financial investors). The target often becomes a more attractive firm through improvements that result after the investors entrance. The possibility of going public (IPO) in the future is highly appreciated by investors. Besides the enterprise should exhibit rudiments for value-increasing measures discussed above, in order to maximize the exit profit. In practice it is observed that small and medium-sized enterprises, in saturated and less attractive markets with a missing unique selling proposition exhibit only non-lucrative exit scenarios. This is an additional reason for the underdeveloped LBO activity in this market segment.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Management A central success factor for a LBO is the managers, who lead and run the company. They must ensure that after the LBO financing, the planned cash-flows are obtained in order to be able to service the high debt level. They also must be in the position to make difficult and drastic decisions for the enterprise in critical situations. The ideal managers are very experienced and have already been active in a management function before or better worked as senior executive in the target company for many years. Further investors attach great importance to a functioning second management level in the enterprise. Family and owner-operated medium-sized enterprises are often deficient in this success factor.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Consequently, a LBO/MBO solution and the entrance of financial investors are not considered. According to a study of the "finance-magazine" and the "Deutsche Beteiligungs AG" in 2003, only 2% of all examined German MBOs are initiated by the old owner. Based on the same survey, 50% of the financial investors would grade the management quality of private companies only as satisfying. This result is backed by the fact, that after approximately one third of the LBOs the existing management was supplemented by new personnel both in the management and in the finance division.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Track record and firm ethics of financial investor Experienced and successful financial investors are typically the best partners for the management. Together with the management, they are supposed to positively support the development of the enterprise by the use of their know-how, their experiences, and their networks. Furthermore, they should always be a cooperative and (non-sparring) partner to the management. Particularly when problems and crises appear. But even in the case of further M&A transactions or in exit scenarios, to act in concert can contribute an important increase in value. An important factor for the success of a MBO is "chemistry" with one another and dealings based on partnership. Within the selection process of a financial investor its company and its investment and partnership philosophy should be exactly examined. In principal financial investors do not interfere into the operational business of a company, but the interfaces and duties should not be underestimated.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

To mention some of these, one should consider a contemporary monthly or quarterly reporting, budget- and five-yearly planning and the active participation of the financial investor in supervision and/or advisory boards as well as with strategically relevant decisions. The investment and partnership philosophy of the financial investor as well as the appearance of investment managers and directors should play an additional role in the important decision process apart from purely monetary reasons and its track record. Business practice shows that trust and partnership cannot be fixed by contracts but based on inter-human relations and firm ethics.

Prof. Dr. Dr. Dietmar Ernst

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5. Integral parts of successful Leveraged Buy-Outs

Fair price Estimating the fair value of a company is a scientific and sometimes philosophical question, but the price of a company is finally the result of a negotiation trial. The suitability of a purchase price is often observed by noting whether it is eligible for financing or not. M&A practice indicates that the banks represent frequently a corrective element during the selling/purchase price calculation. In addition, a large number of transactions fail, in spite of a consensual purchase price agreement between buyer and seller, because of the fact that no bank agrees to finance the transaction. Therefore an important factor for success of each LBO is attached to the suitability of the purchase price and coherently the financing structure. In practice, the largest errors are often made during the purchase price stage. Within an auction process, in which an interesting enterprise is offered to several investors and a price competition is initiated, often, unreasonably high prices are paid.

Prof. Dr. Dr. Dietmar Ernst

page 155

5. Integral parts of successful Leveraged Buy-Outs

Consequently, the failure of the financial investor and the management ("Winner Curse") is already pre-programmed. Interestingly enough, these purchase prices are nevertheless financed (often against better knowledge) by banks. The main reason is the fact that banks experience a high level of competition with other banks who also focus on interesting, lucrative, and prestigious acquisition financing projects. That is, often many banks compete (pitch) for an important transaction. A solid and plausible financial model, verified by a due diligence process, builds the crucial basis for the valuation of a company and an acquisition financing. Such financial models derive future cash flows, which are further used in company valuation methods and the evaluation of debt service ability. Here one always has to bear in mind the saying "garbage in - garbage out". The most common company valuation method in practice is the so called "Discounted Cash Flow" method (DCF method or DCF approach). The simultaneous use of sector specific multiples complements this valuation method in the sense of a plausibility-calculation.

