Private Equity and Debt Alternatives

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Private Equity and Debt Alternatives Linda
Costello Managing Director April 27, 2006
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Common Reasons to Seek Financing

• Expansion Growth in fixed assets or marketing
  expansion
• Acquisitions
• Founder/shareholder liquidity
• Refinancing Improvement of existing debt terms

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How to Finance?

• Available cash on the balance sheet
• Operating cash flow
• External financing
• The principal consideration will be timing of
  the opportunity and
• the alternative need for existing cash.

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Capital Structure Overview

• Very generally, a companys capital base is made
  up of debt and equity.

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Maturity of the Business - Investor Types

• Growth Stage / Expansion Stage
• Buyout funds
• Mezzanine Investors
• Stretch Lenders
• Banks
• Hedge Funds
• Financing
• Buyers
• Corporations

• Seed/Start-Up Stage
• Individuals
• Venture Capital
• Corporations

• Later / Mature Stage
• Buyout funds
• Mezzanine Investors
• Stretch Lenders
• Banks
• Hedge Funds
• Financing
• Buyers
• Corporations

• Early Stage
• Individuals
• Venture Capital
• Corporations

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Private Equity Investor Universe

• Private equity capital is provided by the
  following types of investors
• Private equity groups/buyout firms/financial
  sponsors
• Venture capital firms
• Management teams
• Mezzanine funds
• Wealthy individuals (Angels)
• Investment arms of corporations
• Most private equity firms target investments
  based on some or all of the following investment
  criteria
• Specific industries
• Maturity of the business
• Size of the investment
• Geography
• Control or non-control investments

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Maturity of the Business

• The maturity of the business is an important
  investment criterion most private equity firms
  use to make an initial investment decision.
• Generally, the maturity of a business or its
  stage of development can be categorized as one of
  the following
• Seed/Start-up Stage
• Early Stage
• Growth Stage/Expansion Stage
• Later/Mature Stage

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Significant Terms of Private Equity Investments

• Significant terms in private equity investments
  include the following
• Type of security
• Almost always convertible preferred stock
• Investors will sometimes also invest in the
  common stock
• Liquidation Preference
• 1st money out in the event of any sale,
  dissolution, merger, consolidation, or change of
  control
• Typically 1x 3x of capital invested plus
  accrued dividends with 1x being the most common
• Participation
• In addition to the liquidation preference, the
  investor participates with the other
  shareholders on an as converted basis
• Will sometimes be capped once a certain return
  has been achieved

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Return Expectations and Investment Horizon

• All private equity and venture capital investors
  have certain return on investment expectations
  which they use to evaluate their opportunities
• Private equity firms are typically expecting
  annual returns of approximately 25-35 on their
  investments.
• Venture capital investors are typically expecting
  annual returns of approximately 35-45 on their
  investments although, they typically express
  returns as a multiple of capital invested.
• Assuming a 5 year time horizon this translates to
  a 3.0x 6.0x multiple of capital invested.
• Return expectations are also influenced by the
  investment time horizon of the investor.
• Most later stage private equity firms have a 4-7
  year investment horizon.
• Venture capital investors usually have a longer
  investment horizon.

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Liquidation Preference with Participation Example

• The analysis below assumes the following
• Pre-money value 50 million
• Growth capital 25 million
• Post-money value 75 million
• Pro forma ownership 66.7 common / 33.3
  preferred
• Liquidation preference 1x

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How Do Debt and Equity Differ?
DEBT
EQUITY
Generally the most senior obligation of a company after its accounts payable and other operating expenses. The most junior layer of a companys capital structure and, as such, has no claim on assets.
Contractual obligation and must be paid back on a schedule which is agreed to at the outset. Generally has no fixed repayment schedule.
Often collateralized by a companys assets and, as such, has a claim on those assets in liquidation. Cash value only after all a companys obligations, including debt, have been met.
Usually has an interest cost that is paid on a regular schedule from its incurrence until the final maturity payment. Generally the riskiest investment made in the company, equity is generally the most expensive form of financing.
Debt is generally the lowest cost of financing.
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Senior Lenders Approach

