Summary Private Equity
Lecture 1
1.1 Private Equity Overview
VC and PE = equity investments backed by private capital, in unlisted companies.
Mechanism of financing companies as an alternative to raising funds on public (equity or
debt) markets.
Applicable when perceive risk, uncertainty or time horizon associated with the investment is
too great for debt providers and the public equity market.
Apply to companies at an early stage of their development and especially…
Applicable in growth oriented sectors (particularly high-tech) , where the potential of
innovations may be difficult to estimate
Also used to finance the separation of non-core assets from a parent company, or…
To de-list “undervalued” companies from a stock exchange.
Private equity investors
- Become co-owners of companies,
- Share risk and returns to extent in which they participate in them,
- Get returns directly dependent on the growth and profitability of the investee firm,
- Realise their returns through selling their stakes in investee companies
o Usual exits through trade sales or offerings on a stock exchange.
Classification of Private Equity Funds (Ia)
Based on their investment specialization (types of companies or instruments they invest in), Private
Equity funds can further be (broadly) classified into:
,Lecture 2 > Handout 2.1 Valuation for PE. Review Financial
statements and discussion on CFs
Balance sheet example.
Equity stake of 0-20% is called: “equity investment” or an investment in unconsolidated
entities
On the liability side there could be “Minority Interest”. Here a company can own for example
80% of a company. So you state a full 100% ownership but since 80-100 = -20 so you still
own someone the other 20%, which will be on the liability side of the balance sheet.
Goodwill: Premium paid over companies book value of equity/net assets
E.g. 11 (market value) – 2 (book value) = 9 (goodwill)
If you see goodwill on the balance sheet, there must have been an M&A transaction.
Impairment is writing down goodwill. Pop the bubble > retained earnings go down.
, Working Capital
Definition: Short-term operational assets – Short term operational liabilities.
+ ve EC (STOA > STOL) requires funding
- ve WC (STOA < STOL) provides funding
Market Value vs. Book Value
The financial statements are a mix of historical amounts and mark-to-market amounts
Book values are historical
Market values are forward-looking
Intangible assets not appearing in the financial statements include patents, brand reputation,
superior technology, human capital of workforce, etc…
All valuations should be market value based, but often we use book values
- Difficulty in determining market values for some inputs (e.g. debt, minority interest,
extraordinary assets and liabilities.)
- Often, book value is a good estimate for market value ( e.g. debt, particularly bank debt and
investment grade debt).
However, it is crucial that a market value be used for equity value.
- For equity, book value is an extremely poor indicator of market value.
It is important to use market values for other inputs when, by doing so, the valuation would materially
change.
- Companies with substantial equity investments.
- Compnaies in bankruptcy or in financial distress
Use market values for assingmnets which require greater accuracy
- Live transactions
- Fairness opinions
Equity value
Equity value is a residual claim against the assets of the company.
- All other creditors and security holders have priority in paments.
- Equity value is equal to the value of 100% of the owners’ equity of a company. It reflects the
value of:
o All outstanding shares of each class of common stock
o All warrants, options issued by the company (“equity-linked claim”)
o All convertible debt and preferred stock (“equity-linked claim”)
As practical matter, we typically only value the equity-linked claims which are “in-the-money”,
- In the money, means any equity-linked claim which gives the holder the right to acquire the
common stock at a price nbelow the (i) current market price or (ii) equity value per share.
o Option or warrant exercisable at $15.00 per share, with the stock trading at $ 20.00
o Convertible debt or preferred stock when the conversion price is $ 50.00 per share and
the stock is trading at $ 70.00
- An out of the money option, warrant, or convertible security could have an exercise price of
$30.00 per share when the stock is trading at $25.00
Equity value per share
Since valuations in the market begin with stock prices, we often want to express equity values on a per
share basis. The total number of shares includes common shares outstanding plus equity-linked claims,
such as:
- The number of common shares resulting from the exercise oof the in-the-money options,
warrants issued by the company.
- Does not include options traded on exchanges, which do not involve claims against the
company
- The number of common shares resulting from the conversion of in-the-money convertible debt
and convertible preferred stock.