Prof. Dr. Dr. Dietmar Ernst

page 156

5. Integral parts of successful Leveraged Buy-Outs

For safeguard their interes, banks always contrive their own financial models from submitted business plans. By means of scenario analyses the outside capital structure is derived from banks together with the financial investor and the management. Here, the divergent interests between the parties must be reconsolidated. A too high level of indebtedness would mean a high (in extreme cases would threaten the existence of the firm) future burden for the enterprise and would further endanger the debt service for the financing banks. A too high equity ratio would again make the realisation of financial investors yield expectation (IRR) of 25%-30% per annum more difficult. From the financing perspective, there are clear boundaries, which should, as a rule not be exceeded.

Prof. Dr. Dr. Dietmar Ernst

page 157

5. Integral parts of successful Leveraged Buy-Outs

Practical experiences show that in many cases the desired, purchase price relevant, yield improvements after the entrance of financial investors (cost savings, synergies etc.) can not be realized. Therefore an acquisition financing should be based on yield improvements, that are clearly predictable and comprehensible. Multiples based purchase prices of 8- 10x EBIT(A), which frequently appear with larger LBOs, should be equipped with very high equity capital, in order to avoid a too high outside capital encumbrance. This however again conflicts with the IRR expectations of financial investors, wherein again the problem of "overpaying" becomes clear. A too high of a purchase prices is always to the disadvantage of at least one or even all financing parties.

Prof. Dr. Dr. Dietmar Ernst

page 158

5. Integral parts of successful Leveraged Buy-Outs

Fiscal Optimisation When structuring a LBO, the following elements are of central importance from a fiscal point of view:

exclusion of a recourse on financial investors (non recourse by interconnected NewCo) fiscal deductibility of interests paid on the acquisition loans ability to reckon up interest expenses with the returns of the target company (controlling- and result-payment contract in connection with a fiscal subsidiary) possible use of the loss carried forward by the target company conversion of prime costs to profit tax effective expenses (goodwill and asset step up) optimisation of the fiscal deductibility of equity capital loans (shareholder notes) reaching the border of fiscal admissibility (thin capitalization rules) removal of the disadvantages of a structural subordination direct access to the operative companies' cash-flows and their collaterals

Prof. Dr. Dr. Dietmar Ernst

page 159

5. Integral parts of successful Leveraged Buy-Outs

Feasible and sustainable financing structure The goal of a feasible and sustainable financing structure is to ensure risk reconciliation between the parties involved. The finally implemented debt to equity ratio is determined by various interest priorities. Deviations from these limits of indebtedness can lead to the following consequences: companies' debts can only be served with difficulty; the compensation possibilities in the case of plan inconsistencies and/or the clearance for investments in fixed assets and working capital becomes bounded below if the debt service obligations can not be met, this entails an injury of the covenants and extensive consequences for the financing of LBOs

With the use of financing multiples always the same question arises - to which numbers these are to be referred. Proceeding from a conservative approach we recommend the use of EBIT or EBIT(A). Financial investors however frequently use the clearly higher result before interest, taxes, depreciation and amortisation (EBITDA) to justify a higher debt ratio (and thus to increase their own IRR).

Prof. Dr. Dr. Dietmar Ernst

page 160

5. Integral parts of successful Leveraged Buy-Outs

The problem occurring with this proceeding consists of the fact that the debt of the acquisition financing has to be served from free cash flows and performance measures such as EBIT(A) or EBITDA represent only the auxiliary variables for a first structuring. Now, if EBITDA becomes related as base factor, the danger exists that a too high outside financing portion for the acquisition financing is obtained which cannot be sufficiently served by actual cash-flows afterwards.

Prof. Dr. Dr. Dietmar Ernst

page 161

Contents
1. 2. What is private equity all about? ...

7. 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9

European leveraged finance market One year pre- & post-crunch: Buyouts One year pre- & post-crunch: Leverage One year pre- & post-crunch: New Issuance Senior loan LBO volume Mezzanine volume LBO leverage ratios Rolling 3-month average purchase price multiples Margin development Rolling 3 month average equity contribution

Prof. Dr. Dr. Dietmar Ernst

page 162

1. One year pre- & post-crunch: Buyouts


Purchase price multiples appear to be holding steady. This is due to higher equity contribution and much tighter focus on quality transactions, which still attract competition from Lenders and sponsors alike.
12x

Purchase price multiples

Equity Contribution 50%


45% 42,0% 44,9%

0,4 10x 0,3 0,4 8x 0,3 0,4

0,4

0,5

0,4

40% 35% 30% 25% 34,3% 31,8% 33,8% 30,4% 33,6% 33,6%

6x 10,5 4x 8,7 9,0 8,7 9,3 10,3 10,4 10,1

20% 15% 10%

2x

5%
0x
3Q 06 4Q 06 1Q 07 3Q 07 2Q 07 4Q 07 1Q 08 2Q 08

0%
06 06 07 07 07 07 3Q 4Q 1Q 2Q 3Q 4Q 1Q 08 2Q 08

Purchase Price/EBITDA

Fees/EBITDA

Reflects initial and secondary buyouts only; excludes recaps and refinancings

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 163

2. One year pre- & post-crunch: Leverage


While overall leverage going into deals has decreased, mezzanine is now a larger part of the debt structure. The average leverage ratio is on the decline due to the disappearance of super aggressive deals.