• For middle market borrowers, senior debt is
  typically secured.
• Availability (amount to be loaned) is often
  limited by hard assets for companies with EBITDA
  under 10-15 million.
• A percentage of AR, inventory and fixed assets is
  the starting point for determining revolving
  credit and term facilities
• Uncollateralized term loans may be added at a
  higher cost
• Some amount of the committed financing is
  generally held back as excess availability at
  the time of closing

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Subordinated (Mezzanine) Lenders Approach

• Amount of the loan is typically determined by
  applying a multiple to historical EBITDA rather
  than by the companys asset base.
• The most significant measure of EBITDA is the
  companys trailing twelve months performance.
• Run rate and projected results may also be
  considered.
• Always behind senior lender in security and
  repayment.
• Mezzanine is either unsecured or has a second
  lien on assets and doesnt amortize before senior
  term loan is repaid.
• Interest rate is usually fixed, while senior debt
  is typically priced with a floating rate.
• Financial covenants are generally fewer and
  looser than those of senior debt.

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Senior and Mezzanine Debt Comparison
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The Financing Process
Weeks 9-10 - Selected investor(s) / lender(s)
complete on-site due diligence
Weeks 8-9 - Interested investors / lenders submit
term sheets
Weeks 2-4 - Private Placement materials assembled
Week 1 - Company selects placement agent
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Expenses

• Depending on the nature of the transaction,
  several types of fees and expenses can be
  incurred during the senior and mezzanine capital
  raising process
• Legal
• Accounting
• Consulting
• Advisor
• Debt financing fees
• Travel
• In most transactions, the company raising the
  capital will pay the fees and expenses incurred
  by the capital providers.
• The total fees and expenses incurred in senior
  and mezzanine capital raising transactions are
  generally between 3-5 and are paid out of the
  proceeds.

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How Can an Advisor / Agent Help?

• Knowledge of most likely financing sources
  developed over years of experience.
• Advice regarding structure, pricing and
  covenants.
• Ability to generate increased competition among
  investors and negotiate most attractive terms.
• Shouldering the burden throughout the entire
  financing process to allow management to devote
  more time to day-to-day business.

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Case Study

• A steadily growing, seven-year old company was
  interested in buying a competitor that had
  announced it was for sale.
• The companys passive shareholders also had
  interest in getting some liquidity for their
  initial investment made seven years earlier.

• Financing Requirement
• Purchase of competitors equity
• Refinance existing debt
• Shareholder liquidity
• Transaction expenses
• Total Requirement

38 million 5 million 5 million 2
million 50 million
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Historical Financial Performance
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Targets Historical Financial Performance

• The 38 million purchase price yields an EBITDA
  multiple of 6.9x.

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Acquirers Balance Sheet
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Debt Capacity Acquirer Only
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Combined Financial Performance

• Lenders will take the target companys EBITDA
  into account when analyzing debt capacity.
• Synergies and cost reductions post closing will
  also be examined and incorporated into the
  analysis.

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Debt Capacity Pro Forma for Acquisition

• The combined company has debt capacity ranging
  between 18 and 70 million, therefore the 50
  million requirement can be accomplished solely
  with debt financing.
• Run rate EBITDA is probably the most important
  number in determining debt capacity.

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Likely Covenants

• Limitations on
• Senior debt
• Total debt
• Capital expenditures
• Sales of assets
• Dividends
• Measurement of
• Interest coverage
• Fixed charge coverage
• Reporting requirements
• Monthly financials (30 days)
• Quarterly financials (30 days)
• Annual financials (120 days)

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Conclusion

• The debt market has been active and aggressive
  for the last several years, making possible
  increasingly leveraged financings.
• The large second lien market in which many
  institutions are willing to buy junior bank loans
  has resulted in favorable terms for borrowers.
• More mezzanine lenders have emerged, raising
  funds that must be put to work, and this
  increased competition for junior loans has
  resulted in attractive mezzanine terms for
  borrowers.
• These factors have fueled an unprecedented level
  of middle market borrowing which, while
  potentially moderating somewhat, is expected by
  most to continue into 2006.

