Lecture 1
Venture capital and Private equity = equity investments backed by private capital in unlisted
companies.
PE investors become:
1. Co-owners of companies
2. Share risk and returns to the extent in which they participate
3. Get returns directly, dependent on the growth and profitability of the investee firm
4. Realise their returns through selling their stakes in investee companies
a. Through trade sales or offerings on a stock exchange
Private Equity funds can further be (broadly) classified into:
Buyout Venture Capital (VC)
Invest significant portion of equity in a target and Investments typically made in early stage of
borrow the rest of the acquisition development, innovative, high/new tech companies
with significant growth potential
Take significant majority control in portfolio VCs take a minority stake, usual to syndicate
companies investments with other VC funds
Majority of transactions are mid-market deals (<0.5 Veto on key decisions; seats on the board
bln)
Huge waves of buyout fund raising and investing: VCs sector knowledge and strategic advice is critical
1980’s and 2004-2008
Mezzanine Distressed / Special Situations
Specialised funds that provide a specific form of Specialised funds that invest in (mainly) distressed
financing in highly leveraged (LBO) transactions. companies. Main subcategories: “distressed to
Increase overall amount of debt in transactions. control” and “special situations” or “turnaround
investment”
Mezzanine debt is a: heavily negotiated debt
instrument, structured as PIK debt, tailored to meet
financing needs of specific LBO transactions, lies in
between equity and debt in terms of risk and
expected returns, and has warrants as the form of
equity upside participation.
,Private Equity Risks
● The risks of investing in PE funds are far lower than conventional wisdom would
dictate or many investors perceive → ‘you share the losses, but get all the gains
(upside)’
● The cashflow profile is more attractive than many investors perceive, offering strong
positive cash flows from as early as two years after the first drawdown
● Concerns that there may be ‘too much money chasing too few deals’ has led to fears
about the outlook for PE returns.
, Private Equity Fees
● Most PE firms charge an (annual) management fee of 1.5%-2.5% of committed
capital, usually paid up to the sixth year
● Profits of a LP fund are usually shared on a 80/20 basis
○ There may be a hurdle rate which gives LPs preferential access to profits
when they are insufficient
Carried Interest: a share of the profits of the fund (“carry”)
PE funds will show negative returns (IRR) in the first years of portfolio construction, later
return will turn positive during the value creation and harvesting phase → “J-curve”
Origins of success
a. Selective buying (due diligence)
b. Driving the business plan
i. Keep old management
ii. Bring new management
c. Management incentives (equity stake 5%-10%)
d. Sell well
Venture capital and Private equity = equity investments backed by private capital in unlisted
companies.
PE investors become:
1. Co-owners of companies
2. Share risk and returns to the extent in which they participate
3. Get returns directly, dependent on the growth and profitability of the investee firm
4. Realise their returns through selling their stakes in investee companies
a. Through trade sales or offerings on a stock exchange
Private Equity funds can further be (broadly) classified into:
Buyout Venture Capital (VC)
Invest significant portion of equity in a target and Investments typically made in early stage of
borrow the rest of the acquisition development, innovative, high/new tech companies
with significant growth potential
Take significant majority control in portfolio VCs take a minority stake, usual to syndicate
companies investments with other VC funds
Majority of transactions are mid-market deals (<0.5 Veto on key decisions; seats on the board
bln)
Huge waves of buyout fund raising and investing: VCs sector knowledge and strategic advice is critical
1980’s and 2004-2008
Mezzanine Distressed / Special Situations
Specialised funds that provide a specific form of Specialised funds that invest in (mainly) distressed
financing in highly leveraged (LBO) transactions. companies. Main subcategories: “distressed to
Increase overall amount of debt in transactions. control” and “special situations” or “turnaround
investment”
Mezzanine debt is a: heavily negotiated debt
instrument, structured as PIK debt, tailored to meet
financing needs of specific LBO transactions, lies in
between equity and debt in terms of risk and
expected returns, and has warrants as the form of
equity upside participation.
,Private Equity Risks
● The risks of investing in PE funds are far lower than conventional wisdom would
dictate or many investors perceive → ‘you share the losses, but get all the gains
(upside)’
● The cashflow profile is more attractive than many investors perceive, offering strong
positive cash flows from as early as two years after the first drawdown
● Concerns that there may be ‘too much money chasing too few deals’ has led to fears
about the outlook for PE returns.
, Private Equity Fees
● Most PE firms charge an (annual) management fee of 1.5%-2.5% of committed
capital, usually paid up to the sixth year
● Profits of a LP fund are usually shared on a 80/20 basis
○ There may be a hurdle rate which gives LPs preferential access to profits
when they are insufficient
Carried Interest: a share of the profits of the fund (“carry”)
PE funds will show negative returns (IRR) in the first years of portfolio construction, later
return will turn positive during the value creation and harvesting phase → “J-curve”
Origins of success
a. Selective buying (due diligence)
b. Driving the business plan
i. Keep old management
ii. Bring new management
c. Management incentives (equity stake 5%-10%)
d. Sell well