Leveraged Loans
8x

8x

LBOs

7x
7x

1,2 6x
1,0 1,0 1,4 1,2

6x 0,8 0,9 0,8

0,7

0,7 0,8 5x 0,9 0,8

1,1 1,4 1,3

5x

4x

4x

3x 5,5 4,9 2x 4,5 4,9

3x
5,5 5,2 4,4 4,1

5,8 4,9 4,5 5,0 5,2 5,3 4,4 4,4

2x

1x

1x

0x
1Q 08 2Q 07 3Q 06 4Q 06 1Q 07 3Q 07 4Q 07 2Q 08

0x
06 07 06 07 3Q 4Q 1Q 3Q 2Q 2Q 4Q 1Q 08 07 07 08

Senior Debt/EBITDA

Other Debt/EBITDA

Senior Debt/EBITDA

Other Debt/EBITDA

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 164

3. One year pre- & post-crunch: New Issuance


Loan volumes have been significantly impacted for a number of reasons, the main reason being the inability of banks to syndicate pre crunch deals. This in turn affected the amount of new money available for deals, resulting in a significant decrease in deal count.

Loan Volume
80B 140

Deal Count

70B

120

60B 100 50B 80 40B 60 30B 40 20B 20

10B

0B
4Q 06 1Q 07 3Q 06 2Q 07 1Q 08 2Q 08 3Q 07 4Q 07

0
3Q 06 1Q 07 2Q 07 4Q 06 3Q 07 1Q 08 2Q 08 4Q 07

LBO

Non-LBO

LBO

Non-LBO

LBO includes all sponsor-related activity, including buyouts, refinancings and recapitalizations.

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 165

4. Senior Loan LBO Volume


Volumes in 2Q2008 totaled 21bn, markedly up on 1Q2008, but significantly lower than a year ago, with 62bn of new volume.. 32 deals launched in 2Q2008 as compared to 22 deals for 1Q2008. Annual Senior Loan Volume
140B 320 14B

Monthly Senior Loan Volume (Last Twelve Months)

120B

Deal Count: 20

280

12B

240 100B 200 80B 160 60B 120 40B 80 20B

10B

8B

6B

4B

40

2B

0B 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1Q 2Q 3Q 4Q Deal Count*

0B
Ju l-0 7 A ug -0 7 S ep -0 7 O ct -0 7 N ov -0 7 D ec -0 7 Ja n08 Fe b08 M ar -0 8 A pr -0 8 M ay -0 8 Ju n08

Reflects loan volume of any transaction where the issuer is owned by a private equity firm (includes buyouts, recaps, refinancings, etc)

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 166

5. Mezzanine Volume
Total volume in 2Q2008 was 3bn from 21 deals, significantly up on the previous quarter (1.3 billion from 18 deals). Year to date volumes are 4.3bn from 39 deals, significantly down on the first 6 months of 2007, which had 7.6bn from 75 deals Annual Volume
14B 160

Monthly Volume (Last twelve Months)


2.800M

12B 120 10B

2.100M

8B 80 6B

1.400M

Deal Count: 39
40

4B

700M

2B

0B 2000 1Q 2001 2002 2Q 2003 2004 3Q 2005 4Q 2006 2007 2008

00M

Deal Count*

Source : S&P LCD Note: Numbers exclude Bridge/Mezz transactions.

Prof. Dr. Dr. Dietmar Ernst

Ju l-0 7 A ug -0 7 S ep -0 7 O ct -0 7 N ov -0 7 D ec -0 7 Ja n08 Fe b08 M ar -0 8 A pr -0 8 M ay -0 8 Ju n08

page 167

6. LBO Leverage Ratios


8,0x

The graph on the right, which is based on a rolling three month average, reflects the continuing impact of the credit crunch. Leverage multiples have decreased to 5.5x (1Q2008: 5.8x) from a peak of 7x in September 2007. In addition to lower leverage, sponsors are having to invest higher equity to complete deals.