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Technology Venture Segment of Private Equity Gary
A. Peat Partner April 27, 2006
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Private Equity Overview
Venture Capital State of the business
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Private Equity Overview
Venture Capital today? Steady pace,
competitive, healthy

• A strategy and a real plan
• A real leader is a must
• Capable team must be built to formulate and
  execute plan
• Experience matters, but optimized when in concert
  with entrepreneurship
• A real market, with real customers, paying real
  prices
• Where this exists, there is still real
  opportunity
• Examples today Ecommerce, mobility, software as
  a service, etc.
• Reasonable Expectations 10X is great again
• Exit environment
• IPOs are expensive and difficult and will stay
  that way
• Strategic buyers only pay up for results or
  strong IP or both
• Private equity buyers are not material in overall
  tech MA (yet)

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Council Ventures
Private Equity Overview

• 52 million Fund I
• 3 partners, Gary Peat, Katie Gambill, Denny
  Bottorff
• Leveraged by CEO Council
• Directorships, Chairmanships, Mentorship,
  Rolodex, etc.
• Early stage tech focus
• 10 deals thus far, 1 or 2 more with this fund
• 2 seed (no revenues)
• 6 startup (less than 2 million run rate)
• 2 early stage (under 10 million run rate, still
  not profitable)
• Business models
• 5 tech enabled service (a/k/a software as a
  service)
• EVault, Marketworks, NotifyMD, Advanced
  Academics, Benefit Informatics, iKobo
• 2 enterprise software
• Lancope (network security), AppForge (mobility)
• 1 Healthcare financial services
• Senior Whole Health
• 1 rocket science (microelectromechanical
  systemsa/k/a MEMS)
• MEMX, Inc.

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Venture Capital and Healthcare
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NashvilleHealthcare Silicon Valley

• Over 200 healthcare companies with multi-state,
  national or international presence
• More than 130 professional service firms support
  Nashvilles healthcare community
• 21 public companies - 25 billion revenues
• More than 100 companies have been spun-off from
  HCA, HealthTrust and Hospital Affiliates
• More than 750 million in venture capital
  invested in Nashville healthcare companies from
  1995-1997 (this accounts for 25 of all venture
  capital invested in healthcare services in the
  U.S. during that time)
• Source Nashville Healthcare Council

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NashvilleHealthcare Family Tree
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WebMD An Early Winner

• Invested in Medcast in July of 1998
• - Proven management team
• - Opportunity to create value in emerging
  industry
• - Clayton Associates brought knowledge and
  contacts to the transaction
• Merged with WebMD in November of 1999 for 250
  million
• Shows proactive nature of investing with a proven
  management team and unique business opportunity

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Iasis Healthcare

• Invested first seed equity in 1998
• Developed strategy to own and manage non-rural
  hospitals
• Clayton Associates and FCA assisted in
  recruitment of senior management
• Recruited Joseph Littlejohn Levys 285 million
  equity investment to acquire 15 hospitals
• Top 10 for-profit hospital management company in
  the U.S.

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Psychiatric Solutions

• Invested first seed equity in 1998
• Developed strategy to own and manage behavioral
  healthcare physician practices and facilities
• Clayton Associates assisted in recruitment of
  senior management
• Through acquisition, became a publicly traded
  company
• Today, one of the top for-profit behavioral
  management companies in the U.S.

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Ardent Health Services

• Clayton Associates participated in the first seed
  funding with New York-based, Welsh, Carson,
  Anderson and Stowe
• Premiere provider of healthcare services
  throughout U.S.
• Divested their behavioral healthcare hospital
  holdings and focusing on urban acute care
• Today, over a 1 Billion revenue business

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HCCA International

• Provided growth capital in September 2002
• CEO is a respected executive in the international
  healthcare industry. HCA Alumni.
• HCCA is a recognized leader in global healthcare
  management, operations, recruitment and staffing
  services since 1973
• Operates through offices and staff in the U.S.,
  Canada, United Kingdom, India and the Philippines

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• Relationships, relationships, relationships
• Leverage resources
• Do the right thing
• The next 10 years