Lecture 1
1.1 Private Equity Overview
VC and PE = equity investments backed by private capital, in unlisted companies.
Mechanism of financing companies as an alternative to raising funds on public (equity or
debt) markets.
Applicable when perceive risk, uncertainty or time horizon associated with the investment is
too great for debt providers and the public equity market.
Apply to companies at an early stage of their development and especially…
Applicable in growth oriented sectors (particularly high-tech) , where the potential of
innovations may be difficult to estimate
Also used to finance the separation of non-core assets from a parent company, or…
To de-list “undervalued” companies from a stock exchange.
Private equity investors
- Become co-owners of companies,
- Share risk and returns to extent in which they participate in them,
- Get returns directly dependent on the growth and profitability of the investee firm,
- Realise their returns through selling their stakes in investee companies
o Usual exits through trade sales or offerings on a stock exchange.
Classification of Private Equity Funds (Ia)
Based on their investment specialization (types of companies or instruments they invest in), Private
Equity funds can further be (broadly) classified into:
,Lecture 2 > Handout 2.1 Valuation for PE. Review Financial
statements and discussion on CFs
Balance sheet example.
Equity stake of 0-20% is called: “equity investment” or an investment in unconsolidated
entities
On the liability side there could be “Minority Interest”. Here a company can own for example
80% of a company. So you state a full 100% ownership but since 80-100 = -20 so you still
own someone the other 20%, which will be on the liability side of the balance sheet.
Goodwill: Premium paid over companies book value of equity/net assets
E.g. 11 (market value) – 2 (book value) = 9 (goodwill)
If you see goodwill on the balance sheet, there must have been an M&A transaction.
Impairment is writing down goodwill. Pop the bubble > retained earnings go down.
, Working Capital
Definition: Short-term operational assets – Short term operational liabilities.
+ ve EC (STOA > STOL) requires funding
- ve WC (STOA < STOL) provides funding
Market Value vs. Book Value
The financial statements are a mix of historical amounts and mark-to-market amounts
Book values are historical
Market values are forward-looking
Intangible assets not appearing in the financial statements include patents, brand reputation,
superior technology, human capital of workforce, etc…
All valuations should be market value based, but often we use book values
- Difficulty in determining market values for some inputs (e.g. debt, minority interest,
extraordinary assets and liabilities.)
- Often, book value is a good estimate for market value ( e.g. debt, particularly bank debt and
investment grade debt).
However, it is crucial that a market value be used for equity value.
- For equity, book value is an extremely poor indicator of market value.
It is important to use market values for other inputs when, by doing so, the valuation would materially
change.
- Companies with substantial equity investments.
- Compnaies in bankruptcy or in financial distress
Use market values for assingmnets which require greater accuracy
- Live transactions
- Fairness opinions
Equity value
Equity value is a residual claim against the assets of the company.
- All other creditors and security holders have priority in paments.
- Equity value is equal to the value of 100% of the owners’ equity of a company. It reflects the
value of:
o All outstanding shares of each class of common stock
o All warrants, options issued by the company (“equity-linked claim”)
o All convertible debt and preferred stock (“equity-linked claim”)
As practical matter, we typically only value the equity-linked claims which are “in-the-money”,
- In the money, means any equity-linked claim which gives the holder the right to acquire the
common stock at a price nbelow the (i) current market price or (ii) equity value per share.
o Option or warrant exercisable at $15.00 per share, with the stock trading at $ 20.00
o Convertible debt or preferred stock when the conversion price is $ 50.00 per share and
the stock is trading at $ 70.00
- An out of the money option, warrant, or convertible security could have an exercise price of
$30.00 per share when the stock is trading at $25.00
Equity value per share
Since valuations in the market begin with stock prices, we often want to express equity values on a per
share basis. The total number of shares includes common shares outstanding plus equity-linked claims,
such as:
- The number of common shares resulting from the exercise oof the in-the-money options,
warrants issued by the company.
- Does not include options traded on exchanges, which do not involve claims against the
company
- The number of common shares resulting from the conversion of in-the-money convertible debt
and convertible preferred stock.