6,0x

4,0x

2,0x

0,0x
06 02 05 01 06 03 04 07 08 M rz 04 01 02 03 05 07 04 01 02 03 05 05 04 01 02 03 06 M rz M rz M rz M rz M rz M rz Ju n M rz 07 Ju n Ju n Ju n Ju n Ju n Ju n D ez D ez D ez D ez D ez D ez Se p Se p Se p Se p Se p Se p Se p D ez Ju n 08 07 06

1st Lien/EBITDA

2nd Lien/EBITDA

Other Debt/EBITDA

Excludes Broadcasting, Cable & Telecom loans prior to 2002. Figures based on rolling average 3 month pro forma debt/EBITDA ratios. Figures exclude refinancings and recapitalizations.

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 168

7. Rolling 3-month Average Purchase Price Multiples


Purchase price multiples do not appear to be affected by the liquidity crunch. 10,0x Purchase prices were marginally down on the 8,0x previous quarter at 10.1x EBITDA excluding fees (1Q2008:10.4x) and 6,0x comparable to the multiples at the onset of the crunch. However, it remains to be seen how a tougher economic climate will impact on the purchase price multiples in the months to come.
4,0x 12,0x

2,0x

,0x
03 M rz 0 Ju 4 n0 Se 4 p04 D ec -0 4 M ar 30 .0 -05 6. 20 05 Se p 05 D ec -0 5 M ar -0 6 Ju n06 S ep -0 6 D ez 06 M rz 07 Ju n0 Se 7 p07 D ec -0 7 M ar -0 8 Ju n08 01 02 01 02 03 01 02 03 01 02 M rz M rz M rz Ju n Ju n D ez Ju n D ez Se p S ep S ep D ez 03

Purchase Price / EBITDA

Fee / EBITDA

Excluding Platform Acquisitions and Other Sponsor Driven Transactions.

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 169

8. Margin Development
Margins have increased c.2040bps since the last quarter, reflecting the launch of post crunch deals. The margins for senior A tranches have remained reasonably steady for the last 3 months at E+260 (1Q2008:E+229) The margin for senior B and C tranches have also increased, ending 2Q2008 at E+316bps (1Q2008: 288bps) and E+371bps (1Q2008: E+333bps), respectively. No averages for second lien are available due to a lack of deals involving this instrument. Average Mezz margin at 2Q2008 was E+431 for the Cash pay and 548bps for the PIK element, with cash pay increasing roughly 22bps compared to the previous quarter.

E+600 E+575 E+550 E+525 E+500 E+475 E+450 E+425 E+400 E+375 E+350 E+325 E+300 E+275 E+250 E+225 E+200 E+175
5 4 4 5 4 04 05 04 04 -0 -0 -0 -0 l-0 vnnpar ar ay ay Ju Ja No Ja M M Se M M 5 6 6 05 06 05 -0 -0 l-0 vnpar ay Ju Ja No M Se M 8 6 7 7 8 7 07 06 06 08 07 07 -0 -0 -0 -0 l-0 l-0 vvnnppar ar ay ay Ju Ju Ja No Ja No M M Se Se M M

RC/TLa 2nd Lien

TLb Mezz PIK

TLc Mezz cash

Figures based on rolling average 3 month average spreads. No data available for second lien for Q1/Q2 2008

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 170

9. Rolling 3 Month Average Equity Contribution


Banks are demanding higher equity cushions to protect themselves in the event of a default, with banks are adopting a take it or leave it attitude. The average 3 month equity contribution at 2Q2008 stands at 45%, up from 1Q2008 (42%). This is significantly higher than the 33.7% average of the past 3 years. The additional equity would explain why purchase price multiples have not decreased significantly despite the fall in leverage available.
50%

40%

30%

20%

10%

0%
M rz 0 Ju 1 n 0 Se 1 p 0 D 1 ez 0 M 1 rz 0 Ju 2 n 0 Se 2 p 0 D 2 ez 0 M 2 rz 0 Ju 3 n 0 Se 3 p 0 D 3 ez 0 M 3 ar -0 Ju 4 nSe 04 p0 D 4 ec -0 M 4 ar -0 Ju 5 n0 Se 5 p 0 D 5 ec -0 M 5 ar -0 Ju 6 nSe 06 p0 D 6 ez 0 M 6 rz 0 Ju 7 nSe 07 p0 D 7 ec -0 M 7 ar -0 Ju 8 n08

Excluding Platform Acquisitions and Other Sponsor Driven Transactions. Equity includes ordinary equity, rollover equity and shareholder loans.

Source : S&P LCD

Prof. Dr. Dr. Dietmar Ernst

page 171